Book reviews 325

6.3. Markets and self-regulation of the economy

Perhaps the weakest aspect of AY’s impressive analytical acrobatics is their failure to introduce the regulating role
of market prices into their story. At some level this is puzzling, because price equilibration is a type of informational
feedback that seems well suited to analysis using the tools of stochastic dynamics. It is not necessary to retreat all
the way to attained equilibrium, which seems to assume that market prices can instantaneously regulate economic
interactions without instabilities or frictions of any kind, to acknowledge that price adjustments do play an important
real-world role.
This lacuna is also bound to be a big obstacle to mainstream macroeconomists, even those who may be restless
within the constraints of attained equilibrium, representative agent, rational expectations dogma, engaging scientifically
with the substance of AY’s arguments. The technical demands AY put on their readers are far from trivial; they deploy
a dazzling but unfamiliar range of analytical models and ideas which they handle familiarly but are likely to be terra
incognita for many macroeconomists. It might be tempting for mainstream macroeconomists to ignore this book on
the grounds of its failure to go farther in representing market price equilibration as a kind of excuse for not confronting
the hard questions it raises about the foundations of economic theory and the mathematical challenges it presents.
Who should read this book? In my view mainstream macroeconomists can only benefit by becoming familiar with
the point of view AY represent so ably here, even if they find it unconvincing as a whole. Those who aspire to create a
new macroeconomics, including the various schools of “heterodox” economics, can also learn a lot from this book. In
its imaginative, if not completely realized, reconstruction of macroeconomics it challenges unquestioned presumptions
in all schools of economics.

References

Dumenil, G., Levy, D., 1993. The Economics of the Profit Rate. Edward Elgar, Cheltenham, UK.
LeBaron, Blake, Tesfatsion, Leigh, 2008. Modeling macroeconomies as open-ended dynamic systems of interacting agents. American Economic
Review 98 (May (2)).

Duncan K. Foley ∗
New School for Social Research, 79 Fifth Avenue, New York, NY 10003, United States
External Faculty, Santa Fe Institute, Santa Fe, NM, United States
∗ Correspondence address: New School for Social Research, 79 Fifth Avenue, New York, NY 10003, United States.
Tel.: +1 212 229 5717.
E-mail address: foleyd@newschool.edu

21 March 2008
Available online 28 March 2008
doi:10.1016/j.jebo.2008.03.006

Prophet of Innovation: Joseph Schumpeter and Creative Destruction, T.K. McCraw. Harvard University Press,
Cambridge, MA (2007). 719 + xi pp., index, $ 35.00, ISBN: 978-0-674-02523-3

From the publication of the General Theory of Employment, Interest and Money in 1936 until late in the 20th century,
John Maynard Keynes was generally recognized as the century’s leading economist. Some libertarians might have cited
Friedrich Hayek or Ludwig von Mises. From later in the century, others might have named Milton Friedman or Paul
Samuelson. Few would likely have mentioned Keynes’ virtual contemporary, Joseph Schumpeter. Yet, according to
Pulitzer Prize winner Thomas K. McCraw, “In the early years of this century, computerized databases have begun to
show more references to Schumpeter’s works than to Keynes’s—a situation that would have been inconceivable only a
few years before”. In Prophet of Innovation: Joseph Schumpeter and Creative Destruction, Harvard University Press,
2007, McCraw’s very human and meticulously researched biography of Schumpeter, he explains why.
At the time of his death in 1950, Schumpeter was remembered mostly for Capitalism, Socialism and Democracy,
one of the century’s major works on the economy and society. Since the fall of the Soviet Union has reduced concern
326 Book reviews

