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LEXIS-NEXIS® Academic

July 20, 2001, Friday ,THIRD EDITION

SECTION: BUSINESS; Pg. C1

LENGTH: 1196 words

HEADLINE: OLD THEORY HELPS EXPLAIN NEW REALITY 'CREATIVE DESTRUCTION,' THE LATEST CONCEPT TO EXPLAIN TODAY'S ECONOMY, WAS PUT FORTH BY AN ECONOMIST WHO DIED IN 1950 LATEST CONCEPT TO EXPLAIN TODAY'S ECONOMY HAS ITS ROOTS IN THE LAST CENTURY

BYLINE: By D.C. Denison, Globe Staff

BODY:
He could be the economist most in tune with our times. His concept of "creative destruction" has provided the inspiration, and the titles, for two recent business strategy books. Yet you won't find Joseph Schumpeter opining on CNNfn or Wall Street Week. Schumpeter, who was born in Moravia during the waning years of the Austro-Hungarian Empire, died more than 50 years ago.

Still many financial analysts, academics, and economists say that Schumpeter's theories go a long way to explaining the dynamics driving today's economy.

"Schumpeter's theories capture the duality that many of us see," according to Lee W. McKnight, associate professor and director of the Edward R. Murrow Center at Tufts University's Fletcher School of Law and Diplomacy. "Not just the bursts of creativity and innovation but also the destruction and collapse of companies and entire industries."

Schumpeter's current popularity is primarily based on his description of a process he called "creative destruction," in which innovations sweep away obsolete products and production methods. Those innovations and the companies built on them, in turn, are eventually destroyed by even newer and more efficient advances. According to Schumpeter, this process is intrinsic - even desirable - to capitalism.

McKnight, whose research focuses on international technology policy and the convergence of the Internet and telecommunications industries, recently co-edited a book with two colleagues. The title, "Creative Destruction," was a clear homage to Schumpeter.

"The more we studied the telecommunications industry, the more we realized that it's less about incumbents taking a commanding position and putting up long-term barriers to entry," said Paul Vaaler, a co-editor of the book and an assistant professor of international business and director of the Hitachi Center at the Fletcher School. "Instead, it's increasingly about smaller innovators smashing through the barriers and challenging, if not displacing, the established players. The result is an industry with hypercompetitive dynamics that Schumpeter described in another era. That seems to be a better description of what is going on."

Schumpeter's concept of creative destruction helps explain what's happening to Cisco, Motorola, Intel, and the entire telecommunications industry.

The source of this very contemporary approach was the product of another era, and another world. Joseph Alois Schumpeter was born in Austria-Hungary in 1883. Trained as a lawyer, he led a varied and adventurous life. As a young man he spent impressionable years in Vienna and London. In 1907, he married a woman 12 years his senior and moved to Egypt, where he managed the affairs of an Egyptian princess.

After he returned to Austria, he wrote a few well-received books that led to an appointment as Austria's finance minister in 1919. It was a period of hyperinflation, and Schumpeter lasted less than a year in the job. Later he served as the president of a Vienna-based bank that collapsed, costing him a sizable personal fortune.

The flamboyant Schumpeter claimed that his aspiration was to be "the best horseman in Vienna, the best lover in Austria, and the best economist in the world." (He later boasted teasingly that he achieved two out of three. Schumpeter's academic career flourished after he left Europe for the United States, where he taught at Harvard University from 1932 until he died in 1950. At the time of his death Schumpeter was regarded as a significant economist, but one who was overshadowed by his more influential contemporary, John Maynard Keynes.

Schumpeter's current appeal could be explained by his emphasis on the disruptive power of innovation and technological change, even though he built his theories by observing the high tech of a distant time - specifically electrification and steam power.

"Many of us have realized that we're seeing the same cycles Schumpeter describes, but they are moving faster," Vaaler said. "What we're seeing now is Schumpeter on speed."

Sarah Kaplan, a former "innovation specialist" at McKinsey & Co. who is now a doctoral student at MIT's Sloan School of Management, also has become a proponent of Schumpeter's approach. This past spring she also wrote (with McKinsey senior partner and director Richard Foster) a book with a familiar title, "Creative Destruction." For a few weeks in April and May the book appeared on both The New York Times and The Wall Street Journal's business bestseller lists. It is currently number seven on Business Week's bestseller list.

"Our project started when we began to look at the companies that were featured in books like 'In Search of Excellence' and 'Built to Last,' " Kaplan said. "We discovered that, in fact, many of those companies were not able to keep their competitive advantage. Many of them, in fact, were having a tough time. We discovered that the idea of 'excellent companies' is a myth."

Kaplan and Foster decided to analyze the corporate landscape from a Schumpeterian point of view. "We started looking at the role of technological change and innovation, and things fell into place," Kaplan recalls. "You really can't explain what's going on in our economy without factoring in innovation and technical change. That's why Schumpeter is relevant again."

Maybe too relevant. Although Schumpeter's influence continues to grow in dot-com and new economy circles ("Creative Destruction" was the banner theme emblazoned on the cover of the May issue of the magazine Business 2.0, for example) many economists have felt compelled to point out that Schumpeter's subject was general macroeconomic cycles, not specific firms or industries.

Schumpeter's theories also lend themselves to facile misapplication. Raul Katz, a vice president with Booz-Allen & Hamilton, the international management and technology consulting firm, has recently been hearing "creative destruction" used as a rationalization to justify reckless competitive practices.

According to Katz, who was a co-editor (with McKnight and Vaaler) of one of the "Creative Destruction" books, "Sometimes what you're seeing is simply destruction, without any creation. . . . If companies set prices too low out of desperation, that is destruction pure and simple."

There is also, undeniably, a brutal, Darwinian aspect to Schumpeter's outlook. "There's definitely a dark side to Schumpeter," Lee McKnight said. "Part of his message is that it's a nasty world out there, and someone is going to want to take you out."

Schumpeter himself does not make it easy for today's economists. His reputation rests on just four books that range across an ambitious sweep of disciplines. Still, it's likely that his broader message, at least, will continue to resonate with Internet-era economists and analysts.

"Some people have said to me, 'Gee, your book is really depressing,' " Kaplan said. "And I can see what they mean. If you believe Schumpeter, no one can rest on their laurels. Sustainable competitive advantage is just not there."

Kaplan is unapologetic.

"That's reality," she said.

D.C. Denison can be reached by e-mail at denison@globe.com.

GRAPHIC: PHOTO, 1. The economic theories of Joseph Schumpeter, who died in 1950, carry much weight today. 2. Two recent books share the title "Creative Destruction," a term coined by Schumpeter.

LOAD-DATE: July 20, 2001