Given the destructive consequences of the kind of economic philosophy he favored, Schumpeter is a thinker in need of re-evaluation
I have been immersing myself in Joseph A. Schumpeter's History of Economic
Analysis. My reason for re-reading this classical work was to find the
answer to an enigma: why did Schumpeter call the object of his ambitious work
"a history of analysis", when to an unprepared reader it seems to be
a straightforward history of economic thought? Whoever looks at the matter
covered will find so much more than analysis—page after mesmerizing page on the
socio-political background, on the intellectual scenery, on developments in
neighboring fields, all adorned with wistful reflections on the vanishing
civilization of Europe of which he was such a distinguished product. What did
Schumpeter mean by "economic analysis"? With this odd denomination,
did he want to signify something important about the whole enterprise of
economics? I now think that, in the anti-market atmosphere of the central years
of the 20th century, this was the proclamation of contrarian principles rather
than the mere affectation of a writer who loved to surprise.
I first studied Schumpeter's History at the behest of the
great Lionel Robbins, who had just become my
doctoral supervisor. My intention was to write a thesis on John Stuart Mill and I felt I needed to
be well versed in economics before approaching Mill's work. Robbins told me to
start by reading two books: Alfred Marshall's Principles of
Economics1 and Schumpeter's History—two
weeks for each, he said. It took me much longer than that! The two books set me
on the path to becoming an economist but also left me with an ambivalent
attitude to their two authors. Marshall made me impatient with his ploy of
banishing difficult theoretical problems to the mathematical appendix,
especially his crucial exposition of a general equilibrium model. Not for
nothing did Joan Robinson call him "Marshall,
the old fox". As to Schumpeter, I did not know what to make of his choice
of heroes: François Quesnay extolled for
his Tableau économique, Antoine Cournot placed above David Ricardo, Karl Marx presented as a better
economist than Mill, Leon Walras portrayed as the giant
above all others—and Adam Smith demoted to being a late
mercantilist. Also, I was confused by his constant sniping at free trade. On
the other hand, the broad canvas on which he painted his story I found
beguiling. Let me leave Marshall for another day and concentrate my attention
on 'Schumpeter, the seductive sphinx'.
It is not easy to know what to make of Schumpeter. Devotees of the Austrian
School of Economics would classify him as one of their own, on account of his
efforts to move beyond perfect competition to a new economic dynamics. His
admiration for Karl Marx as economist fits less well with such an affiliation.
His rejection of the general validity of laissez faire excludes him
altogether from the wider camp of classical liberalism. This has not stopped
him from becoming a revered figure in business schools, where his main title to
popularity is the choice of the entrepreneur and creative destruction as the
defining characteristics of the capitalist system.
The Theory of Economic Development, which he published in German
in 1912 at the early age of twenty-nine, did not receive the acclaim it
deserved, principally because it did not appear in English until 1934.2 This book was 'Austrian' in
that it linked booms and busts to the expansion and subsequent contraction of
bank credit. To the explanation of economic growth it incorporated a crucial
'Austrian' actor, the entrepreneur. But he gave a personal twist to both
elements. There could not be a dynamic capitalist economy without cycles;
excessive credit was not such a bad thing, as it was the way of selectively
financing entrepreneurs at the expense of the more staid part of the
population. And in capitalist societies entrepreneurs were neither the
providers of capital nor the inventors of new techniques but rather innovators
who put new ideas in practice and tried to make a profit by exploiting the
advantage of their temporary monopoly.
His book appeared in English when John M. Keynes's much simpler theory of
depressions (and cycles) was to gain the attention of the profession. In any
case, by the time the translation appeared Schumpeter was working on a two volume
work on Business Cycles (1938).3 It
was not a success and could not have been, for it was virtually unreadable.
