Creative Destruction – Joseph Schumpeter, Part 2

Part 1 of this essay can be found here. I’m sorry to have taken so long to finish, but the truth is that the latter half of Capitalism, Socialism and Democracy is much less impressive than the insight into “creative destruction” in the first part.

The latter part deals with a set of related questions.

1. Can capitalism survive? Schumpeter says it cannot. Corporations will grow larger; the entrepreneurial urge will become institutionalized; and advances will be made by and for the benefit of the large corporations. Meanwhile, the efficiency of capitalism will make material goods less costly, permitting the rise of an intelligentsia hostile to the bourgeois values that brought about the prosperity. The intelligentsia and their allies will dominate the government and use the power of the state to nationalize industry.
2. Can socialism work? Schumpeter employs an idiosyncratic definition of socialism. He restricts the meaning to the ownership of assets by the state, leaving out the leveling impulse and egalitarian ideal that accounts for most of socialism’s attraction. Restricted in this way, the agency problem is the same under capitalism and socialism. Schumpeter believes it can work, and is the likely successor to capitalism.

Upon finishing this book, I was immediately struck by Schumpeter’s unwillingness to extend his fundamental insight on creative destruction a little farther. Individual capitalists, seeking momentary competitive advantages, push the economy forward with innovations. Why would this not apply at the macro level as well? Is capitalism itself unable to evolve in response to competitive pressures? I would argue that it had done so in Schumpeter’s lifetime before the publication of Capitalism, Socialism, and Democracy in 1944. This was after the Securities Act of 1933, the Securities Exchange Act of 1934, the establishment of the SEC, the advent of Social Security and unemployment insurance, and bank reform with the FDIC as final guarantor. Nationalization was shortly to get underway in Europe, but was never a factor in the US. Part of the reason may have been that reforms in capitalism served to protect the economy from the episodes of panic and fraud that had characterized its early days. At the cost of some efficiency in the economy, the US had purchased a set of shock absorbers.

Schumpeter may also have failed to anticipate structural changes in national and international trade. The 20th century saw enormous advances in communication and transportation. Among other things, this lessened the geographic limitations on capital. It was once difficult to imagine that transatlantic air freight would ever be commercially viable, or that real-time communications with China would be an ordinary business practice. With information and goods traveling faster and cheaper, nations were thrown into competition with each other just as entrepreneurs were. Globalization would eventually require both capitalist and socialist states to evolve and adapt (China, India) or face ruin (Russia, Argentina). Nationalization was rolled back nearly everywhere it had been practiced. States may vary the mix of benefits, taxation, and economic freedom in response to their constituencies, but they face a test in the world market on the wisdom of those choices. Capital itself is portable and will migrate in response to relative changes in environment. While a ruler may maintain himself in a mismanaged economy by force of arms, his growing inability to purchase those arms limits his ability to resist rivals. Even tyrants are subject to market discipline. A weak president-for-life may find there is such a thing as term limits after all.

Finally, Schumpeter may have exaggerated the power of the intelligentsia. In the 2004 US elections, there may not have been much choice between a candidate who has had a mediocre record in preventing expansion of the state and one who frankly wanted to accelerate its growth. Still, the parties and the candidates favored by academics, the press, Hollywood, the music industry, the “helping professions,” public employees, transnationalists, and all the other groups in favor of expanding state control into the private sphere, particularly in economics, lost big. Even more significant than the margin of the loss was the degree to which the left had to disguise or deny its agenda of income redistribution, steeply progressive taxation, class enmity, price control (pharmaceuticals as a start), and nationalization (health care and insurance). The US has no tradition of a ruling class, and does not seem to wish to start one. Philosopher kings are still waiting for their big break.

11 thoughts on “Creative Destruction – Joseph Schumpeter, Part 2”

  1. I don’t know. Schumpeter’s observations about the intelligentsia bringing about the end of capitalism strike me as being among his most prescient. That looks to me like the battle we’re fighting right now.

