Capitalism, Socialism, and Democracy | Study Guide

Joseph A. Schumpeter

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Capitalism, Socialism, and Democracy | Context

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Economics

Economics is the study of how a society produces, consumes, and distributes wealth. It is considered a part of the social sciences, but it is generally housed separately from humanities and social science programs in post-modern America. The term economics is derived from the Greek term oikonomia, which means "management of the household (oikos)." People disagree about what economics is as a practice and field of study. Some say it is the study of "economizing," that is, how people make the best use of scarce resources in their lives and in societies. Others argue that economics is the study of how people make all kinds of choices.

Economics has multiple theoretical and practical applications. Economists play a leading role in making policies for governments, private businesses, and all manner of other organizations. Academic disputes between economic theories have major implications for the success or failure of societies and economies. Within the academic community, economics is guided by and related to a number of disciplines. Economic historians, for instance, use the tools of economics to analyze the economies of past societies. In combination with sociology, economists analyze the ways economic thinking influences social development.

A book published in 1776 by Scottish economist and philosopher Adam Smith (1723–90), An Inquiry into the Nature and Causes of the Wealth of Nations, is considered the first work of modern economics. Smith's work was the first in the modern era to consider economics a full-fledged discipline in its own right. Today his book is considered the foundational text of classical economics. It introduces influential ideas, such as the theory that the most certain route to prosperity lies not in the intervention of governments but in citizens' self-interested behavior, which governs markets by an "invisible hand."

Classical economics was expanded by later thinkers, among them British philosopher John Stuart Mill (1806–73) and British political economist David Ricardo (1772–1823). This period, which greatly influenced British economic policy until the late 19th century, emphasized a laissez-faire ("leave it alone") economic policy for governments. Classical economists believed the economy grew best when it was guided by the "invisible hand" of economic actors (citizens and businesses) competing and making decisions, not by government planners. The government instead should be concerned with enforcing property rights and contracts between economic actors.

Economics continued to develop in the late 19th century. An important development was the marginal revolution, a new way of defining the value of a given resource, good, or service. According to earlier ideas, like the labor theory of value, the value of goods was derived from the labor used to produce them. For example, a pair of shoes might be priced according to the amount of time or effort it took to make them. Marginalists, on the other hand, proposed that value was derived from the product's "marginal utility," the benefit or satisfaction the consumer gains from the product. In the marginalist model, the shoes might cost more if the brand becomes more popular, even if a similar, less popular pair takes the same amount of work to make. This development ushered in the era of neoclassical economics, which persisted until the 1930s.

Other developments accompanied marginalism, including the idea that the ideal economy exists in a stable equilibrium of perfect competition. Until the 1930s, economics appeared to be a fairly unified discipline. But the events of the Great Depression (1929–39) helped shatter that illusion. The dominant theories of neoclassical economics had failed to predict the crash and the depression. That failure provided room for new theories, chiefly those of British economist John Maynard Keynes (1883–1946), who gave his name to Keynesian economics.

Keynes's chief economic contribution, the General Theory of Employment, Interest, and Money (1935), argued that the "aggregate demand" in an economy determines employment levels. Aggregate demand, the total level of demand in the economy, included government spending. This practice gave governments a powerful tool to solve persistent unemployment during depressions, such as during the worldwide Great Depression of the 1930s. The theories of Keynes and his followers defined the course of economic policy in most of the Western world until the 1970s.

After World War II (1939–45), economics became solidified as an academic discipline. Keynes's new theories had propelled economists to a role of importance in government and in business. An important academic development in this period was the rise of mathematics as the main language of economic theory. In previous eras, most economic arguments had been written in prose. Joseph Schumpeter's Capitalism, Socialism, and Democracy (1942) is an excellent example of the predominant way in which economic discourse was carried out before the mathematical turn.

Today, economics has been integrated fully not only into the halls of governments and workplaces but in people's daily considerations about the world in the forms of budgeting, taking on debt, and investing. At the same time, economics remains a sketchily defined profession and a site of vigorous argument about the best way to build societies of wealth and prosperity both now and in the future.

The Great Depression and the New Deal

Many of the arguments and considerations in Capitalism, Socialism, and Democracy are direct responses to the Great Depression. The Great Depression, which lasted from the stock market crash of October 1929 until about 1939, was the deepest and longest-lasting period of economic downturn since the beginning of industrial capitalism in the mid-18th century. The crash of 1929 wiped out millions of dollars in investments and caused many businesses to struggle or fail entirely. As a result, the depression led to a sustained period of high unemployment. The impact of the crash was not confined to the United States, where it originated, but was felt globally because of a growing interconnected economy, which accelerated in the 19th century.

The roots of the crash took hold in the 1920s. The New York Stock Exchange, founded back in 1792, hosted a rapid expansion of economic activity through the purchase and sale of stocks. People from all sections of society poured their savings into the stock market, pursuing the vast returns that the expanding market promised. By 1929 the value of stock was greatly inflated. Unfortunately, because the underlying economic realities did not support the inflated value, unemployment rose and wages were stagnant. As a result, people struggled to keep up with their heavy debts. In late October 1929, the dam burst when a flood of panicked investors attempted to sell their stock as quickly as they could to get out of the stock market. Many other investors' shares of stock were quickly made worthless, leaving them financially ruined.

