Marshall, whose motto was that nature took no leaps, had stressed continual incremental improvements by managers, and skilled workers that accumulated over time.49 Schumpeter stressed innovative leaps that were dramatic, disruptive, and discontinuous. “Add successively as many mail coaches as you please, you will never get a railway thereby,” he insisted, “. . . the essence of economic development consists in a different employment of existing services of labor and land.”50 But new technologies alone could not explain why some economies were developing and others were not, since new machines and methods could be, and were, transferred globally. Marx had explicitly ruled out any role for the individual in his economic drama. Webb once complained that Marx’s “automaton owner” was driven by forces over which he had no control, and into which he had no insight, blindly pursuing “profit without even being conscious of the existence of any desire to be satisfied.”51 Schumpeter focused on the human element. For him, development depended primarily on entrepreneurship. He shared the obsession of late nineteenth-century German culture with leadership. Having heard Sidney Webb expound on the Fabian theory of hereditary genius as the cause of unequal incomes, he had also become interested in the work of Francis Galton, Darwin’s cousin, and Karl Pearson, a professor at the LSE, on hereditary genius and the role of elites.
The central character in Schumpeter’s narrative was the visionary leader. The entrepreneur’s function was “to revolutionize the pattern of production by exploiting an invention or, more generally, an untried technological possibility.”52 This might mean new products like cars or telephones, new processes like the cyanide method for extracting South African gold, new organizations such as the trust, new markets such as Egypt for rail cars and cotton ginning machinery, or new sources of supply such as India for cotton. In contrast to Marx’s automaton capitalist or Marshall’s owner-engineer, the entrepreneur distinguished himself by a willingness to “destroy old patterns of thought and action” and redeploy existing resources in new ways. Innovation meant overcoming obstacles, inertia, and resistance. Exceptional abilities and exceptional men were required. “Carrying out a new plan and acting according to a customary one are things as different as making a road and walking along it,” Schumpeter wrote.53
His entrepreneurs are motivated less by the love of money than by a dynastic urge—“the drive and will to found a private empire,” as well as the urge to dominate, fight, and earn others’ respect. Finally there was “the joy of creating, getting things done, or simply exercising one’s energy and ingenuity.”54 While Marx had cast the bourgeois as a parasite whose activities would ultimately destroy society, Schumpeter took up and developed Friedrich von Wieser’s notion that “growth was the result of the “heroic intervention of individual men [who] appear as leaders toward new economic shores.”55 He never grew tired of pointing out “the creative role of the business class that the majority of the most ‘bourgeois’ economists so persistently overlooked.” Science and technology were not independent forces, he insisted, but “products of the bourgeois culture” just like “business performance itself.”56 Though many did realize great fortunes, entrepreneurs did more to eliminate poverty than any government or charity.
Despite his energy, vision, and domineering nature, the entrepreneur could thrive only in certain environments. Property rights, free trade, and stable currencies were all important, but the key to his survival was cheap and abundant credit. To carry out his plans, Schumpeter argued, the entrepreneur had to divert land, labor, and machines from their existing uses to his projects. His enablers are “bankers and other financial middlemen who mobilize savings, evaluate projects, manage risk, monitor managers, acquire facilities and otherwise redirected resources from old to new channels.”57 True, the financial sector’s peculiar dependence on confidence and trust made it vulnerable to panics and crashes. But without well-functioning credit markets and a robust banking system, an economy would be deprived of the low interest rates and abundant credit needed for innovation. What distinguished successful economies was not the absence of crises and slumps, but, as Irving Fisher also stressed, the fact that they more than made up lost ground during investment booms.
The highest interest rates in the world were found in the poorest countries. As the economic historian David Landes writes, “In these ‘underdeveloped’ countries, where the civilizing rays of capitalism had not yet exercised their mysterious faculties of enlightenment, there were few banks but many money-lenders, little investment but much hoarding, no credit but much usury.”58 In Egypt, entrepreneurs faced huge obstacles because of the backward state of local banking and the primitive facilities of credit and exchange. Interest rates were twice or three times as much as in the West. The best securities paid interest of 12 to 20 percent. The poor peasant, meanwhile, paid 5 to 6 percent a month.
Having shown that economic theory had been designed for a “system essentially without development,” Schumpeter succeeded in formulating a new one for a body in motion, while building on existing theory. He showed how an economy could produce more with the same resources while evolving a new, more specialized structure. What’s more, his theory implied that any nation could do it. By emphasizing the local business environment instead of natural resources, Schumpeter’s theory suggested that nations made their own destinies. Governments that wished to see their citizens prosper should give up territorial ambitions and focus on fostering a favorable business climate—strong property rights, stable prices, free trade, moderate taxes, and consistent regulation—for entrepreneurs at home. There were no intrinsic limits to growth. Human wants were infinite. Rising incomes and new desires provided just as much opportunity for profitable ventures as opening up new territories. As long as trade was possible, innovation could offset the constraints of population, territory, and resources. It was a beguiling, romantic, even a heroic narrative. His was an equal opportunity, optimistic, and, not coincidentally, unwarlike formula for economic success.
