Capitalism, Socialism, and Democracy | Study Guide

Joseph A. Schumpeter

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Capitalism, Socialism, and Democracy | Main Ideas

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Creative Destruction Is the Heart of Capitalism

Joseph Schumpeter's keenest insights and most influential ideas concern the nature of capitalism itself. Schumpeter was intensely dissatisfied with theoretical models of capitalist economics that were based on the notion that an ideal economy existed in an equilibrium of perfect competition. Such a state would consist of many independent buyers and sellers competing on a completely even footing, without a trace of monopoly in evidence.

Schumpeter had two main problems with this model. First, he thought it did not reflect how real economies worked, had ever worked, or would ever work. As a theoretical model it was thus fundamentally useless because it did not reflect reality or provide useful insights. Second, he thought such an equilibrium would be undesirable even if it could be achieved. Schumpeter saw the engine of capitalism's success not in stability but in the constant roiling churn of instability.

For Schumpeter, capitalism's success lay in the process of "creative destruction," a paradoxical term he coined in Capitalism, Socialism, and Democracy. Schumpeter's understanding of capitalism rested on the idea that it fostered constant creativity through innovation by risk-taking entrepreneurs. Competition forced people and businesses to constantly innovate by inventing or creating new products, processes, and forms of labor organization.

Schumpeter broke with many of his colleagues in economics by suggesting that even monopolistic entities were forced to constantly innovate and might even be in a better position to do so than less successful entrepreneurs. This was because monopolies, too, had to innovate or be swept away. And Schumpeter agreed with many of capitalism's critics that this periodic "sweeping away" was an intrinsic part of capitalism's function, not merely an unfortunate accident or the result of occasional human error or of mismanagement.

In the churn of creative destruction, economic actors had to innovate or die and be replaced by those who could innovate. For opportunities to be created, old or stagnant businesses had to fail and be destroyed. For this reason, Schumpeter opposed government intervention (for instance, through the New Deal in the United States) during depressions. He felt such intervention inhibited the normal functioning of a capitalist business cycle, sweeping away the "dead wood" to provide room for new entrepreneurial growth.

Capitalism Leads to Socialism

The constant process of innovation, success, failure, and renewal, was what made capitalism vibrant and what had delivered so much to so many, in Schumpeter's view. But he also foresaw that this process was what would create the circumstances for its own destruction. Indeed, Schumpeter thought capitalism's destruction was inevitable. But Schumpeter's prediction was for more than merely the inevitable death of capitalism; it was for the inevitable rise of socialism in the aftermath. In this he agreed with German political and social economist Karl Marx (1818–83), although Schumpeter differed with Marx on how and why it would come to pass.

Schumpeter's argument was that the inevitable transition of capitalism into socialism had little to do with economics. He believed that capitalism was the superior economic system but that its superiority alone was not enough to secure its future. Instead, his answer to the question of why it would happen was rooted in sociology. The creative and destructive force of capitalism had wrought many economic marvels. However, capitalism has an innate tendency to sweep away not only failed businesses but all sorts of social forms, traditions, ideas, and behaviors and replace them with little but capitalist logic.

The medieval world of lords, knights, manors, and guilds had been destroyed by capitalism's ascent but replaced, in Schumpeter's view, with nothing. Or nothing, at least, more than the desire to ascend in society through the successful management of a business and the acquisition of capital and property. On one level, this was intellectually and culturally stupefying, for "the stock exchange is a poor substitute for the Holy Grail" and the potential glories and conquests of feudal and traditional societies.

This unsatisfactory replacement even happened to the potential glories of earlier stages of capitalism. Schumpeter notes with some dismay that owning a share of stock was not as exciting or vital as physically owning a factory or another productive apparatus. Worse still, in place of enthusiastic defenders of a system, the need for an educated workforce (to produce inventions, innovations, and to manage businesses) produced a class of intellectuals who had no stake in defending the system but did share a culture of criticism and disdain for capitalism.

So Schumpeter saw that capitalism was cutting its own legs out from under itself and, at the same time, building the circumstances that would see socialism rise. In Schumpeter's view, the best argument for capitalism was in the long-term prosperity unfettered capitalism brought. Taking the long-run view, however, required people to bear substantial short-term misery in the form of unemployment, recessions, lost fortunes, and all the other attendant or accompanying negative social phenomena of being on the losing side of creative destruction.

Schumpeter was not blind to these ills. He even acknowledged that few within the economics profession of the time were willing to adopt a purely long-term point of view (compare John Maynard Keynes's [1883–1946] observation that "in the long run we are all dead"). To avoid and minimize short-term harm, people and governments would increasingly look to intervene in the economy and institute state control.

