Nonetheless, the flood of foreign capital was transforming Egypt’s feudal economy. Historian Niall Ferguson argues that while old empires extracted tribute, modern ones injected capital and promoted economic growth. In 1900 Egyptian manufacturing had consisted of two salt factories, two textile mills, two breweries, and a cigarette factory. Sugar refining had been by far the most important industry, employing 20,000 workers. By 1907, brand-new industries such as ginning and pressing cotton, cottonseed oil, and soap manufacture employed 380,000 workers. Wages rose along with cotton prices and Sultan Hussein Kamel, who had succeeded his father as khedive, marveled at the rapidity with which Egyptians were acquiring European culture: “I have seen in our factories the most intricate machines handled by Egyptians.”24
Egypt’s foreign colony—expats as well as Jews, Copts, and Greeks who had settled there hundreds of years earlier—helped make Egypt “almost the most cosmopolitan country in the world.” Cairo swarmed with fortune hunters, bankers, brokers, and entrepreneurs who invested in tourism, railways, banking, sugar, and, of course, cotton. Thomas Cook and Son tamed the Nile and provided English tourists with a “little piece of the West floating along the African river.” John Aird & Company completed the Aswan High Dam in 1902. Cecil Rhodes promoted his dream of a transcontinental African railway. Not all the entrepreneurship was for profit. J. P. Morgan, an acknowledged “Egyptomaniac,” was only one of several American millionaires—including John D. Rockefeller, the founder of Standard Oil—who was financing archeological digs along the Nile.
Egypt became the poster child for the new imperialism. Speaking to a Liberal Party club in London after his retirement, Baring boasted, “History, so far as I am aware, records no other instance of so sudden a leap from poverty and misery to affluence and material well-being as that which has taken place in Egypt.”25 Over-Baring, as he was known, was, of course, a self-interested promoter. Yet as hostile a critic of British imperialism as Luxemburg did not contradict him.
When William Jennings Bryan, the three-time Democratic presidential candidate, stopped in Cairo on his way back from India in 1906, he found the first sight of the city disconcertingly, even disappointingly modern. Instead of crumbling stones and “picturesque Oriental wonders,” he found bright lights, electric trams, automobiles, hydraulic bridges designed by Alexandre-Gustave Eiffel, bottled water, and as many high rises as minarets. It was no harder to buy a cold Bass Ale or a copy of the Daily Mail than in New York or London. The business district, with its towering glass and cast-iron department stores, pharaonic luxury hotels, multitude of banks, and telephone and telegraph offices, gave Cairo the appearance of a European city. Its pastel-colored belle époque apartment buildings, wide boulevards, and outdoor cafés reminded Bryan of Paris.26
Nile cruises were a particular favorite among affluent honeymoon couples, but Schumpeter arrived in Cairo with more pressing matters on his mind than holding hands with Gladys on the deck of a Cook’s steamer. As they made their way to Egypt, by train to Marseilles, steamboat to Alexandria, and again train to Cairo, news of the global financial crisis had followed them. In each capital that experienced a violent stock market collapse, the wave of bank runs and bankruptcies was called by a different name. Many businessmen assumed that the trouble in their community was the worst and that its causes were primarily local. In fact, identical symptoms erupted in half a dozen countries both before and after the panic in New York. The links in a chain that stretched around the globe were popping.
