“Capitalism, Socialism & Democracy,” J. Schumpeter (1942)

A professor of mine once said that Schumpeter’s CSD is the most misunderstood book in economics. I think that’s probably right. I also think that, to the extent that Schumpeter has lately entered the economics Pantheon, his admirers ought not hang their hat on this particular book; there’s a story out there that Frank Knight called CSD good dinner-table conversation and nothing more, which also strikes me as pretty accurate. Schumpeter could also have used a bit more of the mathematization that he encouraged in students of his like Samuelson – his ideas about cycles of entrepreneurial activity being the cause of the business cycle seem mighty strange in retrospect (no surprise that Schumpeter was more or less a failure as a Finance Minister!). The book is not short, so I just want to expand here on a few points: Schumpeter on socialism, his ideas on education, and his argument in favor of oligopolies.

First, socialism. How on Earth has this book managed to become popular among the Glenn Beck crowd? Schumpeter clearly is not in favor of socialism, but he does see it as inevitable. I suppose statements of that type are inherently Marxist – that is, the idea that overwhelming social forces drive history in a linear way, and in a manner outside the control of individuals or small groups. Unlike Marx, Schumpeter sees socialism coming about essentially because it is so successful: businesses will grow bigger and managers will become technocrats rather than defenders of private property, while simultaneously resentment will grow among educated classes that do not find their work fulfilling. Some parts of this argument are puzzling in retrospect: for instance, contra Schumpeter, I doubt that owners of financial claims are somehow less willing to support private property than direct small business owners.

Next, and related, we ought discuss Schumpeter’s ideas on education. There is a section of the book where he really comes off as much like a pre-war upper-class European as is humanly possible. I’m not even talking about the claim that workers in the future (meaning today) will have less incentive to work hard and earn money because they now live in cities with modern appliances and do not need to save enough to maintain the Country Home that all gentlemen must have (Really! This argument is made!). Rather, there is an argument that the extension of education to lower classes will lead to growing underemployment and dissatisfaction with work, in the long run. What I find strange here is that Schumpeter was the leading proponent of the importance of creative destruction, of innovation, of new products. Indeed, it’s fair to say that he considered short-run efficiency essentially unimportant for welfare, at least compared with growth, and I agree entirely with this sentiment. That said, where exactly does he think efficiency-improving invention comes from, if not from increases in the education level? As every economist believes from Solow on, at the very least, expanding human capital is essentially the only way to grow long-run. Why would an author who sees clearly the importance of innovation be so down on increasing the educational franchise?

Third, on a more technical point, I am confused about what might be called Schumpeter’s Defense of Monopoly. It seems he is arguing something like the following: most innovations come from big business, most big business sells oligopolistic products, so it’s reasonable to suspect that partial monopoly profits are necessary in order for firms to endure the fixed cost of R&D. I see two modern objections. First, I don’t think it’s true that most innovation comes from monopolistic industry skunkhouses. I’ll write on this site sometime about the lovely work of Von Hippel, but his empirical research essentially suggests that most innovation is created by end-users and only later marketed by existing big businesses. Second, more theoretically, I don’t know if it’s right to think of R&D investment as a choice that a business makes in isolation. Rather, we ought think of it as an equilibrium phenomenon. That is, consider an industry with many firms. A potential innovation is out there, and each firm simultaneously decides whether to invest. The invention costs C, a full monopoly for the new product would earn P, and if multiple firms invest and discover the new product, they earn Cournot oligopoly rents conditional on how many such firms there are; I’m implicitly assuming the discovery cannot be immediately copied for free by non-inventing firms, so this P is essentially just earnings until the product is copied. Two things are clear: first, in equilibrium, there may be one, many, or all of the firms investing, depending on C and P. Second, the socially optimal number of firms is not necessarily one: depending on C and P, again, there is a tradeoff between wasteful investment (sometimes called a “patent race”) and ex-post inefficiency in a monopolistic market. Third, this analysis has nothing to do with the pre-invention industry structure unless we assume C is lower for firms already in the industry. That is, we need a good reason to assume something other than free entry in the post-invention industry. Fourth, all this is a long way of saying that, under some conditions, Schumpeter’s analysis of monopoly is probably OK, but that he implicitly assumes quite a bit, and he could have used a bit more quantitative structure in his writing.