with many of the important issues raised in his most popular work, Schumpeter’s recent rise to the top of the 20th
century economist pantheon may seem even more surprising.
At the time of Keynes’ death in 1946 and Schumpeter’s in 1950, when the United States and the rest of the industri-
alized world were still emerging from the great depression (as well, of course, from World War II), the business cycle
and monetary matters (both international and domestic) loomed large. Younger economists and others accepted without
reservation Keynes’ diagnosis of the problem – lack of consumer demand and shrinking investment opportunities –
and his proposed solution—large public spending programs and discretionary fiscal policy. Even though Schumpeter
had written extensively about both money and the business cycle, his diagnosis of these issues attracted much less
attention.
Even at this very early stage of the post-WWII period, major implications of Keynesian analysis were not being
borne out by economic reality. Rather than excess saving and weak consumer spending, pent-up demand fueled strong
consumer spending growth in automobiles, housing and consumer durables. Entirely new industries emerged to produce
televisions, computers, pharmaceuticals, and other goods and services. Instead of weak investment demand, the US
and other economies began to experience an investment boom. Keynesian analysis completely missed the dramatic
growth that continued almost unabated from the early post-WWII period until the 1970s. Even then, growth continued,
though a combination of inflation, fiscal profligacy, and burdensome regulation prevented the capitalist economies
from realizing their full growth potential.
What Keynes had missed was the tendency of the economy to undergo almost continuous change. Different sectors
of the economy grow rapidly for a time, only to be supplanted by other growth sectors. Part of the reason Keynes may
have missed this pattern was his tendency, perhaps to simplify and clarify his basic argument, to view the economy,
notably business investment, solely in aggregate rather than industry specific terms.
All that Keynes missed is central to Schumpeter’s analysis of the economy and to capitalism itself. Schumpeter
recognized and referred to this process of continuous change as “creative destruction”. In his voluminous writings,
Schumpeter illustrated this process by looking at various economies, Britain in the early stages of the industrial
revolution, Germany later in the 19th century, and the United States in the 20th. He also focused on change in
particular industries, such as textiles, railroads and automobiles. In doing so, he contributed significantly not only to
an understanding of capitalism but also to the study of economic history. Most significantly, his analysis seems totally
applicable to the capitalist economies of today.
As well as showing the limitation of the aggregate analysis of Keynesian economies, his analysis of behavior by
industry – and the process of creative destruction – helped businesses to understand better what they must do to prosper
and ultimately to survive. All businesses, no matter how successful as a result of some initial innovation, must continue
to innovate if they are to survive. It is not surprising that very few companies prosper for more than a few decades at a
time. In the US, the only continuously successful company over the course of the 20th century was General Electric.
The changing mix of companies in the Dow Jones Industrial stock price index illustrates how virtually all other major
companies enter and then leave the index within a few decades.
Schumpeter pointed out that the innovation that has enabled large firms such as GE to remain successful shows
that innovation is not a monopoly of small firms but can occur in much larger ones as well. This focus on inno-
vation at large firms highlights another limitation of traditional economic analysis, namely the notion of atomistic
competition as the only successful way to achieve growth and efficiency in a capitalistic economy. Schumpeter rec-
ognized that large-scale enterprises were capable of promoting rapid growth and was convinced that the successful
WWII mobilization of American industry, led largely by very large firms, demonstrated the vitality of large enterprise
capitalism.
Recognition of the continuous process of creative destruction, and the ability of large as well as small companies to
innovate, fostered a major change in the curriculum of business schools. Corporate strategy has become a centerpiece
of many MBA programs, as business practitioners and professors recognize that promoting innovation and recognizing
the inherent nature of creative destruction is vital to the successful operation of almost all businesses in a capitalistic
economy.
Closely related to this focus on business strategy, and the need for continuous change in a world of creative
destruction, Schumpeter recognized and literally formulated the notion of entrepreneurship. A growing body of work
in economics and other fields such as sociology is focused on what policies promote entrepreneurship, innovation, and
growth. Along with business strategy, most MBA programs now offer courses or entire programs in entrepreneurial
studies.
 Book reviews 327