• • •
Schumpeter completed the manuscript of The Theory of Economic Development in May 1911. By then he was back in Vienna, staying at his mother’s apartment, and waiting to hear whether he had been chosen to fill an empty chair at the University of Graz. The city, where he had spent part of his childhood, was a pleasant provincial town and its university was not especially distinguished. Nonetheless, it had the advantage of being just two and a half hours by train from the capital. The faculty proved to be anything but amenable, deemed his work “barren, abstract and formalistic,” and voted to appoint another candidate. Only intervention at the education ministry by his mentor Böhm-Bawerk succeeded in overturning the decision, fulfilling Schumpeter’s ambition to become the empire’s youngest full professor at the age of twenty-eight.
When Schumpeter started teaching in Graz in fall of 1911, he got a chilly reception from students, who boycotted his classes, as well as from his new colleagues. But it was nowhere as frigid as that accorded to his magnum opus, which appeared that fall. It was, he later testified, “Met with universal hostility.”59 Even Böhm-Bawerk was sharply critical, so much so that he devoted sixty pages to an attack on Schumpeter’s book the following year. More discouraging, his mentor was one of the few economists to review it at all.
When Schumpeter got an invitation to spend the academic year 1913–1914 as the first Austrian exchange professor at Columbia University, he accepted with alacrity. Gladys, however, made it clear that she did not intend to accompany him. Their marriage had soured soon after it had begun, perhaps because an English feminist and Fabian and a Viennese prince were hardly likely to be compatible or simply because both were, at least on Schumpeter’s testimony, promiscuous. Accepting that the marriage had been a mistake, he made no effort to dissuade her. In August 1913, he sailed alone from Liverpool on the RMS Lusitania, while Gladys resumed her former life in London.
Schumpeter’s sabbatical was a great success. He adored New York and was adored in turn by Americans who were ch
armed by his sparkling conversation and astonished by his personal habits, such as taking an hour every day to complete his toilette. One colleague at Columbia called his inaugural lecture at the university “a remarkable performance . . . and . . . very unusual—both brilliant and profound.”60
The triumph was crowned by a note from the president of Columbia informing him that the trustees had voted to give him an honorary degree. Lecture invitations from Princeton, Harvard, and other universities poured in. Irving Fisher invited him to New Haven for Thanksgiving. At dinner they talked about the possibility of a European war. Like the English politician Norman Angell, Fisher was convinced that economic integration made the possibility remote. Many nations were now so dependent on foreign capital, he said, that they could no longer afford to misbehave. Schumpeter listened skeptically.
Before leaving the United States, he could not resist touring the country by train as Marshall had done. He did not return to Vienna until August 1914.
Act II
FEAR
Prologue
War of the Worlds
The world will seek the greatest possible salvage out of the wreck.
—Irving Fisher, 19181
“Sidney had refused to believe in the probability of war among the great European powers,” Beatrice Webb later commented in the margin next to her original diary entry for July 31, 1914.2 Investors didn’t see the Great War coming either, judging by the stock and bond markets that hovered near all-time highs. Surely war was economic suicide and therefore unthinkable. One week after Germany overran Belgium, George Bernard Shaw predicted in the New Statesman, his venture with the Webbs, that the war would be over in a few weeks. As Webb observed in early August, the war seemed like “a terrible nightmare sweeping over all classes, no one able to realize how the disaster came about.”3
For Webb, the war was “a blank and dismal time.” Her political stock had been falling since before 1914 and continued to decline. She hoped that she and Sidney would be given some important role in the Liberal-led wartime coalition government of David Lloyd George. No offer materialized, and the Webbs eventually went off on a somewhat desultory world tour. When Beatrice was finally appointed to a commission to study the gap between women’s and men’s wages in 1918, she regretted accepting the assignment almost immediately. “I am not the least interested in the subject,” she complained. She was too preoccupied by fears of “the kind of world we shall live in when the peace has come.”4
• • •
A Cambridge don, civil servant, speculator, and art patron, John Maynard Keynes was rather homely and quite rude. He made up for these shortcomings with cleverness, a charming voice, and efficiency in practical matters. His best friends, who invariably called him Maynard, were the artists, writers, and critics known collectively as “the Bloomsbury Group.” They counted on him to buy their paintings, advise them on real estate, and invest their trust funds—all while they debated whether he was or wasn’t a hopeless philistine.
When Britain declared war in August 1914, Bloomsbury immediately agreed with Shaw that war was madness and would “benefit only a few capitalists.”5 Keynes pledged to seek conscientious objector status, but then dismayed his friends by changing his mind. He upset them further by accepting the invitation of the then Chancellor of the Exchequer, David Lloyd George, to serve on the Treasury staff. Keynes argued that while the war was undoubtedly bad, his presence in the government would make it less so.
The Treasury’s task was not only to achieve “maximum slaughter for minimum expense” but also to finance the war without debauching the world’s safest currency or jeopardizing Britain’s supremacy as the world’s banker.6 As the war dragged on, Britain loaned massive sums to her European allies and was obliged to borrow even more massive sums from the United States. Because the loans were so colossal, writes Keynes’s biographer Robert Skidelsky, the “headache of inter-allied debt . . . became the chief source of irritation, misunderstandings and almost constant squabbling within the Alliance.” Within a few months, Keynes became “the go-to official for inter-Allied (read American) loans.”7 Communication within Whitehall was by memorandum, and Keynes was a wizard with a pen. His energy, confidence, and nerve never seemed to flag.
