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…)