In Cairo the trouble began when Sir Douglas Fox & Partners, the British engineering firm that had built the first leg of Rhodes’s transcontinental railroad, had tried to obtain a concession to build a “funicular railway from the base to the summit of the pyramid of Cheops.” Perhaps the gods of the underworld took offense, wrote economic historian Alexander Noyes, or else investors saw the proposal as a sign of how crazy speculation had become.27 In any case, the Egyptian stock market plunged. Brokers and businessmen dismissed the decline as temporary. Within a month a fancy dress ball drew such a huge “rollicking, pleasure-seeking and picturesque crowd” that the dance floor was too crowded for dancing. But in April the market crashed a second time and, this time, kept going down. As the Economist reported from London:
Piles of shares were waiting to be sold, though the market was so satiated with paper that the offer of threescore shares in any security sent down quotations whole points. It was equally difficult at one time to buy. It was well known that a number of small houses were tottering, and when the crisis became most acute, one of these firms suspended payments.28
This time full-scale panic erupted. In a matter of weeks, nearly one-quarter of the value of the companies listed on the Cairo exchange had vanished like a mirage. The effect on the real estate boom was immediate. The “great staircase of unsound values” constructed with borrowed money came tumbling down. In May, rumored difficulties at several Cairo banks triggered a bank run. “The total diminution in Egyptian interests, other than Governments, appears to represent about a billion dollars since the completion of the Assouan Dam,” reported the New York Times’s correspondent grimly.29 It hardly helped matters that the political situation had suddenly become, in the words of a senior British diplomat, “simply damnable,” nationalist agitation having turned “intensely virulent.”30
Baring and other British officials tried to put the best face on the situation. Repeating the conventional mantra that depressions were the economic equivalent of fasting after a binge, they insisted that the “crisis must in the end be extremely beneficial to Egypt and Egyptian finance, as it will purge the financial arteries of much that is unhealthy.”31 But when credit dried up completely, the Bank of England was forced to send an “instantaneous shipment of $3,000,000 gold.” A leading Egyptian expressed familiar regrets when he admitted, “We have been working beyond our means, by using capital which was not ours.”32
The Egyptian crash was, however, part of a worldwide phenomenon, just as Cairo was a link in a chain that stretched from San Francisco to Santiago, London to Bombay, New York to Hamburg and Tokyo. The chain had been forged not just by ships, railroads, and telegraph cables, but by bills, notes, bank transfers, and gold and the boom that had appeared unique to Cairenes had in fact been almost universal. As a London banker observed after the fact, “beginning about the middle of 1905, a strain on the whole world’s capital supply and credit facilities set in, which increased at so portentous a rate during the next two years that long before October, 1907, thoughtful men in many widely separated markets were discussing, with serious apprehension, what was to be the result.”33 The event that triggered the chain reaction had taken place on the far side of the world. Besides practically leveling the city, the great San Francisco earthquake and fire of 1906 resulted in enormous claims to insurance companies in London. As insurers were forced to sell pounds in order to buy dollars to settle them, the pound started to fall in terms of its gold price. To stem the outflow of gold, the Bank of England raised its discount rate to 6 percent in October 1906. The result was a credit squeeze for borrowers.
Under the gold standard, when England sneezed, the United States caught cold. The New York stock market plummeted in March 1907, and in May economic activity began to decline. The recession set the stage for the last and worst banking panic—the panic of 1907—that focused on the New York trusts. The resulting credit freeze forced thousands of banks and businesses around the United States into bankruptcy. A severe economic downturn continued for more than a year, and business conditions did not fully recover until 1910. In England, and on the Continent, the slump was even deeper and longer. In Cairo, on the other hand, the Panic of 1907 was only a pause.
• • •
One week after departing from Paddington Station, Schumpeter and his bride were sitting on the elegant terrace of the legendary Shepheard’s Hotel overlooking bustling Al Kamel street, flicking flyswatters, listening to “a hundred different propositions from guides and tr
aders,”34 and imbibing “the peculiar colonial atmosphere of Cairo” along with their drinks.35 Young and beautiful, they blended perfectly in a cosmopolitan scene where, as the London Traveler explained, “Americans, Britishers, Germans, Russians are assorted with Japanese, Indians, Australians, South Africans, well-to-do, well-dressed and handsome specimens of what we call civilization.”36
The collapse of stock and real estate prices had left a mountain of civil lawsuits in its wake. Schumpeter joined an Italian law firm and was soon representing European businessmen before Egypt’s peculiar Mixed Court, a relic of Ottoman administration. The court building overlooked Ataba-el-Khadra, where all the electric trams converged. Cairo’s noisiest square was filled with “the raucous shouting of the pedlars, the rattling of the water-carriers’ tiny brass trays, the blowing of motor car trumpets and the ringing of tram bells . . . the uproar heightened by the voices of men and women in passionate controversy.”37
Schumpeter found that his legal practice, though lucrative, hardly required all his time. Instead of going straight to the country club when he left the court, he often ducked into a favorite coffeehouse—for Cairo, like Vienna, was a city of coffeehouses. These male-only retreats served as chess parlors, offices, literary salons, and, increasingly, headquarters for Islamic fundamentalists and anti-imperialist conspirators. Sipping Turkish coffee and puffing on a hookah that was passed around in the same manner as in Vienna, Schumpeter composed quickly and neatly, his pen flying over the sheets of paper.