http://www.scribd.com/doc/8676091/J-a-Schumpeter-Capitalism-Socialism-and-Democracy (Here’s a copy online – it’s easy to find – but the book is still under copyright so your best bet is a quick trip to the library…)

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4 thoughts on ““Capitalism, Socialism & Democracy,” J. Schumpeter (1942)

  1. Manoel Galdino says:

    Sadly enought there are bad marxists out there. But is not fair with good marxists or even whith Marx himself to say things like:

    It is Marxist to believe in ‘the idea that overwhelming social forces drive history in a linear way, and in a manner outside the control of individuals or small groups’

    This is soooo wrong in so many ways, that surprises me that you (a person whichcited the comunist manifest) may say it.

    Let’s put it straight: People make choices and people produce social reality. The argument of Marx is not that people don’t create reality and thus don’t have the ability to change it. The marxist argument is that reality appears AS IF it was produced in a unpersonal way, drived by forces outside the realm of people.

    In fact, Marx criticizes many people because they don’t see capitalism as a historical result. These people failed to see that capitalism could be overcomed, be socialism or even something worse than capitalism. There is no determinism here.

    That Marx was overly optimistic about the chances of socialism and the problems of socialism is another thing. But there is no determinism. This is really a bad reading of Marx.

    If I may suggest a reading, take a look at The Eighteenth Brumaire of Louis Napoleon. There you will see Marx analysing political phenomena and you will find out that there ir no determinism.

    best regards,

    Manoel

    ps.: And the stuff about linearity of history is so wrong that I fail to see how you could ever think that a thinker like Marx could ever say something like that.

    regards,
    Manoel

    • afinetheorem says:

      I don’t know about that. Marx famously says “society does not consist of individuals, but expresses the sum of interrelations,” so I don’t know how this could be interpreted as saying that *individual* action matters. I am with you that he doesn’t see class action as inevitable – the class consciousness needed to be developed – but that development was out of the hands of individuals or small groups.

      As for the linearity of history….I dunno, this point seems rather obvious to me in Marx’s writing, and it definitely was the interpretation of GA Cohen, whose writing provided my introduction to Marx.

      Neither of these points are meant to imply *determinism*, but tendencies with a clear drift whose control lies in social forces like production rather than in “Great Men”? I think so.

  2. Greg says:

    Rather, there is an argument that the extension of education to lower classes will lead to growing underemployment and dissatisfaction with work, in the long run.

    I’ll have to re-read my copy, but I don’t think this was so amazing in context. The innovations that Schumpeter had seen as an adult — the production line, electric appliances — were de-skilling and de-humanizing. Schumpeter was extrapolating from what he knew; the lower classes would have progressively less need of education in order to be productive.

    It’s been asserted (see comments by Mark A Sadowski here) that the pre-WWII period was unique in being the only time that TFP growth was concentrated in manufacturing. This might be where Schumpeter went wrong.

    I also think that people focus far too much on the adjective in Schumpeter’s famous phrase, and not nearly enough on the noun. My impression is that Schumpeter placed the weight on destruction for good reason – it is the driver of growth. Innovations are always there, like mutations in genetics; they remain latent unless niches open up.

  3. I don’t remember the famous say by Marx, but it’s been a while now that I read Marx.

    Of course the type of microfoundations of microeconomics is not suitable to Marx’s analysis. If I may be a bit anachronist here, I would say Marx see society as an emergent phenomena. So, individuals are important, but you can’t reduce society to sum of individuals.

    As for the linearity. I never read Cohen, although I had heard of him before, of course. But Marx see history much more as a progressive-regressive process at the same time. So, say, on the one hand Capitalism is better than Feudalism, since it freed man of personal relations etc. (that’s where you can see linearity), but on the other hand, it increased exploitation of men, children and women, increased alienation etc.

    Btw, Marx famously said: “History repeats itself first as tragedy, second as farse”. Hardly a linear account of history, don’t you think?

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