An episode toward the end of the war captures Keynes’s uncanny ability to stay focused on the big picture. In the early spring of 1918, the Germans caught the Allies off guard and smashed through the western front. Tens of thousands of German troops were soon encamped a few miles from the Arc de Triomphe, and Paris was being shelled day and night. The Big Bertha howitzers were sowing terror as far away as London. If Paris were to fall, anxious Britons reasoned, the Germans could move them to the channel beaches and bombard the southern counties.
Keynes was too tantalized by a suggestion from one of his Bloomsbury friends to indulge in such anxious speculation. The painter and critic Roger Fry had given him a heads-up about an extraordinary collection of modernist paintings that was about to go on sale. Edgar Degas, who had been an art dealer before he devoted himself full-time to painting, had amassed hundreds of works by Manet, Corot, Ingres, Delacroix, and other contemporary artists over his long career, rarely parting with a single canvas. This treasure trove was to be auctioned off at the Galerie Roland in Paris on March 26 and 27.
Recognizing a chance to save a piece of the civilization he loved and for which his country was fighting, Keynes did not hesitate. He immediately contacted Charles Holmes, director of the National Gallery, to urge him to lobby the war cabinet for a £20,000 war chest. Judging that his superiors at the Treasury would react with disapproval to such extravagance at a time of national sacrifice, Robert Skidelsky relates that Keynes recast the scheme as an insurance policy against default: “Under our agreements with the French Treasury we are entitled to set off British government expenditure in France against our loans to them,” he began his memorandum to the Chancellor. At that point in the war, France owed Britain such gargantuan sums that the likelihood of collecting interest on the debt, never mind the principal, looked exceedingly remote. How much better, Keynes argued, to collect “priceless pictures than dubious French bonds.”8
A few days later, Keynes sent the painter Duncan Grant, his former—and Vanessa Bell’s current—lover, a triumphant telegram: “Money secured for pictures.”9 Meanwhile, he had contrived to get himself and Holmes invited to an Allied conference in Paris. They crossed the channel escorted by “destroyers and a silver airship watching overhead” and traveled to Paris by train.10 To avoid tipping off French dealers and inquisitive British reporters, Holmes disguised himself with a false mustache and whiskers, and both he and Keynes used aliases. The ruse was so successful that at the close of the auction two days later, Keynes wrote gleefully to his mother, “I bought myself four pictures and the nation upwards of twenty.”11
In fact, he came home with one of Cézanne’s still lifes of apples and two Delacroix, while Sir Charles Holmes returned to the National Gallery with twenty-seven drawings and paintings, including a Gauguin still life and Manet’s Woman with a Cat. Prices had slumped under the threat of German occupation, and Keynes was especially pleased that Holmes had had to use only half of his budget. Of his return from France, Vanessa Bell wrote to Roger Fry that “Maynard came back suddenly and unexpectedly late last night having been dropped at the bottom of the lane . . . and said he had left a Cezanne by the roadside! Duncan rushed off to get it.”12
• • •
An Anglophile and constitutional monarchist, Joseph Schumpeter was horrified when Austria and Germany entered the war as allies. When he got a draft notice in December 1914, he promptly applied for a permanent exemption on the grounds that he was the only professor of economics at the University of Graz. According to his biographer Robert Lorie Allen, he hoped for an advisory role in the government and spent as much time as possible in Vienna cultivating politicians of all parties. (He was equally promiscuous in his private life, Gladys having announced her intention
of remaining in England for good, even though she had not consented to a formal divorce.) But Schumpeter proved too radical for his own party, the conservative Christian Socials, and too conservative for the Socialists. The longer the war dragged on, the more frustrated he became at being “totally cut off from any possibility of being effective.”
Having opposed the war, Schumpeter lobbied the emperor and his advisors to make a separate peace with the Allies—which, in fact, Franz Joseph nearly did—as well as to seek a postwar alliance with England. On the eve of surrender, Schumpeter was waging a personal campaign on two fronts: against the increasingly popular notion of a postwar economic and political union or “Anschluss” with Germany, and against the increasingly fatalist attitude on the part of the Austrian middle class toward the future of democracy and private enterprise in Europe. He spent the final year of the war anticipating the problems that the Austrian government would face after the war.
Six months before the armistice, at a public lecture at the University of Vienna, Schumpeter proposed a blueprint for postwar economic recovery. Like Keynes, he was an optimist. In The Crisis of the Tax State, based on his lecture, he argued against the inevitability of Socialism and predicted that the capitalist welfare state, which he called the “Steuerstaat” or “tax state,” would survive the war. The crisis he foresaw would result not from the triumph of Socialism, he argued, but rather from a gap between the voters’ expectations and their willingness to pay taxes. The major challenge for democratic governments would be avoiding chronic budget deficits and inflation.