Also, Schumpeter presented cycles as phenomena occurring at set intervals, when
he should have thought of them as the random result of the bunching of
entrepreneurial innovations. And his detailed historical exposé was
not easily translatable into mathematical models, which is the way growth
theory was moving. Thus the positive contributions of these volumes, as those
of his youthful book, went underground, so to speak. The central role of
innovation driven by entrepreneurs and new firms in the search for profits; the
role of bank credit in sustaining the whole process; and the resulting
continuous change that endangered the position of existing interests were ideas
of Schumpeter's that would take time to move back center stage.4
Creative destruction
Another concept was still to come, that of "the gale of creative
destruction" as the center of the capitalist process. With those words he
summed up the idea that the economy only progressed by destroying existing
modes of production and substituting innovative ones, much to the disarray of
those employed in the up to then useful activities. That felicitous phrase
appeared in his next book, Capitalism, Socialism and Democracy (1942)—paradoxically
a book that described the slow death of the capitalist economy. It was an
instant success and is still read today by friends and foes of capitalist
society. It was published in 1942, barely two years before Friedrich Hayek's Road to Serfdom.
The contrast between those books could not be starker. One is a detached,
almost cynical picture of the undoing of capitalism by its success and its
replacement by planned socialism that would discipline the working classes. The
other is a heartfelt warning that liberty is in danger because of the slow
whittling down of the free market and the mindless drift towards planned
welfare.
I find it surprising that Schumpeter should be held in such high esteem
precisely because of this book and its one short chapter on "creative
destruction". Thus Michael Cox and Richard Alms in their entry in the Concise
Encyclopedia of Economics,5 praise
Schumpeter for turning a spotlight on the role of new technologies, new
markets, and new organizational ideas in transforming the economy. Innovation
undercuts old ways of doing things and destroys the jobs linked to them. But it
also brings about new employment through the continued (though no doubt
irregular) growth we have enjoyed in the West and now in the whole world. One
could say that 'creative destruction' is not a new idea.6 However, many years of static
analysis had turned the attention of the profession away from the dynamics of
capitalism, except for Marx who got this dynamics all wrong. So that it is true
that Schumpeter did a signal service to economics when he said that capitalism
"is by nature a form or method of economic change and not only never is,
but never can be stationary".
But Capitalism, Socialism and Democracy contains much more
than the chapter on creative destruction. In fact, one of the curious features
of Capitalism, Socialism and Democracy is that the gales of
creative destruction of chapter seven disappear from sight as soon as
Schumpeter starts discussing the capitalism of his day. Socialism came as the
inheritor of a monopolistic kind of capitalism, not the competitive kind (Capitalism,
Socialism, and Democracy, page 169). It was needed to rescue "big
business capitalism" from its "fetters" (page 179).
What ails the capitalist society?
The rest of the book makes one look askance at the ambivalence of its
author. It is no mere coincidence that the 2010 edition was prefaced by
fashionable Joseph Stiglitz.7 This
is another case where a presenter does not appear to have read the book
carefully. Stiglitz says that the threat to capitalism does not come from the
left (as if Schumpeter had said that) but "from the right, from the
capitalists themselves": large corporations that lord over markets for
long periods and put capitalism in jeopardy. As an example he points at the
prolonged monopoly of Microsoft over PC operating systems. This does not
capture the whole of Schumpeter's view of the decay of capitalism. First, he
would have observed that this firm's privileged position is now being
undermined by creative destruction. Secondly, he laid the blame of the loss of
innovative capacity of the capitalism of his time not only on big business but
on idle managers, unionized workers, and disgruntled intellectuals.
The book opens with a long discussion of Marx, whose back Schumpeter pats
with paternal indulgence. The real matter of the essay is broached in Part II
on Capitalism, with the following shocking answer to a loaded question:
"Can capitalism survive? No. I do not think it can." (page 53) For
Schumpeter capitalism is being brought down by its very achievements. The
monopolies it fosters, the unequal wealth it creates, the seeds of envy it sows
in its thrust for growth expose it to destructive criticism, so that different
forces conspire to make its walls crumble. When capitalism nears maturity there
is a noticeable obsolescence of the entrepreneurial function. Enterprises grow
into firms and firms into corporations which then become content to enjoy the
advantages of the status quo. The population of mere employees
grows steadily and with it a conservative attitude suspicious of any change.