    And, on entrepeneurialism, is rent-seeking entrepeneurial activity? I’m not so sure. And a lot of the business plans we’re seeing these days look to me like just plain rent-seeking.

  2. You raise good questions and make a number of good points, particularly about the market discipline to which even despots are now subject.

    One thing I disagree with is your speculation that our Depression-era “reforms” meliorated subsequent economic setbacks. I think it’s at least as likely that a combination of increased national wealth, institutional learning (the Fed didn’t repeat its catastrophic deflationary mistakes of the early 1930s) and the market discipline that you cite in other context has prevented a recurrence of the Great Depression. Indeed it was mainly govt bungling that made the post-1929 recession into an unprecedented disaster and delayed recovery for years. IMO we should be extremely hesitant to assume that our regulatory “shock absorbers” have done more good than harm.

  3. “regulatory “shock absorbers” have done more good than harm.”

    Only viewed narrowly. They were political shock absorbers. They were the minimal interference with capitalism that was politically viable. There was absolutely serious discussion of getting rid of capital markets and creating a national planning board to allocate capital. Total nightmare.

    The public needed its confidence restored before it would invest again. Also, the practices on Wall St. prior to 1929 were pretty fast and loose and the smart guys all knew that they were going to get regulated. Joseph Kennedy wrote a friend in the late 20s and said come down here quick because you can make money by the barrelfull, but when this thing blows up the whole game is going to be shut down. They all knew it.

  4. Lex, I think that’s facile. Of course we can’t know, but look at foreign affairs, the other big policy area which Roosevelt had to contend with. He could have struck a deal with the fascists to split the political difference between interventionists and the isolationists and domestic demogogues. Doing so would have been analogous to his handling of economic regulation. Instead he took a relatively principled position and was able to finesse it politically. Maybe he could have done similarly WRT the economy. I think the difference lies in the fact that he believed in fighting fascism, and had competent advisors, whereas in economic affairs he was unprincipled and poorly advised. It’s not unreasonable, as long as we’re arguing hypotheticals, to speculate that better leadership on his part in economic matters might have had better (i.e., less interventionist, more successful) results.

  5. “…whereas in economic affairs he was unprincipled and poorly advised.” Nope. There was effectively no one arguing for libertarian-type policies. There was no “principled” position being argued by anybody who was at all well-known which you would have liked. The Republicans were as stumped by what to do as everybody else. I have this book Arnold Kling recommended which has interviews with economists. Milton Friedman was in graduate school at the time. He says no one knew what to do. Classical economic theory was stumped by a situation where there was all this demand lying in the streets, but the businesses are all shut, and no one will step up to supply it. Friedman wasn’t even Friedman yet. What should have been done only became apparent over time. FDR wasn’t unprincipled, he was groping for a solution like everybody else. Facing the fascists was a lot easier. He knew what to do. As to better leadership, I don’t see what else anyone was actually proposing which would have been better. His liberal supporters were bitterly disappointed that he did not go much more socialistic.

    More to the point of Mitch’s post, we should also remember that Schumpeter was writing in the wake of World War II, which was seen by many as the triumph of the planned economy. It was easy to see how private enterprise could look like it was on the way out. As to his prediction about the intelligentsia, even if it is less true in the last few years, he did a good job of predicting the second half of the 20th century. Most prophets do less well.

  6. True, Friedman wasn’t then the distinguished monetary historian and libertarian we know him as now, but a range of economic opinion existed between laissez faire and various statisms. The difference between then and now is that statism has been much weakened by experience while laissez faire is much more popular, but the range of opinion that exists now existed then. It’s not unreasonable to speculate that much harmful economic regulation might have been avoided if FDR had been more of a laissez-faire advocate and had similarly inclined advisors. On the margin it’s a matter of chance that he wasn’t. Decisive leadership can help to sway public opinion away from bad ideas, and in economic affairs FDR didn’t have it. Maybe nobody did at the time. Maybe he would not have been able to affect the central problem, excessive restriction by the Fed of money and credit, but perhaps he might also not have burdened us with the agencies and regulations that have cost us so much since then.