“German economics does not really know what ‘pure’ economics is all about,” the twenty-four-year-old author opined. Schumpeter intended his book to be a plea to critics, especially German economists, “to understand not fight; learn, not criticize; analyze and find what is correct . . . not just simply accept or dismiss” economic theory, and a rebuttal of the view, popular in German universities, that “English” or theoretical economics was a dying discipline.38 True, “Economics, like mechanics, gives us a stationary system, not like biology, a narrative of evolution.”39 It could shed no light on the dynamic process that had transformed, first Britain, then France, Germany, and Austro-Hungary, and now Egypt. But this gap in economic theory was an argument for constructing a new, dynamic theory, not for abandoning theoretical economics.
Schumpeter closed his book’s final chapter on the future of economics by posing two questions: Could one prove the existence of economic development in the sense that growth could be traced to economic rather than demographic, political, or other external causes? Was it possible to devise a plausible narrative of economic evolution under the assumption that existing social arrangements—capitalism and democracy—would persist? His provisional answer to both was a strong affirmative.
Schumpeter had only just sent his 600-page manuscript off to a publisher in Germany in early March 1908, when the sirocco began blowing from the south and he was stricken with Malta fever, a debilitating, often fatal bacterial infection. The omnipresent dust, furnace-like heat, and the threat of complications convinced him that it was time to return to London. He had achieved his twin objectives in coming to Cairo. Besides finishing his first book, he was now, if not rich, at least back in funds. His law practice had prospered and he had been lucky, having ingratiated himself with one of the khedive’s daughters and become her investment manager. Having succeeded in doubling the rental income from her estates, as he later recalled, and overseen the reorganization of a sugar refinery, he had earned a substantial sum.40 By October 1908, he was back in London recuperating at his brother-in-law’s house, plotting his return to Vienna.
He had recovered sufficiently by February 1909 to deliver his “Habilitation” lecture on The Nature and Essence of Economic Theory at the University of Vienna. His performance on the podium won rave reviews and the title of Privatdozent. The reviews of his book were more mixed, although even the critics were impressed. To his chagrin, his alma mater did not make him an offer. Instead of a prestigious appointment in one of Europe’s great capitals, he had to accept an associate professorship in a remote outpost of the Empire not dissimilar to his place of birth.
• • •
Cernowitz was a polyglot town of transients, and its university was new and undistinguished. The inhabitants were divided among German Protestants, Jews who spoke German, and Romanian Catholics, most of whom had arrived relatively recently and many of whom were itching to move on to Vienna, Paris, or New York. Partly because few had deep roots there, no single ethnic or religious group dominated the rest, engaged in proselytizing, or had much impulse to do anything but mind their stores and businesses and take a stroll through the city park on Sunday. Schumpeter expressed his resentment by being unfaithful to Gladys, snubbing his colleagues, and thumbing his nose at decorum. He scandalized the faculty by sauntering into meetings in his jodhpurs. On one occasion, he challenged the university librarian to a duel.
Reflecting on the years he spent in the Bern patent office from 1902 to 1909, Albert Einstein observed that the solitude and monotony of his country life stimulated his “creative mind.” He recommended similar periods of enforced isolation to other scholars bent on producing works of genius, by taking up temporary occupation as a lighthouse keeper, for example. It gave one time to think one’s thoughts and, of course, to write them down. It also cut down on the distracting buzz of other people’s ideas.
