A Celebrated and Puzzling Book.

• Author: Lemieux, Pierre

Capitalism, Socialism and Democracy

By Joseph A. Schumpeter

431 pp.; Harper & Brothers, 1942

Eighty years ago, publisher Harper & Brothers released the first edition of Capitalism, Socialism and Democracy by Harvard economist Joseph Alois Schumpeter (1883-1950). The book, whose last edition appeared in 1950, is as famous as its author, for whom The Economists business column is named. This last edition is used for this review.

In the book, Schumpeter argued that capitalism will naturally evolve into socialism, that socialism can work, and that it is not logically incompatible with democracy. I will argue against all three of these claims.

What is capitalism? / Schumpeter is perhaps best remembered for his idea of "creative destruction." He believed that capitalism had generated the highest standard of living ever known because it continually creates new consumer goods and services, new methods of production and transportation, new markets, and new forms of industrial organization, while destroying obsolete ways of doing things. In other words, capitalism is a process of invention and innovation that constantly disrupts the economy and improves people's standard of living.

A related idea is that the capitalist businessman is always competing against other disruprors and threats of disruption, even if his industry is a monopoly or an oligopoly. Capitalist competition or threats of competition will "enforce behavior very similar to the perfectly competitive pattern" dear to economists. The relevance of this observation cannot be underestimated and extends to today's economy.

The only "plausible capitalism" that Schumpeter could imagine, however, was a system made of large corporations. He argued that monopoly or oligopoly is the rule, perfect competition is the exception. The latter would in fact be less efficient and it has "no title to being set up as a model of ideal efficiency." It is thus a mistake to think that government should regulate businesses to make them work as if they were small businesses in perfect competition.

Large businesses are the product of creative destruction, and they typically are both more efficient and more stable. Because of the strategic control they exercise on their prices and outputs, they are more adaptive and fare better in recessions. As for their market power, Schumpeter observes that cases of long-run monopoly are rare. Monopolies will not last long "unless buttressed by public authority"--another important observation. Given the organizational efficiency of big corporations with market power, he denies that their prices are necessarily higher and outputs smaller than they would be in some perfectly competitive industry. Thus, he correctly argues, there is no general case for trust busting.

Although there is much truth in his characterization of capitalism, it focuses too narrowly on big business and underestimates the diversity of free markets and the constant competitive pressure and threat from small competitors. Of course, one may put the label "capitalism" on whatever one wants, but how useful is a definition that ignores the rest of free-market businesses, including those that are not yet big? The economic system that produced a standard of living unrivaled in the history of mankind encompasses not only big business but all free-market activities.

Creative destruction is as much a product of small entrepreneurial firms as of the large ones that Schumpeter emphasizes. Walmart did not exist in 1968 nor Apple in 1975 nor SpaceX in 2001. Big corporations were once small and disruptive, and it is because of their disruptive success that they became large. And after some time, such firms are often pushed back down the ladder. Only 10% of Fortune's largest American corporations in 1955 were still on the list in 2021, according to an analysis by Mark J. Perry of the American Enterprise Institute. Large companies often go bankrupt or are acquired or broken up: think of Pan Am, Borders, Sears, Blockbuster, etc. Many divest themselves of chunks of their businesses in order to survive: General Electric is a recent case. Except for growing regulation and protectionism, which favor incumbents, the churning of the business world continues.

Obsolete entrepreneurs / Another indication that Schumpeter's concept of capitalism does not exactly correspond to the real world is his prediction of the obsolescence of entrepreneurs. We may think of them as the source of creative destruction, but he viewed future innovation as coming from "teams of trained specialists" that run the "giant industrial units"--a force of bureaucratization and automatization. Entrepreneurship and innovation would become routine. Economic growth would become more and more automatic. In brief, he thought that corporate bureaucrats would be the new entrepreneurs. Large firms would be so efficient that they would gradually eliminate the very function of the entrepreneur. Capitalism would "make itself superfluous."

Schumpeter's bureaucratic capitalism seems to leave little room for the messy free market and the individual liberty that goes with it. But experience, if not theory, shows that managers and entrepreneurs are two different animals, both important. We may thus suspect that the Schumpeterian concept of capitalism will prove too narrow for a meaningful...