From the Prophet of Innovation

I recently finished reading Prophet of Innovation - Joseph Schumpeter and Creative Destruction - by Thomas K. McCraw. Below are key insights from this masterpiece:

On Capitalism:

"A society is called capitalist if it entrusts its economic process to the guidance of the private businessman. This may be said to imply, first, private ownership of non-personal means of production ... second, production for private account, i.e., production by private initiative for private profit." He went on to say that a third element is "so essential to the functioning of the capitalist system" that it must be added to the other two. This third element is the creation of credit. The core ethos of capitalism looks constantly ahead and relies on credit in launching new ventures.

On Disruption:

Entrepreneurial interventions make the notion of the steady state a mere fiction, nothing more than a hypothetical teaching device. The idea of equilibrium itself becomes problematical, since continual disruption is the basis for economic development and embodies the essence of capitalism.

On the Types of Innovation:

(1) The introduction of a new good—that is one with which consumers are not yet familiar—or of a new quality of a good (2) The introduction of a new method of production, that is one not yet tested by experience in the branch of manufacture concerned. (3) The opening of a new market, that is a market into which the particular branch of manufacture of the country in question has not previously entered, whether or not this market has existed before. (4) The conquest of a new source of supply of raw materials or half-manufactured goods, again irrespective of whether this source already exists or whether it has first to be created. (5) The carrying out of the new organization of any industry, like the creation of a monopoly position (for example through trustification) or the breaking up of a monopoly position.

On Corporations:

The corporation turned out to be a crucial innovation. Its permanency prevented forced liquidation of the business when one or more of the old-style partners wished to dissolve the partnership or died. Limited liability enabled people to participate more freely in the economy as investors, without unlimited personal risk. The separation of ownership from control created opportunities for talented managers to climb the corporate ladder and lead great enterprises. At the same time, the secondary market for corporate shares, run by stock exchanges, allowed holders of stocks and bonds to convert their investments into cash at a time of their own choosing.

On Competition:

Perfect competition lends itself verv well to mathematical modeling, however, and that advantage has been almost irresistible to economists. But because it neglects the dynamics of creative destruction, Schumpeter finds perfect competition wholly unsuitable for understanding a modern capitalist economy. When, for example, a new product or process is introduced, all buyers and sellers cannot possibly have complete information about potential markets. "As a matter of fact," Schumpeter writes, "perfect competition is and always has been temporarily suspended whenever anything new is being introduced." And the continual emergence of new products and new ways of doing things is "the fundamental impulse that sets and keeps the capitalist engine in motion. Despite its irrelevance to perfect competition, he continues, big-business capitalism has proved its superiority, in the long run, at expanding total output and raising living standards.

On Social Sciences:

Logic, mathematics, physics and so on deal with experience that is largely invariant to the observer's social location and practically invariant to historical change: for capitalist and proletarian, a falling stone looks alike. The social sciences do not share this advantage. It is possible, or so it seems, to challenge their findings not only on all the grounds on which the propositions of all sciences may be challenged but also on the additional one that they cannot convey more than a writer's class affiliations and that, without reference to such class affiliations, there is no room for the categories of true false.

On Creative Destruction:

Schumpeter's signature legacy is his insight that innovation in the form of creative destruction is the driving force not only of capitalism but of material progress in general. Almost all businesses, no matter how strong they seem to be at a given moment, ultimately fail—and almost always because they failed to innovate. Competitors are relentlessly striving to overtake the leader, no matter how big the lead. Responsible business people know that they ignore this lesson at their peril. Every day they feel themselves, as Schumpeter put it in Capitalism, Socialism and Democracy, "in a situation that is sure to change presently." They are "standing on ground that is crumbling beneath their feet."...Only through innovation and entrepreneurship can any business except a government-sponsored monopoly survive over the long term...Because of the importance of entrepreneurship, and because Schumpeter wrote about it with such insight and verve, his name will be forever linked to the idea.

A must read!