Cernowitz proved to be Schumpeter’s lighthouse. In the two years he spent there, he distilled what he had absorbed, observed, imagined, and thought between the ages of twenty-four and twenty-six when he was living abroad, and poured the resulting combination into The Theory of Economic Development.
• • •
For Schumpeter, the process of development not only implied that the economy was getting bigger, but also that its structure was evolving, its workers becoming more productive, its industries more specialized, its financial system more sophisticated. He took for granted that the aim of all production was “the satisfaction of wants,”41 and that a rising living standard was the result of development. But development was not the “mere growth of population or wealth.” A nation with a rapidly growing population could produce more output without delivering higher average wages or consumption. Predatory empires like ancient Egypt’s could enrich themselves at the expense of weaker powers without achieving ever higher levels of productivity. New, sparsely populated territories could be opulent without having developed a capacity for specialization or a high degree of interdependence.
A nation’s ability to provide its citizens with a high standard of living depended first and foremost on its productive power, which enabled the economy to produce more and more with the same resources, like the porridge pot in the Grimm brothers’ fairy tale. Output per worker had doubled or tripled in his own lifetime after more or less stagnating for nearly two thousand years between the births of Christ and Victoria. In the same spirit as Mark Twain had ventured in 1897 that “the world has moved farther ahead since the Queen was born than it moved in all the rest of the two thousand put together,”42 Schumpeter treated economic development as a fact rather than a theoretical possibility. By contrast, Malthus and Mill had
lived at the threshold of the most spectacular economic developments ever witnessed. Vast possibilities matured into realities under their very eyes. Nevertheless, they saw nothing but cramped economies, struggling with ever-decreasing success for their daily bread. They were convinced that technological improvement . . . would . . . fail to counteract the fateful law of decreasing returns . . . and that a stationary state . . . was near at hand.43
It was no longer possible to dispute, as it had been possible in 1848 or even in 1867, that the living standards of ordinary people had improved. In the rich countries, consumption of food as well as clothing, tobacco, meat, and sugar had risen sharply. Better nutrition was reflected in demographic trends. Infant mortality began to plummet after 1845, life expectancy at birth to rise after 1860, and average height, which fell bet
ween 1820 and 1870, to increase after 1870. The twin blights of homelessness and begging began to disappear. “The capitalist process, not by coincidence but by virtue of its mechanism, progressively raises the standard of life of the masses,” Schumpeter wrote. Even the normally cautious Alfred Marshall had insisted in 1907 that “The Law of Diminishing Return is almost inoperative . . . just now.”44
If development were being driven mainly by globalization, as Marx had hypothesized, and local conditions mattered little, average living standards should have become more, not less, similar. But anyone who had recently lived in Cairo as well as in London, Cernowitz, and Vienna had to be struck by the stunning differences in the level and rate of economic development of different countries. In 1820, the average standard of living in the world’s richest country—still Holland—was roughly three and a half times that of the poorest nations of Africa and Asia. By 1910, however, the lead of the richest over the poorest had grown to more than eight-fold.45 These differences in living standards primarily reflected differences in productive power rather than in territory, natural resources, or populations. For any given amount of capital and labor, the most efficient economies could produce many times as much as the least efficient ones.46 What’s more, the productivity of some economies was growing several times as fast as others. So the question was not just what process could increase productive power by multiples in the course of two or three generations, but why the process operated so much faster in some countries than others.
The traditional answer would have been that a nation’s development depended on its resources. Schumpeter took the opposite view. What mattered was not what a nation had, but what it did with what it had. He identified three local elements of “industrial and commercial life” that drove the process: innovation, entrepreneurs, and credit. The distinctive feature of capitalism, he believed, was “incessant innovation,” the famous “perennial gale of creative destruction.”47 Marx too had observed that “The bourgeoisie cannot exist without constantly revolutionizing the instruments of production” but he had had in mind primarily factory automation.48 Schumpeter took a broader view. “Innovation,” by which he meant the profitable application of new ideas rather than invention per se, could involve many types of change, he pointed out: a new product, production process, supply source, market, or type of organization.