Organized labor endangers work discipline. Finally, a swarm of underemployed
intellectuals are spawned by an educational system that does everything in its
power to rob capitalism of all legitimacy. Dare I place Schumpeter himself in
this category? In his discharge I will note that he said, "If a doctor
predicts that his patient will die presently, this does not mean that he
desires it." But, as we shall see, he did present socialism as a possible
rescuer of capitalist society in its death throes.
The pure logic of socialism
Part III starts with another revealing question and answer: "Can
socialism work? Of course it can." (page 149) In fact, socialism as
Schumpeter conceives it works on the same analytical principle as capitalism,
only better. "There is nothing wrong with the pure logic of
socialism". This is "so obvious" that "the only authority
standing for denial is Professor Ludwig von Mises." It is only a question
of discovering individual wants and calculating existing factors of production
by a method of approximation that mimics the price system of a free market. The
economist who settled the question, said Schumpeter, was Enrico Barone" in
his article on "The Minister of Production in a Collectivist State"
(1908). The minister would ask consumers about their reactions to price
schedules and producers their reactions to intended quantities, see the
replies, and by iteration discover the arguments of the general equilibrium at
which welfare would be maximized. This method he saw as much more ordered than
the fumbling of the free market. Nothing was said of the temptation of demanders
and producers to cover up their real utility functions, nothing of the
unavoidable ignorance of the central planners due to consumers and producers
not knowing their utility functions until they actually contract. As James M. Buchanan remarked more than once,
these socialists presume that individuals "carry around with them fully
determined utility functions, and [that] in the market they act always to
maximize utilities subject to the constraints they confront." This
assumption is wrong.
[... T]here is no means by which even the most idealized omniscient
designer could duplicate the results of voluntary exchange. The potential
participants do not know until they enter the process what their
own choices will be. From this it follows that it is logically
impossible for an omniscient designer to know, unless, of course, we
are to preclude individual freedom of will.8
More than fifty years had to pass before Ludwig von Mises' depiction of the market
as an engine of discovery and Hayek's insistence on the dispersion of knowledge
in society were proved true and the free market superior to any socialist
mimicry: down went the Berlin wall and up went the true face of real socialism
for all to see.
Be that as it may, Schumpeter clearly held socialism a superior type of
organization of society. Chapter 17 has a section III, titled "The case
for the superiority of the socialist blueprint". There one can read that
socialism will perform better "as soon as the capitalist economy permanently slacks
down", which seems to indicate that Schumpeter thought the demise of
capitalism was at hand.
Socialist management may conceivably prove as superior to big business
capitalism as big business capitalism has proved to be to the kind of
competitive capitalism [...] of a hundred years ago. (page 174)
In his view, socialist planners could start the process from a desired (and
more just) distribution of resources and manage the economy with less
disturbance and loss than in the free market. "As a matter of blueprint
logic it is undeniable that the socialist blueprint is drawn at a higher level
of rationality." (page 175)
How to get from here to there
But before going on to describe the socialist society in its practical
functioning rather than as a blueprint, let us take a look at the transition
from one system to the other as Schumpeter saw it. "The first thing that
must be done is to bring about inflation." Price increases would be
inevitable with the new wage claims. "Inflation expropriates the holders
of claims in terms of money in a delightfully simple way." Then he went on
to paraphrase Lenin: "in order to destroy the bourgeois society you must
debauch its money." Thus Schumpeter begins to show ruthlessness unexpected
in him.
There would follow an extensive program of nationalizations. Such a program
"might [...] accomplish a big step towards socialism": banking,
insurance, railroads, mining, electricity, iron and steel, building and
building materials, "and for non-economic reasons armament, movies,
shipbuilding, trade in foodstuffs" would be taken over. (pages 208-209)
Here Schumpeter was showing an uncommon power of divination of what Clement
Attlee in Britain and Charles de Gaulle in France would do after the war, with
the results everyone knows.