It is unlikely that Keynes intended for his analysis to be interpreted as so unfriendly to capitalism as it was by some of
his supporters. Although Schumpeter’s analysis is inherently more supportive of capitalism, he recognized the trend –
and also the need – for government intervention. What he hoped was that the intervention would not be overwhelming,
and he recognized and analyzed the emergence of the mixed economies that have emerged and prospered in the
industrialized world over the past six or seven decades. As well as the need for regulations, Schumpeter recognized the
need for the capitalist economies to promote some degree of equality in income distribution. Schumpeter supported
capitalism despite the problems of unequal income distribution and other market failures, because he thought it promoted
rapid growth of aggregate incomes and, on balance, was less likely to result in totalitarianism than alternative economic
systems such as socialism. With regard to the very large compensation of corporate heads over the past couple of
decades, he might have argued well that although entrepreneurship and innovation is spurred not only by the prospect
of large economic gains, these prospects certainly contribute to the efforts to start new enterprises and to innovate. The
seemingly outrageous gains spur the prodigious efforts of many to innovate and to achieve “monopolistic gains”. In
focusing on the executive incomes of those few who succeed, we should also consider the low incomes of the many
who join the race for large gains only to fail.
Along with his focus on innovation in his analysis of economic development, capitalism, socialism and democracy,
Schumpeter was extremely interested in innovation in the field of economics itself. In his monumental study, the History
of Economic Analysis, he focused on economists and other thinkers as far back as the Greeks. (This very long focus
partly reflected his extremely broad erudition, including fluency in both Classical Greek and Latin.) In his discussion
of economic analysis, he especially denigrated Ricardo, and Keynes to a lesser degree, for their focus on stationary
states and outcomes. Particularly with Ricardo, he felt that much of his analysis of international trade was limited
by the failure to move beyond an initial comparative-static analysis. He also focused on how economic analysis was
almost invariably driven by the political goals or biases of the analyst. First discussed by Max Weber who suggested
the need for more value-free analysis in the social sciences, this problem of objectivity concerned Schumpeter and
may have constrained some of his own analysis. However, Schumpeter did not conclude that analysts should somehow
neutralize their biases before pursuing their research. Rather, he recognized that almost all innovation and progress
in economic science is initially driven by some policy-oriented goal or bias of the analyst. Without this motivation,
innovation within the field of economics would be stifled. What Schumpeter proposed was that analysts proceed fully
recognizing their policy-oriented goals. Over time, those errors in analysis driven by a particular, perhaps one-sided
policy focus would be corrected as others with alternative foci entered the fray.
Although McCraw’s discussion of Schumpeter’s economics and professional legacy is quite comprehensive and
impressive, readers of this journal may well be disappointed by his neglect of the many heterodox economists who
were taking Schumpeter seriously long before the current century. The complete absence of evolutionary economics
in the tradition of Nelson and Winter (1982) is the most noteworthy of these omissions. If McCraw’s representation
of Schumpeter’s place in 20th century economics contains important omissions, it detracts nothing from the plea-
sure of reading the book and relatively little from its value to the reader. This is partly because McCraw discusses
not only Schumpeter’s economics, but also his personal life and times. Schumpeter grew up near Vienna, when this
Fin de Siecle capital of the Hapsburg Empire was home to Freud, Schoenberg, Schnitzler, Klimt and other founders
of European modernism. His life was strongly buffeted by WWI, the dissolution of the Empire, the Great Depres-
sion, and WWII. By the time of WWII, he had moved to the US where he spent the final 15 years of his life at
Harvard. However, he never felt fully integrated into American society and was understandably conflicted by the
rise of Hitler and WWII. Fully recognizing the evils of Nazism and the need to defeat it, he presciently feared that
Germany’s defeat would greatly strengthen a potentially more fearsome adversary, the Soviet Union. At a personal
level, Schumpeter’s close relationships with his mother, his first wife, another close female companion, and his sec-
ond and final wife are quite moving. Although he had many personal and professional friends, at times he appeared
quite lonely and seemed to use his unending commitment to his work, colleagues and students to fend off depression.
He died in 1950 of a cerebral hemorrhage, and his wife and colleagues thought he had literally worked himself to
death.

Reference

Nelson, R.R., Winter, S.G., 1982. An Evolutionary Theory of Economic Change. Harvard University Press, Cambridge, MA.
328 Book reviews

Burton Zwick ∗
Silberman College of Business Administration,
Fairleigh Dickinson University, Madison, NJ 07940, USA
∗ Tel.: +1 973 443 8821.

E-mail address: burtzwick@verizon.net

28 March 2008
Available online 8 April 2008
doi:10.1016/j.jebo.2008.03.009