Summary and Analysis Chapter 10



Unlike Thomas Malthus and Karl Marx in the previous century, John Maynard Keynes looked forward to better times for capitalism in the twenty-first century. In his Economic Possibilities for Our Grandchildren, he predicted that by the year 2030, the age-old problem of equal distribution of wealth might be solved. Even though Keynes did not foresee the panacea immediately after World War I, in later years he deduced that capitalism would continue its upward climb. Certainly he could not attribute the easing of hard times to the bounties of nature, since the supply of raw materials was quite obviously finite and dwindling. Instead he lauded the ability of factory workers to utilize technology, thereby making each succeeding generation more productive. For example, in the 1960s, American workers turned out over five times the goods per hour in comparison with their forebears a century earlier. In like manner, Keynes envisioned a rosy future for his native England, calculating that by the year 2060, the nation would produce seven and one half times the wealth of the past century.

The canny student of economy, however, cannot accept this cheerful prognostication without further delving, for a complete analysis of modern times requires a thorough study of more than Marx and Keynes. A third spokesman is necessary: the brilliant gadfly Joseph Alois Schumpeter (1883-1950), a spirited, histrionic Viennese aristocrat and Harvard professor, who saw capitalism in the twentieth century in terms of dynamic growth, yet he relegated it to destruction in the long run.

A contemporary of Keynes, Joseph Alois Schumpeter was a native of Austria, born of solid, yet undistinguished stock. Educated amid the upper crust at an exclusive school, he developed elitist airs that followed him throughout his life. From being a brainy enfant terrible who challenged his teacher at the University of Vienna, he moved to England, where he served successfully as a financial adviser to an Egyptian princess. While in her employ, the twenty-seven-year-old Schumpeter published The Theory of Economic Development (1912), an unassuming overview of capitalistic growth. Surprisingly, the book describes a capitalist economy which lacks accumulation of capital. Relying on a circular flow, the model, like a toy train maneuvering around a hearthside track, remains static and predictable, never altering or expanding.

In answer to the age-old stumper of where profits originate, Schumpeter declares that capitalism, grounded in inertia, has no momentum. Workers, he predicted, would, in time, receive full remuneration for their toil while owners will derive value equivalent only to the resources they contributed. Capitalists would obtain nothing except their wages as managers. Thus, in a changeless economy, profit does not exist.

As Schumpeter elaborates, the only explanation for profits occurs when the static economy fails to follow its circular path, a situation which occurs when capitalists introduce innovative technology or organizational changes. Such ephemeral profit disappears after competitors emulate the innovation. In rapid order, innovation becomes the standard operating procedure. Like a huge, insatiable maw, the system swallows up ideas, turning them into the well-digested fuel of everyday productivity. Because the introducers of these changes differ from the norm, Schumpeter awards them the title of entrepreneur, one who is a business trailblazer, or risk-taker.

An additional surmise of Schumpeter's Theory of Economic Development is his explanation of the business cycle. As a swarm of imitators follows the trail blazed by the business pioneer, investment spending leads to a short-lived economic boom. Competition, as always, forces prices down. Ultimately, profits disappear. Ironically, the entrepreneur is not necessarily the receiver of the profit generated by an innovative idea. As a rule, profits tend to go to the business owner, with the entrepreneur forced out of the picture by the dynamics of the new process.

Schumpeter paints an unappealing picture of the life of an entrepreneur — a talented specialist who differs markedly from the military leader or politician. Treated by society as an upstart or social pariah, the entrepreneur resides outside the limelight. Unlike people who are motivated by the urge for riches or title, the entrepreneur prefers instead to found a dynasty. Goaded by the will to conquer, to climb to the top of the heap, this creator resembles a paladin, or "knight errant of the system." For the entrepreneur, the carrot at the end of the stick is not the monetary reward but the challenge itself, the vacuum into which innovation falls.

After the publication of his ingenious work, Schumpeter served as commissioner on the nationalization of industry, an arm of the socialist German government, as well as finance minister of Austria.