The great lie of democracy
Among the more interesting chapters of the book are those concerned with
democracy. Schumpeter took a realistic view of this great political ideal.
"Democracy is a political method." It is simply an
arrangement to arrive at political decisions and "not an end in
itself". (pages 217-218) It is not a procedure whereby the people take
decisions for the common good by choosing the issues and who will carry them
out. The reality of democracy is the inverse: some individuals acquire the
power to take decisions "by means of a competitive struggle for the
peoples' votes." (page 241) He thus drew an interesting parallel between
the imperfect competition of the political and the economic world.
Under capitalism democracy could work well given certain conditions, such
as good human material, a restricted sphere of political decisions, a competent
bureaucracy, democratic self-control and a large measure of tolerance for
differing opinions. The achievement of these conditions, however, Schumpeter
regarded with some justified skepticism, but that skepticism became
Machiavellian expediency when he admitted with equanimity that "as a
matter of practical necessity socialist democracy may turn out to be more of a
sham than capitalist democracy ever was". (page 269)
The reason for limiting democracy under socialism was that "no
responsible person can view with equanimity the consequences of extending the
democratic method [...] to all economic affairs." (page 266) His
conclusion was stark:
"effective management of the socialist economy means dictatorship not of the proletariat but over the proletariat in the factory". (pages 266-269)In effect, popular sovereignty would be reduced to voting in general elections. If the men used this sovereignty to relax the discipline in the factory, a socialist government, having the future of the country at heart, could restrict even this degree of sovereignty. In any case, tools of discipline would be much more powerful under socialism. Dismissal would mean loss of sustenance. The government could be strict in the guidance of the young. The authorities could also forbid strikes and treat shirking as sabotage.
There even are passages in the work extolling the control of workers in
Russia after 1932: the voluntary extension of working hours without extra pay;
no democratic 'meetingism'; "and nothing more [...] heard of the right to
strike". (pages 192-193) Schumpeter was not totally unaware "of the
sinister connotations of all this," but he excused this regimentation as
being demanded by "the unripeness of the situation" in a country like
Russia having just set foot on the path to socialism. (page 194)
Schumpeter's conception of economics
How could Schumpeter go so wrong? The answer, I hold, can be found in The
History of Economic Analysis. Of course, there is his personality to be
taken into account, a personality that speaks of contradiction, of being pulled
in different directions, of living passionately in diverse countries and
cultures. People who know central Europe only from hearsay will be confused by
this strange man. Some have said that he was a snob trying to feign aristocratic
roots; they do not understand what it was to be a traditional Austrian
gentleman. Some marvel at the number of languages he spoke, but a central
European would be thought uneducated if he did not know many languages,
including Latin if he was born before World War I. Some think he tended to show
off his intelligence and erudition; in Continental Europe it is not done to
hide your light under a bushel. Also, the fastidious gentleman that he was did
not hold democracy in high regard and thought that the working class lacked
self-discipline. He was one of the more distinguished products of the
bourgeoisie that had "put up a splendid fight for heart and home," he
said in his very Capitalism, Socialism and Democracy. He even went
out of his way to praise "the impressive economic and even more impressive
cultural achievements of the capitalist order." (pages 113-144) So there
is need for a deeper explanation of why Schumpeter uncharacteristically took
the side of socialism and why he was so unnaturally detached from the society
that was his heart and home.
Many a writer has seen the same paradox in Schumpeter's History that
I saw when I first read it: he proclaimed that "histories of economics
should confine themselves to economic analysis" and then proceeded to
weave in" intellectual history, biography and economic sociology".9 I now think there is no
paradox but a conscious application of a distinctive methodological point of
view. There is no contradiction in the History but the result
of keeping to the definition of what the task of economists should be: to use
the set of neutral instruments discovered by economists through the ages for
the analysis of the problems and policies of each time and place. The History focuses
on telling how those instruments were slowly fashioned and whence they came. I
now also think that deciding to write on the development of economic analysis rather
than the history of economic thought is the symptom of a much
deeper mistake.