    You seem to be arguing that things turned out for the best, or at least that they couldn’t have turned out better. I think they might have turned out much better with a different emphasis in leadership than FDR could or would provide, and I think it’s well worth considering what might have been done differently, and not only by FDR.

    My original point was about govt bungling, which I think is indisputable in the case of the Fed. At a time of bank and business failures and credit contraction the Fed put fuel on the flames by contracting the money supply. It’s true that the Fed had, compared to now, very limited information about monetary and economic conditions. However, given that the Fed had been created to provide monetary stability and meliorate the effects of panics and recessions, I think it should have been possible to draw some cautious inferences when the creation of the Fed was followed a few years later by a recession of unprecedented severity and length. The pattern of government economic regulation causing problems that are then addressed by more regulation is as old as history, as is the response of arguing that things would have been even worse if the secondary regulation hadn’t been adopted. I think you may be falling into this trap.

  7. “a range of economic opinion existed between laissez faire and various statisms” “if FDR had been more of a laissez-faire advocate and had similarly inclined advisors.”


    No one with any power or access to power was advocating anything remotely like laissez faire.

    It is impossible to make any sense of this period unless you understand that classical economic theory was considered to be repudiated by virtually everyone. My shorthand expression “even Friedman wasn’t Friedman” was a perhaps too-subtle way of saying that no one who had any political viability at all was advocating a non-statist or even anti-statist program. Even worse, there was virtually no one in the academic or intellectual world at this time who was seriously advocating a non-statist or even anti-statist program.

    There was no political or intellectual basis for a non-interventionist program. Moreover, people were in breadlines. They wanted jobs. They wanted government to DO SOMETHING. It was a crisis atmosphere. Hoover, who was extremely activist by pre-1929 standards was painted as a “do nothing” and his party suffered electoral annihilation.

    “…or at least that they couldn’t have turned out better.” “…it’s well worth considering what might have been done differently…” Exactly. No one has ever shown me any historical fact which makes me think that anyone who actually existed at that time who was proposing something better who could have been elected, or who might have influenced Roosevelt. Hooever? No. Alf Landon? No. Amongst economists, they all clung to Keynes like drowning men grabbing onto life raft — he was the only guy who stood up and said “I have figured out what has happened to us, and I see a way out of it.” On the other hand, there were lots of people proposing lots of even worse things who might have been elected and who tried to influence Roosevelt.

    As to the Fed, the crash was in 1929, Hoover was President until after the turn of the year in 1933. The Fed did most of its damage on Hoover’s watch. Moreover, he agreed with it. He also signed the Smoot-Hawley tariff — as it passed through committee, at each milestone, there were downward shocks in the market. There is a good case to be made that the crash was actually caused by anticipating the effects of the upcoming tariff. Both tight money and high tariffs were Republican principles that Hoover believed and subjected the country to for his entire presidency, most of it during the worst years at the beginning of the depression which he presided over. The public rejected both of these policies by electing FDR. The GOP was as wrongheaded in many important ways as the Democrats were at that time.

    I don’t think I’m falling into any traps. Even assuming arguendo that everything that happened during FDR’s watch was a bad idea in some objective sense, the problem remains that very few people knew any better what to do at the time.

    I don’t think I’m falling into any traps. I just try to judge these guys by sitting behind their desks in my imagination, and remembering that they, unlike us, did not know what was going to happen next, and did not know many things we know now.

  8. This may be of interest. A couple of interesting paragraphs:

    [I]n 1932, 12 University of Chicago economists, including Aaron Director, Harry D. Gideonse, Frank Knight, Lloyd Mints, Henry Simons, and Jacob Viner, issued a memorandum advocating budget deficits as a method for getting out of the Great Depression; the memo also argued for the federal government’s no longer balancing its budget annually but instead over the phases of the business cycle. They admitted that the Depression could be overcome through appropriate adjustments in market prices and wages to reflect the actual underlying conditions of supply and demand in the various sectors of the economy. Given a “deflation of costs and elimination of fixed charges, business will discover opportunities for profitably increasing employment.”

