Capitalism, Socialism, and Democracy: Third Edition

In the section on capitalism Schumpeter really tries to do two things. First, he attempts to provide a defense for capitalism based on its dynamic nature. Schumpeter is critical of the defenses of capitalism which base themselves on the notion that under perfect competition “the profit interest of the producer tends to maximize production” (pg77). In two footnotes Schumpeter explains the problems he has with this standard defense of capitalism.

In the first he writes, “The principle, as far as it can be proved at all, applies to a state of static equilibrium. Capitalist reality is first and last a process of change. In appraising performance of competitive enterprise, the question whether it would or would not tend to maximize production in a perfectly equilibrated stationary condition of the economic process is hence almost, though not quite, irrelevant” (pg77). The standard defense relies on the notion that under perfect competition (a state in which prices are parameters and not variables) production will take place up until the point that marginal cost just equals price. It is further argued that this is precisely “as much as it is in general `socially desirable’ to produce” (pg78). But as Schumpeter points out in his footnote this only takes place when the economy is in a state of static equilibrium. Since a capitalist economic system is never in such a state the defense becomes (almost) irrelevant.

In the second footnote Schumpeter is responding to a closely related theorem, namely, the theorem that competitive industry tends to produce a maximum satisfaction of wants. Schumpeter writes, “this theorem, even if we waive the serious objections to speaking of non-observable psychic magnitudes, is readily seen to boil down to the triviality that, whatever the data and in particular the institutional arrangements of a society may be, human action, as far as it is rational, will always try to make the best of any given situation. In fact it boils down to a definition of rational action and can hence be paralleled by analogous theorems for, say, a socialist society” (pg77). Utlimately the defense of capitalism which rests on the notion that perfect competition leads to a maximum satisfaction of wants boils down to the proposition that given any set of parameters (consumption preferences, capital allocations, technical levels, etc.) human beings will tend to make the most that they can with what they have. This applies to any institutional form and is not specific to capitalism.

Schumpeter offers a different (and in my opinion a better) defense of capitalism by pointing to its dynamic character. Schumpeter argues that capitalism is a process which is constantly engaged in revolutionizing the means of production (creative destruction) as entrepeneurs seek `super profits’. This dramatically increases the total output of society and a huge share of this increased output winds up finding its way to the lower classes of society. As Schumpeter says, “There are no doubt some things available to the modern workman that Louis XIV would have been delighted to have yet was unable to have…On the whole, however, a budget on that level had little that really mattered to gain from capitalist achievement” (pg67). The Louis XIV’s of the world are not primarily the ones who benefit from the dynamic of the capitalist system since the capitalist system is overwhelming geared towards mass production and so produces goods that can be consumed cheaply by the masses. This defense of capitalism does not rely on any theorems about maximizing utility under perfect competition and is a far more realistic defense of the advantages of a social system that is ruled by the profit motive.

The second goal of Schumpeter's section on capitalism is to describe the ways in which the processes unleashed by capitalism tend, inexorably, to undermine its own foundations. The most interesting example of this is the way in which property comes to be redefined through the joint stock company. There is a separation of ownership and management. The role of the entrepreneur also begins to erode as the process of creative destruction becomes mechanized and standardized. Instead of the adventurous entrepreneur taking a chance on a new idea we have corporations and their programs of research and development. One of the great virtues of Schumpeter's work is that he manages to avoid viewing things from a restrictively economic standpoint and is able to see the importance of sociological factors in determining the behavior of the economic sphere. So Schumpeter also spends some time discussing sociological changes brought about by capitalism which in turn have an effect on the economic process (family relations for example)

In the section on socialism Schumpeter attempts to work out a logical blueprint for a socialist society that would be capable of solving all the problems that a free-market is able to solve (the allocation of capital, provision for public goods, incentives and motivations for workers and managers, etc.). Schumpeter attempts to argue that there is at least no logical reason why socialism could not work. I am not sure he is entirely successful but this section is at least thought provoking and indicative of the problems that socialists necessarily face in constructing an alternative social arrangement for production and distribution.

In the final section on democracy Schumpeter attempts to reconceive democracy as a competition for political leadership. Democracy is not the rule of the people for Schumpeter, rather, democracy is "the rule of the politician" (pg285). Public policy, on this view, becomes merely a by-product of political competition. This is probably a more realistic picture of how democracy really works then the standard view but it relies on the notion that human beings have far less awareness and knowledge in regard to affairs that do not concern them directly, or that they do not deal with on an everyday basis, and, therefore, do not have strong opinions one way or another. They can be swayed by politicians. In other words, this is not necessarily an analysis of the `eternal' nature of democracy. If human beings were to achieve a better grasp of social issues this vision of democracy might not apply.

In summary, this book is definitely worth reading. Although the first and last sections can be skipped and if you are really in a hurry you can simply read the section on capitalism and you definitely will have read the most interesting and the most influential section of this work.

The book starts with a critical examination of Marxian doctrine — Marx the Prophet succeeded in “weaving together those extra-rational cravings which receding religion had left running about like masterless dogs, and the rationalistic and materialistic tendencies of the time” (p. 6). Marx the Sociologist “linked the fate of the class phenomenon with the fate of capitalism ” (p. 19). Marx the Economist was a follower of Ricardo (p. 22), but not merely a follower. His one truly great achievement was “to see and to teach systematically how economic theory may be turned into historical analysis, and how the historical narrative may be turned into histoire raisonnie”, instead of assigning the facts of economic history “to a separate compartment” (p. 44).

