live and which strongly point to socialism as the heir apparent.1
These words were written in 1942 by Joseph Schumpeter, Austrian-born Harvard social scientist, in his prophetic work, Capitalism, Socialism and Democracy. Inasmuch as I intend to build my comments around this work, it might be appropriate for me to reinforce my own judgment of Schumpeter’s competence with a statement by the Nobel Prize-winning economist, Paul Samuelson. In one of his Newsweek columns in 1970, Samuelson wrote:
It is just twenty years since Joseph Schumpeter died. Although it is not my practice to tout profitable speculations, today I’d like to suggest that Schumpeter’s diagnosis of the probable decay of capitalism deserves a new reading in our own time. The general reader cannot do better than begin with his 1942, Capitalism, Socialism and Democracy.
Nothing that has happened in recent years at Berkeley or Harvard would come as a surprise to those who have absorbed this work. And if there are good clubs in the great beyond, one can picture Schumpeter—an 87-year-old by this time, martini glass in hand—reading The New York Review of Books and chuckling with clinical amusement. Only his Viennese veneer keeps him from saying, “I told you so.”2
(In common with his sometime colleague at Harvard, John Kenneth Galbraith, Schumpeter was possessed of a very healthy ego. He is reported to have remarked in his later years that, as a young man, he had had three ambitions: to become one of the world’s greatest economists, one of the world’s greatest horsemen, and one of the world’s greatest lovers. He continued by saying that he was happy to report that he had succeeded in two of those ambitions. He did not identify which two.)
I
On what does Schumpeter base his forecast, and how does all this relate to the life and times of the American businessman today? Bear with me; all will be revealed in due course. We begin with the analysis.
(1) The first question that Schumpeter seeks to answer is this: Has capitalism proved to be a successful economic system in the sense of producing over time continuing improvement in the economic well-being of the masses? His answer to this is an unequivocal and resounding, Yes! In his words, “The capitalist process, not by coincidence, but by virtue of its mechanism, progressively raises the standards of life of the masses.”3 “Queen Elizabeth owned silk stockings. The capitalist achievement does not typically consist in providing more silk stockings for queens but in bringing them within the reach of factory girls in return for steadily decreasing amounts of effort.”4
I direct your attention to his phrase, “not by coincidence....” Critics of capitalism usually argue that the economic performance under capitalism in England and the United States was not the result of capitalism but of a combination of fortuitous circumstances and wise governmental action to counteract capitalist excesses.
Schumpeter takes each of the “fortuitous circumstances” in turn and discards them as possible explanations of the capitalist track record. For example, the virgin land and other natural resources of the American continent were but “objective opportunities” waiting to be exploited by an efficient economic system—and capitalism was that system. I might add that some million or so Indians lived lives of severe economic privation on top of those self-same resources in an area where over 200 million now live lives of Galbraithian affluence.
In the same way the technological revolution of the last two hundred years has been not an historic accident but a predictable concomitant of the capitalist system. More on this later.
To the claim that capitalism’s success was significantly produced by governmental corrections of capitalist excesses, he makes two replies. The first is that the track record (in terms of improvement in real wages) was just as good in the period of minimal state intervention and minimal trade union activity (1870-1914) as in later periods. The second is that most such interventions actually reduced the rate of improvement in economic well-being. For example, he argues that the unemployment figure was increased by the anti-capitalist policies of the 1930s. He concludes: “We have now established a reasonable case to the effect that the observed behavior of output per head of population during the period of fullfledged capitalism was not an accident but may be held to measure roughly capitalist performance.”5
(2) Schumpeter turns next to the question of whether there are any purely economic factors that would prejudice the chances of capitalism continuing to bring improvement in the economic well-being of the masses. In this section, he is answering the doom-sayers of the thirties (including and particularly John Maynard Keynes) who saw in the depression evidence of a deeper malaise in the capitalist economy, in the form of a vanishing of the investment opportunity that had sparked the capitalist engine for so many decades.
His attacks here are centered upon an enemy that has largely disappeared by now, as the “stagnation thesis” which so captured our imagination in the thirties has been undone by the simple course of events. I’ll spare you the details of the argument and report only one of the assumptions of the stagnationists: that, by the late 1930s, all of the great technological breakthroughs had been made, and the capitalist world from then on would be missing this great stimulus to private investment spending. This is an example of what the New Yorker refers to as the “clouded crystal ball.” Schumpeter correctly labels this assumption of the stagnationists as nonsense and describes their other assumptions as either equally nonsensical or irrelevant. His conclusion is that there were no purely economic factors to obstruct continuing success for the capitalist system.
(3) In his answer to his next question, Schumpeter presents what I believe to be the most accurate and useful description of the nature of competition under capitalism ever developed. His question is this: How can capitalism be so successful a system when capitalist reality has always been at such odds with the perfect competition requirement of the textbook models? There are only two possible explanations. One is that “fortuitous circumstances” produced economic growth in spite of the gross imperfections of the capitalist system—but Schumpeter has already denied the validity of this thesis. The second, and the one for which he opts, is that the traditional textbook model of competition and monopoly, with its emphasis on perfect competition as the ideal and the target, is simply not relevant. As he puts it, “If we economists were given less to wishful thinking and more to the observation of facts, doubts would immediately arise as to the realistic virtues of a theory that would have led us to expect a very different result.”6
Perhaps the best way to explain the difference between the textbook and the Schumpeter models of competitive behavior is with an example. In Table A you are given the shares of the diuretic market held by various firms over a ten-year period. By the criteria of the textbook model, each year—taken separately—would reveal a grossly imperfect market structure. Why? Because a few firms dominate the market. In addition (although the data given here do not reveal this), the profit margins on these products for the leading firms each year would most probably be very handsome indeed—perhaps far above what would be thought to be a “normal” profit. The technical description of the market structure, in the language of the textbook model, would be that of “oligopoly”—the rule of the few.
All of this Schumpeter would label as nonsense. Why? Because the investigator would be examining “each year—taken separately” rather than the never-ending game of leapfrog that the data reveal and that represents the true nature of the competitive process.
To the textbook economist, both the size of the firms relative to the market and the high profits on individual products would be evidence of market imperfection, implying “corrective” action (e.g. breaking up the larger firms). To Schumpeter, not only are size and profits not anticompetitive per se; both are natural and desirable features of the competitive process, when viewed as a dynamic process