    But they insisted that to follow a market solution would involve “tremendous losses, in wastage of productive capacity, and in acute suffering” because wages and other prices had become downwardly rigid and unresponsive to significant market changes except with a prolonged lag. An economic upturn, instead, should be stimulated through “the form of generous Federal expenditures, financed without resort to taxes on commodities or transactions.”

    FDR stubbornly attempted to keep the budget in balance while extending government control of the economy. The U. S. did not recover from the depression until preparations for WWII forced deficit spending on the country

    Regulatory burden and interference with laissez faire did not begin with FDR. The Sherman and Clayton acts were passed long before his presidency. Much of the regulatory burden we are still saddled with came from the Progressive era, the FDA, the FCC, the FTC, the Federal Reserve regulating banks and the now defunct ICC. Looking at the New Deal, the legislation that still affects us is primarily the Securities Acts, Social Security, the Agricultural Adjustment Act and the National Labor Relations Act. Almost all of the NIRA (1935), the WPA (1942) and the CCC (1942) style programs are gone. And the pernicious effects of the AAA are now due to Bush’s reinvigoration of subsidies to agriculture.

    FDR’s real legacy was a generation (the “Greatest Generation”) that was brought up to believe that whatever problems one had in life could be solved by the government. That generation is now passing from the scene and it’s only great president, Reagan, finally disabused the country of FDR’s notion.

  9. 1,000 economists, literally, tried to get Hoover not to sign the Smoot Hawley tariff. They had the same amount of luck.

    Economists are always trying to get politicians to do or not to do something.

    Not balancing budgets was a very wild notion at that time. Hoover tried to balance the budget during the worst of it. We now say, “they were nuts”. Doctors “bled” patients for centuries, but now we know that they should have a transfusion. Knowledge increases, even in economics and eventually it reaches the level of public and political awareness.

    “a generation … that was brought up to believe that whatever problems one had in life could be solved by the government.” These are the same guys who came home from WWII and spent their working lives carrying out the greatest economic expansion ever seen in the history of the world, the Postwar boom. I think the lesson they learned is that they will not let middle class America be reduced to poverty and they will demand that the Government prevent that. By and large, the programs they benefitted from the most were voucher-type programs like the GI Bill and GI housing loans. They balked at the Great Society and have been unhappy with big Government ever since. These guys built the interstate highway system, another government program, and the suburbs, essentially the entire world we Americans know and inhabit. They also quietly but firmly waged the Cold War, decade after decade. They are now getting their drug benefits from Bush. They see Government as a servant of middle class America, and they at least are working that servant hard, as they always have, in their interests.

    Very good points about regulation beginning with the progressive movement. Don’t forget that it was the business communitey that pushed for federal regulation of banking, railroads, etc. rather than have to deal with a bunch of inconsistent, often incompetent and sometimes corrupt state governments. The wish on the part of big business and the progressives was for uniformity and codification — the dispute was who would be in charge.

    Roosevelt and Hoover both were from different branches of the progressive school. That was what was in the air. People really thought a committee of experts was smarter than the random and jungle-like behavior of the marketplace. Mises was virtually unknown here and Hayek was just getting started.

    It was a very different world. Only the passage of time has made many of its contours clear to us.

  10. One thing that I get out of the thirties is how well the US’s federal system of government worked. At a time when virtually every government in the world was moving toward a state-centered syndicalism, the Supreme Court hamstrung the NRA. At a time when governments tilted toward dictatorial leaders, the US had the choice between Roosevelt and, sequentially, Hoover, Landon, Willkie, and Dewey. None of those five were particularly radical, none stood for the interests of one part of the country against the rest.

    The US had an ample supply of firebrands at the time — Father Coughlin, Huey Long, etc. But none of them ever got onto the ballot or had serious national power.

    The thirties saw a lot of decisions made which later experience has shown to be unwise. But the overall rejection of radical solutions has to be chalked up as a big victory for federalism.

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