Streetwise Professor

June 27, 2020

Our Schumpeter Moment

Filed under: Economics,Politics — cpirrong @ 12:54 pm

One of the first economics books I read, in high school, was Joseph A. Schumpeter’s Capitalism, Socialism, and Democracy. Truth be told, I only had a dim understanding of what Schumpeter was saying. I came in at the end of the conversation as it were. Not having any exposure to Marx, for example, rendered me rather incapable of comprehending Schumpeter’s critique of Marxism. This also made me fail to appreciate that what Schumpeter was advancing was an alternative dialectic that ended in the same place: the demise of capitalism.

As I accreted knowledge over the years, I have returned to Schumpter from time to time, and gained new insights from CS&D. Witnessing the current tumult in the United States, and the West more generally, makes me appreciate the book and its insights all the more. We are experiencing a Schumpeter moment. The factors that he identified as the sappers that would undermine capitalism (and liberal democracy, as distinct from social democracy) are in clearly in operation today: large scale corporate enterprise and intellectuals.

Schumpeter wrote CS&D in 1943, in the immediate aftermath of the Great Depression, and when the viability of capitalism after the World War was much in doubt. The Depression was considered a crisis of capitalism, and the most renowned predictor of such a crisis, Karl Marx, was all the rage. The starting point of CS&D is therefore Marx.

Schumpeter examined Marx and Marxism sympathetically and seriously, but ultimately rejected the Marxian theory of capitalist self-destruction. The causal mechanism in Marx was the “declining rate of profit”, an implication of the classical economics in which Marx was steeped. This declining rate of profit would lead to pressure to cut wages, resulting in the immiseration of the proletariat, which would eventually spark a communist revolution.

Schumpeter rejected this prediction on theoretical and empirical grounds. In essence, Schumpeter rejected the classical (and neoclassical) frameworks which did not recognize technological advance and innovation. Schumpeter argued that waves of technological innovation–“creative destruction”–would result in new enterprises and industries supplanting old ones. The temporary monopoly power of the innovators would generate profits. But profits would not disappear, as would happen due to entry in a technologically stagnant classical world. Instead, the incumbent monopolists would be supplanted–destroyed–by the creators of new ideas and technologies.

So Schumpeter concluded that capitalism would not die a Marxist death. But he did conclude that it would die nonetheless, although by a different dialectic.

Schumpeter identified two major dynamics. The first was the destruction of the entrepreneurial function and the entrepreneur, and the dominance of the bureaucratic corporation. The second was the rise of an intellectual class, a rise that could only occur due to the massive wealth created by capitalism.

Marx said that capitalism would fall due to its internal contradictions. Schumpeter said the same, but identified totally different internal contradictions.

With respect to the elimination of the middling, independent entrepreneur, Schumpeter summarized thus:

To sum up this part of our argument: if capitalist evolution—“progress”— either ceases or becomes completely automatic, the economic basis of the industrial bourgeoisie will be reduced eventually to wages such as are paid for current administrative work excepting remnants of quasi-rents and monopoloid gains that may be expected to linger on for some time. Since capitalist enterprise, by its very achievements, tends to automatize progress, we conclude that it tends to make itself superfluous—to break to pieces under the pressure of its own success. The perfectly bureaucratized giant industrial unit not only ousts the small or medium-sized firm and “expropriates” its owners, but in the end it also ousts the entrepreneur and expropriates the bourgeoisie as a class which in the process stands to lose not only its income but also what is infinitely more important, its function. The true pacemakers of socialism were not the intellectuals or agitators who preached it but the Vanderbilts, Carnegies and Rockefellers. This result may not in every respect be to the taste of Marxian socialists, still less to the taste of socialists of a more popular (Marx would have said, vulgar) description. But so far as prognosis goes, it does not differ from theirs.

Instead of “bureaucratized giant industrial unit,” today I would say the “bureaucratized giant tech firm.” And instead of Vanderbilts, Carnegies and Rockefellers, Bezoses, Gateses, Zuckerbergs, and Pages. And maybe Waltons and their ilk as well.