Another factor in why interventionism would become more popular was that state bureaucracies would usher it in on their own. In Europe, Schumpeter observed that the civil service and bureaucratic layer had no loyalty to capitalism because they predated it. In the United States, which was younger than capitalism, the bureaucratic problem was that the civil service had no such tradition and did not understand how vital the creative destruction process was to capitalism. Schumpeter is not merely making theoretical arguments. Rather, he is presenting his assessment of what happened in Europe after World War I and in the United States during the Great Depression as socialist parties took power or government policies began to take control of economic matters in the New Deal of the Roosevelt administration.

The final reason for socialism's ascent was simple. Where capitalism offered no high and mighty goals, socialism did. Its rhetorical emphasis on justice, equality, and other noble goals caused people to wish to strive for something better. Socialism offered the promise of a new heroic age and the bounties of the good society. Schumpeter's observations here stem from his jaundiced (hostile or distasteful) views of socialist activists he had met, whom he tends to deride as irrational cultists throughout the text. But he cannot deny the power of their "religious" fervor and believes the rational capitalist system has no equivalent answer, so he is glum about capitalism's future.

Socialism Can Work, but at a Cost

Schumpeter thought the ascent of socialism was inevitable. He also thought it could "work," but at a cost that would have to be deemed acceptable. Of course, Schumpeter's definition of what it means to "work" must be borne in mind. He did not think socialism could be as economically efficient as capitalism because it lacked the essential fire of capitalist creative destruction. He thought it obvious that a planned economy could indeed provide "consumer's goods" to its populace, even though he thought it probably could not produce so many, of equivalent quality, as a capitalist system.

But socialism, as he notes, aimed at "higher goals than full bellies." Schumpeter believed socialism would "work" because it encouraged people to aim at lofty and noble goals like justice, equality, and the thrill of "building" a new world as part of a collective endeavor. Socialism would thus fill the cultural void left by capitalism with its rationalist insistence only on optimizing society for economic efficiency.

Within this argument lies a criticism. Schumpeter clearly thought socialism was less economically efficient than a capitalist system. But he also thought it was not clear that socialism would necessarily be democratic. Schumpeter argued against the prevailing definition of democracy, that it was a system reflecting the "will of the people." Schumpeter thought such a will did not exist and certainly that no system had ever harnessed it.

Instead, he preferred a definition of democracy as a system that allowed for competition between potential leaders for the right to govern, by competing for the people's votes. This definition is closely aligned with the competition of capitalist economic entities in the marketplace. Schumpeter believed that capitalism and democracy were more closely related than socialism and democracy, even as he stressed that capitalism and socialism were distinct in important ways from democracy itself.

Marx Must Be Taken Seriously

It might seem strange for a capitalist economist to begin with a lengthy discussion of Karl Marx. It is essential to Schumpeter's argument, however, that he spends so much time taking seriously Marx's ideas. And he certainly wants the reader to take Marx seriously. For one thing, from the vantage point of the late 1930s and early 1940s, when Schumpeter was writing, Marxist or neo-Marxist ideas were a major force in world events and world politics, especially following the Russian Revolution in 1917 and the rise of the Soviet Union thereafter.

A state that called itself Marxist (through Vladimir Lenin's early 20th-century expansion on Marx's ideas in Russia) was rapidly becoming a major world player and the heart of a rival social system to capitalism. Moreover, socialist policies were in ascendancy around the world after the Great Depression. Schumpeter himself had argued against the expansion of the role of the U.S. government to oversee economic matters in the New Deal policies of the 1930s. With all this being the case, a responsible capitalist economist could not dismiss Marx and Marxism.

This does not mean that Schumpeter was a Marxist—far from it. He disagreed with Marx in fundamental ways. He is heavily critical of Marx's work as an economist and as a prophet. But, equally, he praises Marx's keen insight as a sociologist (which is the field of study Schumpeter himself uses to guide his predictions) and a teacher. He disdains the followers of Marx for their "religious" zeal, but he points out that Marx himself was above such behaviors. Even his criticism of Marx's work as an economist is keen to stress that Marx worked in a set of specific historical circumstances that may have led to some of his errors.

What is important to Schumpeter is that Marx be taken seriously. Not only had Marx's followers taken positions of power in the early 20th century, but also Marx's analyses of capitalism had real intellectual weight to them—more than Schumpeter felt many of his peers realized. Marx, Schumpeter cautions, was not just a spinner of slogans or a frothing revolutionary. He was a sociologist and analyst of the first rate, whose work contained real and crucial insights about the sweep of history and the functioning of capitalism as a social as well as an economic system.

Although Schumpeter disagreed with Marx's analysis in crucial ways, he agreed with Marx's conception of capitalism as a transformative, creative, and destructive force. Marx had shown that capitalism swept away the social foundations of feudal societies. His prediction that capitalism would do the same to the societies that gave rise to capitalism itself was, to Marx and Schumpeter, equally obvious. Those who disdained Marx (dismissing his ideas rather than merely disagreeing with them) risked missing important warnings about the structural weaknesses of the capitalist system. Missing these warnings, Schumpeter implies, would itself be a factor in capitalism's downfall.

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