A passage in the methodological introduction to the book will make my
thesis clearer. Economic theory, he says, devises 'gadgets' in its study of the
manifold phenomena of the real world, with whose help resulting reality may be
analyzed. Examples of these gadgets are the 'marginal rate of substitution', 'marginal productivity', 'multiplier',
'accelerator' [...], relations between concepts and methods of handling these
relations, all of which have nothing hypothetical about them. And it is the sum
total of these gadgets [...] which constitutes economic theory. In Mrs.
Robinson's unsurpassably felicitous phrase, economic theory is a box of tools.
(History of Economic Analysis, page 15)
One could ask, where have the multiplier and the accelerator gone? The
discarding of these two gadgets may indicate that the point of economics is not
fashioning of tools but discovering the laws and regularities of society. As I
say, Schumpeter saw the advance of economic knowledge as the slow discovery and
definition of these neutral analytical instruments, which could then be applied
to different problems or situations. In this way,
"... we construct a composite instrument or engine or organon of economic analysis [...] which functions formally in the same way whatever the economic problem to which we may turn. (page 16)
Schumpeter is thus content with analyzing social problems with his box of
tools and tries to harbor no preconception as to what the results of given
policies or institutional reforms will be. For him, those preconceptions simply
constitute the pre-scientific view or Weltanschauung of the
different economists and it is not very productive to try to tell one from the
other. The consequence of his formal conception of economics is that at bottom
he is indifferent to the various ways of organizing social affairs. He
congratulates himself for his kind of economics being free from 'ideology'.
(See Part I, chapter 4, "The Sociology of Economics".) He even goes
as far as to say that Marx "as a matter of fact" was not
influenced by his very definite philosophical views when doing his "work
of analysis". (page 32)
Now, there is another conception of economics that is not merely formal or
instrumental. It sees economics as a systematic effort to discover reality. The
knowledge slowly gathered by economists allows us to foresee how individuals
react to incentives and how the universal 'laws' of human societies function.
In the field of economics the profession has accumulated knowledge that is
substantive and allows us to predict with some confidence the effect of certain
policies or institutions. It would be easy to give examples in microeconomics:
think only of the interesting results of Gary Becker and his followers in the
application of economics to social questions, such as the war on drugs, or the
size of families, or gains from education. Even in the field of macroeconomics,
under a cloud at present because of the late financial crisis, we can with
confidence make predictions. For example, we can predict the long term effects
of persistent increases in money supply on inflation and the rate of exchange;
or the beneficial effects of free trade in the reducing the number of the poor.10
Schumpeter reasons differently. He continuously proclaims his agnosticism
as to the truth of economic theorems. Thus, he explains the hostility against
classical economics because of "the alliance of economic theory with the
liberalism of the nineteenth century". He proceeds to say that "many
people hated economic theory because they thought it was just a device for
bolstering up a political program of which they disapproved". And he even
traduces the professional economists of the time because "they did all
they could to harness their analytic apparatus into the service of their
liberal political creed". (page 19) The result of his 'neutral' position
can be seen in the distance he repeatedly takes from the doctrine of free trade
in many places of his History. But, what if free trade, in
inauspicious circumstances and against the expectations of so many, does in
fact have the observable results deduced by the classical economists? Is this
ideology or science?
Value-free science
There is great confusion about the role of values in science. Of course we
should not, in as far as we can, let our values, political or moral, distort
our account of the facts. But this does not mean that we cannot observe the
effects of a policy in application of a theoretical conclusion. Schumpeter's
pronouncements verge on the absurd when he writes:
We may [...] prefer the world of the modern dictatorial socialism to the
world of Adam Smith, or vice versa, but any such preference comes within the
same category of subjective evaluation as does, to plagiarize Sombart, a man's
preference of blondes over brunettes.