The rate of entrepreneurial dynamism has definitely declined in the US (as indicated by the decline in the rate of new business formation even prior to Covid-19). Via a variety of mechanisms political and economic (note the ordering), the most recent victors of creative destruction are destroying the entrepreneurial class that Schumpeter identified as the social and political bulwark of capitalism.

Schumpeter’s most piquant critiques focus on intellectuals. He has something of a difficulty in defining exactly what they are. In the end, he comes to something like Potter Stewart’s definition of pornography: you know them when you see them.

Schumpeter argues that intellectuals are hostile to capitalism because under it they do not receive the economic rewards–and crucially, the status–that they believe that their (allegedly) superior intellectual attainments deserve. But the massive wealth that capitalism creates permits the extension of higher education, and the support of a group of individuals (Schumpeter does not believe they truly represent a “class”) who are inveterately hostile to the system that allows them to exist in the first place. Schumpeter notes:

But in the case of capitalist society there is a further fact to be noted: unlike any other type of society, capitalism inevitably and by virtue of the very logic of its civilization creates, educates and subsidizes a vested interest in social unrest. . . .

Broadly speaking, conditions favorable to general hostility to a social system or specific attack upon it will in any case tend to call forth groups that will exploit them. But in the case of capitalist society there is a further fact to be noted: unlike any other type of society, capitalism inevitably and by virtue of the very logic of its civilization creates, educates and subsidizes a vested interest in social unrest.

Schumpeter trenchantly notes that a salient characteristic of intellectuals is the

absence of direct responsibility for practical affairs. This touch in general accounts for another—the absence of that first-hand knowledge of them which only actual experience can give. The critical attitude, arising no less from the intellectual’s situation as an onlooker—in most cases also as an outsider—than from the fact that his main chance of asserting himself lies in his actual or potential nuisance value

Which brings to mind Orwells aphorism: there are some ideas so stupid only an intellectual can believe them. Because they are not tested by empirical/practical experience.

Schumpeter also has a quasi-Leninist take on intellectuals. They can be a vanguard of revolution. The masses are incapable of acting independently and autonomously. Intellectuals provide the leadership and coherence to inchoate dissatisfaction.

Schumpeter points to another internal contradiction of capitalism. The insistence of the entrepreneurial capitalist class on freedom (which is what allowed it to escape from the thrall of feudal governments) makes it incapable of cracking down on its mortal enemies.

Looking at Schumpeter through the lens of 2020 America, I am astounded at his prescience. Of course, almost 80 years on the exact dynamics of today are different than Schumpeter prognosticated. But as Twain said, it rhymes.

For what do we see today? A (tech) corporate oligarchy that is hostile to the middle class, and to entrepreneurs, and which largely supports–often enthusiastically–the current attacks on middle America. An oligarchy that uses its economic power to exercise political and social power. A declining entrepreneurial class. And most notably, a seething host of discontented intellectuals–notably in academia–who are inveterately hostile to capitalism and liberal democracy, and who are at the vanguard of opposition to it. Yet further, a large group of Americans of traditional values who are largely paralyzed in the face of these attacks on their beliefs, institutions, and livelihoods, in large part because their bourgeois values prevent them from responding forcefully to the mortal threat that the oligarchs and intellectuals present.

Tragically, the insane lockdowns adopted in response to Covid-19 are accelerating this process. They have perversely benefited the Amazons and Facebooks and Walmarts (there are no coincidences, comrade!) and devastated the small businesses of America. They have created seething discontent due to unemployment and social isolation that is fertile ground for intellectuals to exploit. Throw in George Floyd, and you have a perfect storm.

It is interesting to note that in the prematurely triumphalist 1990s, in the aftermath of the fall of the USSR, Schumpeter’s arguments were dismissed as having been disproved by events. Most notably, the man who has my vote as The Most Wrong Person Ever, Francis Fukuyama sneeringly wrote:

Schumpeter’s work stands as one of the most brilliantly wrong-headed books of the century in its central prediction that socialism would ultimately replace capitalism because of the latter’s insuperable cultural contradictions. Writing in 1943, Schumpeter argued that there was no inherent reason why central planning should work less well than free markets in the production of technological innovation, a point not as glaringly off the mark then as now. The central problem with capitalism, however, was not economic but cultural: it would produce a privileged class of people who would reject the sources of their own wealth and seek a socialist order. In this he seemed quite right for many years as intellectuals and artists in the West struggled against the very system that made their discourse possible. Things began to look rather different after the Reagan and Thatcher revolutions in the 1980s and the subsequent collapse of communism. Schumpeter’s book contains what is probably the most realistic, albeit minimalist, definition of democracy as a competition among elites for the allegiance of the people.