The administration of President Herbert Hoover (1874–1964) struggled to cope with the crash and its after-effects. In bank runs, people rushed to withdraw their savings from banks, which caused the banks to run short of liquid assets or cash on hand. Citizens suffered mass unemployment. By 1932 about 15 million people, or more than 20 percent of the U.S. adult population, were unemployed.

In these circumstances, the Democratic candidate for president, Franklin Delano Roosevelt (1882–1945), won the 1932 presidential election. Upon his inauguration, Roosevelt's administration began a program of sweeping reform to stop the social crisis of the depression and forge a path forward for the American economy and society. This program of reforms and interventions is broadly known as the New Deal, after the term Roosevelt had used in a campaign speech to summarize his offer to Americans.

New Deal policies included reforms and regulation of the financial system, a jobs program overseen by the Works Progress Administration, and social welfare programs, like Social Security, which provided income assistance to retirees. These interventionist programs represented a break with pre-depression economic policy and the death of laissez-faire economics. Roosevelt's administration made it clear that it was the government's duty to intervene in times of economic hardship to save a sinking ship. The theoretical underpinning for this interventionism came from the economic theories of John Maynard Keynes, among other sources.

Across the world, the depression led to a crisis of confidence in capitalism and disintegration of democratic political order. Government intervention in national economies increased. Roosevelt's New Deal had its critics, though, including Schumpeter. Schumpeter alleged that the program was interfering with the normal function of capitalism and more importantly represented an unwelcome step toward authoritarianism. In European nations like Italy and Germany, a less debatable response to the depression was a turn toward dictatorship. In Europe, the depression enabled the collapse of democracy and the rise of fascist governments, which pledged to restore economic stability and national honor.

Another challenge to capitalism came from the socialist states and parties, which advocated total state control over economic affairs. Although Keynes and Roosevelt were capitalists, Schumpeter believed their policies were a symptom of a wider turn against capitalist economics, which would eventually lead toward socialism. From the perspective of the early 1940s, the path toward socialism did not necessarily look like a bad bet.

The Rise of Socialism

At its most basic, socialism is a political and economic system in which property and resources are controlled by a public body rather than by private enterprise. In a socialist economy, a public authority controls resources and makes decisions for the good of society about employment and production of goods and services.

Socialism is an old idea. Diverse thinkers before the modern era proposed societies where resources and production facilities were owned and operated by social equals for the good of all. Utopia (1516), written by theologian and philosopher Sir Thomas More (1478–1535) was just such a work. More's Utopia (from a Greek word meaning "nowhere") was an imaginary community in which all people were equals and property was held by all members of the society. Utopian socialism takes its name from More's Utopia. That type of socialism is the political trend against which the great economist and theorist of socialism Karl Marx (1818–83) defined his own brand of socialism.

Marx wrote in a period of great social upheaval and revolution in the mid-19th century. He proposed a model of historical progress in which capitalism would inevitably give way to an ideal communist society. This transition would be brought about by a class struggle between the bourgeoisie (the owners of capital and property) and the proletariat (the urban working class). Marx's work and that of his collaborator and patron Friedrich Engels (1820–95) provided both a theoretical foundation and a program of activity for the socialist agitators whose movement had grown alongside the rise of industrial capitalism. Although Marx did not invent socialism or communism, his work became one of the most influential definitions of socialism and analyses of capitalism. Marx inspired legions of subsequent socialists, the "religious" followers Schumpeter disdains in Capitalism, Socialism, and Democracy.

World War I's conclusions gave socialist radicals a first real chance to put their political theories into practice. In 1917 the Russian February Revolution abolished the tsarist imperial regime. Later that year, the October Revolution instituted an explicitly Marxist regime to govern one of the world's largest countries. These revolutions were led by Vladimir Lenin (1870–1924) and his Bolshevik Party, which took advantage of the crisis of the Russian state to seize power in 1917. Lenin took Marx's ideas and added his own theory of revolution in order to put Marxism into practice. The world had its first socialist state.

But others were to follow. In Germany in late 1918, Kaiser Wilhelm II's regime fell apart, and a socialist uprising proclaimed an independent republic in Bavaria. This uprising began a period of revolutionary activity that was ultimately unsuccessful in instituting a socialist takeover of Germany. However, the socialist and the more radical communist parties played a major role in German politics until they were violently suppressed by the Nazi government that took power in 1933.

For those like Schumpeter who believed that capitalism worked best when it was unfettered by state interference, the 1930s were a period of dismay. Even those states that were not socialist, like the United States, seemed to be drifting in the direction of socialism as a result of the Great Depression. Socialist political parties rose to prominence worldwide. A major example is the Labour Party in Great Britain, which took power for the first time in 1924. Since then the Labour Party has been one of the two dominant parties in Great Britain, alongside the Conservative Party.

The events of World War I and the Great Depression turned socialism from a radical fringe to a major force. Socialists took power in several countries and directed major policy changes in many others. Laissez-faire economics had given way to Keynesian interventionism and, more significantly, to Soviet central planning (economic policy-setting by government officials). From the perspective of the 1930s and 1940s, it was not ridiculous to believe that socialist systems would continue to rise through the rest of the 20th century. Indeed, the perseverance of socialism is just what Schumpeter predicted.

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