He even perversely applies Robbins' interdict to the observable results of
the predictions of economic theory, when he says that, "there is no
objective meaning to the term progress in matters of economic or other policy
because there is no valid standard for interpersonal comparison." (page
40) Personal evaluation surely refers to our liking or disliking the actual
outcome of policies but not to the deriving predictions from an economic theory
or to the accuracy of the predictions themselves. Let us take an instance where
a theory may have been colored by political valuation, the theory that it is
necessary to create 'the new man' for centrally planned economies. The
prediction of their failure in achieving their aims and especially the
measurement of the effects of such policies on the population are not a matter
of personal preference. There will be people who think that the predicted
unfeasibility of such a theory and the observation of the death of tens of
millions of people of the present generation is a price worth paying for the
creation of the future just society but that does not change what the results
of real socialism have been in the 20th century: the economic theory with whose
help those consequences were predicted by von Mises and Hayek ceases to be
'ideology' if the observed consequences of disregarding those predictions can
be linked to the theory. They cease then to be a matter of personal preference.
It should be unnecessary to say that this does not mean that all has been
done and discovered in the field of economic research. Even the best
established theories can be refuted by facts and turn out to be wrong. But over
the centuries economists have accumulated a respectable amount of useful
knowledge about the workings of society—quite enough to give the free market
the benefit of the doubt. Given the destructive consequences of the kind of
economic philosophy he favored, Schumpeter is a thinker in need of
re-evaluation.
Footnotes
Marshall, Alfred, Principles of Economics. 1920. Library of Economics
and Liberty. 10 September 2013.
Joseph A. Schumpeter's The Theory of Economic Development: An
Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle (translation
into English by Redvers Opie). Harvard University Press (Cambridge): 1934.
Joseph A. Schumpeter's Business Cycles: A Theoretical, Historical,
and Statistical Analysis of the Capitalist Process. McGraw Hill (New York):
1939.
See Thomas K. McCraw's perceptive article "Schumpeter's Business
Cycles as Business History". Business History Review 80
Summer 2006): 231-261. See also his masterful biography Prophet of
Innovation: Joseph Schumpeter and Creative Destruction. Harvard, 2007.
W. Michael Cox and Richard Alm, "Creative Destruction."The Concise Encyclopedia of
Economics.2008. Library of Economics and Liberty.
Ricardo indirectly discussed the effects of commercial and technological
advances in his 1815 pamphlet on the free trade in corn and in the chapter on
machinery of the 1821 edition of his On the Principles of Political Economy and Taxation. Nassau Senior, in his
"Fourth elementary proposition of the science of political economy"
foresaw the possibility of increasing returns to the investment of capital. (Political Economy (1850, 1854).) Marshall
in the Preface of his Principles of
Economics (1890) famously wrote: "The Mecca of the economist lies in
economic biology rather than in economic dynamics. But biological conceptions
are more complex than those of mechanics; a volume on Foundations must therefore
give a relatively large place to mechanical analogies; and frequent use is made
of the term "equilibrium," which suggests something of statical
analogy. This fact, combined with the predominant attention paid in the present
volume to the normal conditions of life in the modern age, has suggested the
notion that its central idea is "statical," rather than
"dynamical." But in fact it is concerned throughout with the forces
that cause movement: and its key-note is that of dynamics, rather than
statics."
Joseph A. Schumpeter's Capitalism, Socialism, and Democracy.
Routledge Classics (Oxford): 2010.
James Buchanan's "Order Defined in the Process of Emergence," in The
Logical Foundations of Constitutional Liberty, Volume I of the
Collected Works of James M. Buchanan. Liberty Fund (Indianapolis): 1999. This
consideration also tells neo-classical economists that they cannot model
individuals as reacting mechanically to incentives.
It has been calculated that the number of people living with less than $1 a
day has been reduced by some 350 million from 1975 to 2000; or by some 783
million if the poverty line is drawn at $2 a day, at the same time as world
population was increasing from 3.6 to 6.5 billion. Pinkovskiy and Sala-i-Martin
(2009), "Parametric Estimations of the World Distributions of
Income." NBER, Working Paper 15433. PDF file. It is not far-fetched to connect
this fall in poverty head counts to globalization rather than to foreign aid.
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