“Brilliantly wrong-headed”? That’s what Freud called “projection,” Mr. Fukuyama. (Though with respect to him, the adjective “brilliantly” can safely be omitted.)

In light of current events, Schumpeter appears much more prescient than Fukuyama. The confluence of corporatism and a coddled, cosseted intellectual class–both the products of capitalism and liberal democracy–is on the verge of killing capitalism and liberal democracy. Which is exactly what Schumpeter foresaw in 1943.

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13 Comments »

  1. Neither the role of intellectuals, nor the increasingly bureocratic enterprises as harbingers of destruction are original Schumpetarian insights. They were first stated by Ludwig von Mises in “Socialism” (1922) which iI highly recommend.
    Liberal democracy is not a necessary condition- see the role of the Intelligenzija in the Russian revolution…
    You can get elite overproduction (term coined by Peter turchin) in many different ways…

    Comment by Viennacapitalist — June 27, 2020 @ 2:48 pm

  2. @viennacapitalist. Of course the antagonistic attitude of intellectuals to capitalism was well-known. Schumpeter’s contribution was to emphasize the that capitalism created the group that (in his view) would be instrumental in destroying it. Schumpeter’s alternative internal contradictions narrative (contra-Marx in particular) is what sets it apart.

    You are playing bait-and-switch with Russia, by emphasizing liberal democracy as opposed to capitalism. The Russian intelligentsia actually conforms to Schumpeter’s thesis. It’s emergence and growth corresponds almost precisely to the rapid industrialization of Russia that occurred 1862-1913. Although Russia was not a liberal democracy, capitalism with Russian variations was certainly a growing force.

    As for the Revolution, it is wildly improbable that it would have occurred when it did, or succeeded, without the cataclysm of WWI (and the connivance of the Germans in shipping Lenin back to Petrograd in 1917). The intelligentsia was able to prey on a gravely weakened state.

    In the West generally, and the US in particular, it has had to play a much longer game, carrying out a slow Long March Through the Institutions. But again, without the bounty of capitalism, such a thing would not have been possible. The wealth showered on universities, and the ability of families and individuals to make enough to pay for them or their progeny to go to college, has made it possible to create over several generations the collections of supposedly educated idiots in journalism, politics, and on the streets of American cities right now.

    Comment by cpirrong — June 27, 2020 @ 5:51 pm

  3. Hard times make hard men; Hard men make good times; Good times make weak men; Weak men make hard times. We’re not going to end these times with good men for they won’t take the necessary actions only conceivable by hard men. This is the ultimate denouement of the WW II generation who made the last 80 years so good.

    Comment by The Pilot — June 27, 2020 @ 9:26 pm

  4. Do you think maybe a lot of this is the entrepeneurs, having become extremely rich, seeking to shore up their position by winding up the drawbridge to protect themselves from the creative destruction that put them on top.

    Comment by Peewhit — June 28, 2020 @ 12:32 am

  5. @ Prof
    Obviously, you need to be able to have a surplus of goods to maintain an unproductive intellectual class – hence capitalism as the necessary condition.
    However, there is no internal contradiction in capitalism, as Schumpeter claims.
    There is no theory (known to me) that says that under capitalism corporations tend to get larger and larger in size (it is an empirical observation).

    Indeed, as Mises shows, monopolistic structures are themselves the result of anticapitalistic interventions: legal impediments to competition, taxation, monetary policy, etc…
    While your small Business Pays taxes and has to adhere to strict labour laws, big tech is exempt from most of it. While your small Business has tediously apply for a bank loan, big corporations issue negative yielding paper that is purchased by the central bank.

    Loose monetary policies during the 19th century in order to finance countless wars also played (an underappreciated) role in the Russian Revolution btw. And then there is the fact that Inflation, also affects the culture of the Society in Question.