There follows Part II, “Can Capitalism Survive?” Schumpeter has his own individual view of the working of capitalism. The Marxian theory of exploitation, depending on the effect of a perpetual reserve of labor in keeping wages down to the subsistence level, is disproved by experience (pp. 34-7). He himself belongs to the school of thought which treats profit as an excrescence of the economic system, so that in the stationary state neither profit nor interest would exist.

Profit in his view is derived from “innovations”, and he uses the term “entrepreneur” for one who initiates an innovation. “The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organisation, that capitalist enterprise creates” (p. 83). “In dealing with capitalism, we are dealing with an evolutionary proces “; capitalism “is by nature a form or method of economic change, and not only never is but never can be stationary”.

Even monopoly profits are of slight significance, though “there is or may be an element of genuine monopoly gain in those entrepreneurial profits which are the prizes offered by capitalist society to the successful innovator” (p. 102).

“Can capitalism survive?” Professor Schumpeter asks. “No, I do not think it can,” he replies (p. 61).

It might be supposed that, if innovation is “the fundamental impulse that sets and keeps the capitalist engine in motion”, the end would come through an exhaustion of possible innovations. In Chapter X he turns to consider the prospect of a “vanishing of investment opportunity “. In his opinion “there is no reason to expect slackening of the rate of output through exhaustion of technological possibilities” (p. 118), even when “capital-saving” devices pre-dominate (pp. 119-20). But in Chapter XII he poses the possibility that “the economic wants of humanity might be so completely satisfied that little motive would be left to push productive effort still further ahead” (p. 131). If improvements in methods of production were also assumed to have reached their limit, “a more or less stationary state would ensue…There would be nothing left for entrepreneurs to do…Profits and, along with profits, the rate of interest would converge towards zero. The bourgeois strata that live on profits and interest would tend to disappear.”

“For the calculable future,” Schumnpeter comments, “this vision is of no importance. But all the greater importance attaches to the fact that many of the effects…can also be expected from a development that is clearly observable already. Progress itself may be mechanised.”

For, he explains (p. 132), “innovation itself is being reduced to routine. Technological progress is increasingly becoming the business of teams of trained specialists who turn out what is required and make it work in predictable ways…Thus economic progress tends to become depersonalised and automatised. Bureau and committee work tends to replace individual action” (p. 133). The part played by the capitalist entrepreneur ceases to be one of individual leadership, acting by virtue of personal force and personal responsibility for success, and this affects the entire bourgeois stratum which hitherto has been recruited and revitalized by absorbing the entrepreneurs and their families. The bourgeoisie “depends on the entrepreneur, and as a class lives and will die with him”.

"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" (p. 119). There is, no doubt, a tendency for the individual freelance innovator to be superseded by the big concern. The big concern can supply finance and organization for new departures outside its original scope. And the opportunities may be discovered by individuals in its own employment.

But it is not clear that this portends a decay of capitalism. It may transform the character of the middle class, but Schumpeter maintains that the middle class hitherto evolved by capitalism has lacked the qualities essential for political leadership, and has depended on the remnants of feudalism to provide a governing class. May not the new middle class be better qualified not only to conduct economic activity but to animate a political community? In any case, if it is an approximation to a socialist middle class, presumably a completely socialist middle class will manage no better.

His view of the future is shaped by his theory of profit. And his idea that without individual innovating enterprise profit will vanish or become unimportant is surely a profound miscalculation. Indeed, his theory is one more instance of the propensity of economists to explain away profit. Marx's theory of exploitation belongs to the fallacies of a past age. But the present age has its fallacies too. The profit-making which communism would suppress is not dependent on innovations or on monopolies. It arises, with all its anomalies and abuses, from the mechanism of competition and is the remuneration of selling power. It would persist therefore in the stationary state, or under conditions of depersonalized and automatized progress. Profit-making would still be the object of attack. In proportion as the profit-makers become fewer in numbers, they become more open to attack by the multitude, whether by revolutionary action or by the peaceful operation of democracy.

Between socialism and democracy, as conceived by Schumpeter, there is no necessary connection, but there is no incompatibility (p. 284). He is skeptical of the classical doctrine of democracy, postulating a popular will (Chapter XXI). But his own definition of it, as a method "by which individuals acquire the power to decide [in the political field] by means of a competitive struggle for the people's vote", is surely not adequate. The competitive struggle, occurring when there is a cleavage of opinion, and parties offer alternative governments, is a frequent and lively development in democracies. But it often happens that there is no competition and no struggle; the preference of the electorate for a particular group of statesmen is recognized to be decisive, and oppositions are confined to occasional bodies of criticism.

Moreover, the struggle for power, if it is to be democratic, must be one of persuasion. Actual democracies are imperfect, and persuasion is adulterated with intimidation or corruption.

Schumpeter's attitude to democracy as well as to socialism and capitalism is that of a tolerant but ironic critic. Whoever is carried away by great issues, it will not be he. But that is a very salutary approach. His book is full of wisdom, even though of a detached and fatalistic kind.