    Comment by viennacapitalist — June 28, 2020 @ 6:39 am

  6. I am reminded of my father’s definition of an “intellectual” – someone who doesn’t use the intellect God gave him.

    I think he meant that people who do use their intellects tend to be known not as “intellectuals” but as scientists, engineers, doctors, and so on.

    My eye was taken by “elite overproduction (term coined by Peter Turchin)”. The idea is old but that’s rather a good label to stick on it.

    Our blogger will know: didn’t Adam Smith touch on the idea with reference to lawyers?

    Comment by dearieme — June 28, 2020 @ 10:44 am

  7. @viennacapitalist. It’s amusing that you presume to lecture me on industrial organization.

    Comment by cpirrong — June 28, 2020 @ 3:58 pm

  8. I enjoyed reading this article, possibly more than any other Street Wise items. The subject is one close to my thinking and ties in with other writers of the time including Ayn Rand. I noticed an article published in 2000 at https://www.econstor.eu/bitstream/10419/94776/1/wp533.pdf on the Schumpeter’s ideas and the Swedish economy which included in its summary the following point:

    “The turning point away from the path to socialism coincides with real world developments that disclosed two major flaws in Schumpeter ́s analysis. First, the ever more obvious failure of socialism in Eastern Europe went against Schumpeter’s assertion that socialism can work. Second, Schumpeter, who thought that modern technology would make the giant corporation increasingly predominant, did not foresee the revival of entrepreneurship that took place in the Western countries around 1980.” My how things have changed in 20 years.

    Your thoughts Prof?

    Comment by Alessandro — June 28, 2020 @ 5:04 pm

  9. @vienna, in free markets the successful tend to get bigger market shares. Millions of votes in the form of dollar bills are cast for them every day. So there’s your theory.

    Comment by Michael van der Riet — June 29, 2020 @ 1:15 am

  10. @Alessandro, I wonder if the decline of entrepreneurship is associated with the steep rise in preda-tort class actions. It’s just too goddam risky.

    Comment by Michael van der Riet — June 29, 2020 @ 1:22 am

  11. @ Prof
    No Lecturing, just arguing that there is nothing inherently contradictory about capitalism – basically the main argument in Mises’ book. He was analysing the marxist claim from all possible angles to show that the Hegeilian dialectic is unscientific nonsense. The same goes for Schumpeter who just applies the dialectic to other factors, as you have argued. It’s appeal lies in the fact that it superficially fits the data, but, as I do not have to tell you, this doesn’t make a valid Theory…

    @ Michael van de Riet
    If dollar bills buy you legislation that benefits you and harms your competitors, i.e. allows you to infringe on their property right, you do not have capitalism. The more that takes place the less capitalistic your economy is. The biggest propaganda success of the left has been to convince People that Nazi Germany, or Fascist Italy, was somehow capitalist – when all contemporary German economists of high calibre (Mises, Röpke, etc.) were at pains to point out that that’s not true – These economies merely had a formal capitalist appearance…

    Comment by viennacapitalist — June 29, 2020 @ 1:42 am

  12. Nice piece – even got a long-time lurker like me to comment.

    On the entrepreneurship issue – one aspect that I would focus on is the problem of liquidity. If you knew that your holding period for an investment was measured in decades, not months, you would be far more careful about what you invest in. But the ability of investors to withdraw money at the drop of a pin means portfolios inevitably end up looking the same – I work in very illiquid markets compared to the US, and funds tend to have identical holdings, mostly because they know that they can sell those holdings on if need be. The only funds that did well in my space had long lock-ups and could take the time to really analyse businesses and invest in sustainable growth. They could back small companies and let them become big ones. Investors aspire to this, but offering daily redemptions means they will not be able to fulfil this. Regulations are making this worse – it is so hard to offer a fund that doesn’t allow for quick and easy redemptions in Europe.

    Viktor86

    Comment by Viktor86 — June 30, 2020 @ 2:41 am

  13. Great post. I have lost friends in the C19 crisis and ensuing organized riots that happened after George Floyd. I will not be marched to the gulag. I know some lost friends of mine that will, and it will surprise them when they are.

    Comment by Jeff Carter — July 4, 2020 @ 8:29 am

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