Unfortunately, the unstable times did not permit his creative beacon to shine very far. After Schumpeter moved into a position as bank president in Vienna, the collapse of Europe's financial structure led to huge personal debts. During this trying period, Schumpeter's young and charming wife, whom he had groomed for her role as his helpmeet, died in childbirth.

Like the fabled phoenix, Schumpeter rebounded. He built a career as a visiting professor in Japan, Germany, and the United States. At Harvard, he married economist Elizabeth Boody. Renewed, he allowed his creative juices to flow at will.

In his thousand-page, two-volume Business Cycles, Schumpeter attempted to account for the Great Depression. He based his explanation on a description of three distinct types of business cycles:

  1. A short cycle.
  2. A second span lasting 7-11 years.
  3. A fifty-year cycle evolving from blockbuster inventions like the steam engine or automobile.

The Great Depression, which stands out from the norm of economic ups and downs, was the cataclysm that erupted when a series of all three cycles hit bottom simultaneously.

Schumpeter's conclusion produced a major economic contribution: the belief that capitalism, which evolves from the values of the civilization itself, was losing its steam. Even though his prediction emphasizes a moribund state of the economy, the author appends a small hope that there are still three decades in which capitalism will struggle before dying out completely.

A more complete economic vision appears in Schumpeter's Capitalism, Socialism, and Democracy (1942), in which the author mounts an offensive thrust against his arch-enemy, Karl Marx. Departing from his predecessor's obsession with the antagonism between capitalist and worker, Schumpeter fastens onto the bourgeois nature of the capitalist. Crucial to his denouncement of the wearer of the lounging suit is the author's depiction of plausible capitalism, which describes capitalism as an economic success but a sociological failure. The system bogs down in a bureaucratic nightmare of red tape, where entrepreneurial input counts for little. Yet, even though Schumpeter's scenario plays well on the surface, it is riddled by the disease of rationalism, which gobbles up its own reason for being.

Schumpeter, from the vantage point of his cleverly constructed soapbox, appears to defeat Marx at his own game. The whole breastwork of logic carries some measure of significance in that it predicts the bureaucratization of business and government as well as the ebb and ultimate foundering of the middle-class ideal. Still, the fabric of his logic is weakened in fiber. The mood of Western capitalism did indeed follow his predicted trends through the 1960s. However, it has not resigned itself to the benign socialism he envisioned.

The overwhelming weakness of "the world according to Schumpeter" is that the prognosis is more social and political than economic. In guessing which way the tide of history will direct itself, he lends credence to a belief in a noncapitalist elite, who will form the dynamic core of an otherwise inert society. Unlike Marx's paradigm, which centralizes a disgruntled proletariat in the heart of change, Schumpeter's model places a changing cast of creative movers and shakers at the lead position of capitalistic innovation.


Like the consummate poker player shoving the whole pot into a grandstand showdown, Schumpeter begs the whole question of economics by reducing it to a single quibble: Is the function of economics analytic or predictive? Do economists merely compartmentalize facts about life as we know it or do they serve as visionaries? In other words, is it better to know where the market has been rather than where it's going? Obviously, Schumpeter himself chose the latter role, opting to lay out a vision of future generations than to muck about with the nuts and bolts of mundane money matters.

The driving force in Schumpeter's world-picture is his accolade to the talented few, the idea people who render service to an otherwise not-very-engaging business machine set in the well-worn ruts of sameness. An even more intriguing possibility is that Schumpeter, imbued with elitist notions from childhood, may have set up this paradigm as a means of self-glorification, seeing himself as the swami of elitism.

Whatever his motivation, he has produced a passionate interest in the captains of industry — not the grasping, dog-eat-dog Vanderbilts, Rockefellers, and Morgans of the previous generation, but the Lee lacoccas and Donald Trumps, the Sam Waltons and Ray Krocs, whose genius expresses itself in the proverbial "better mousetrap."

Certainly, Schumpeter's contribution to economics places an emphasis on the part of the whole, which has, in past overviews, tended to fall between the cracks. Instead of stressing the inevitability of money following money or of workers locked into a predetermined social stratum, he opens a window on the spectrum of creativity. To Schumpeter, economics is less dry, less stultifying when interpreted as an outgrowth of wit, talent, and innovation.

From his perspective, the future of capitalism appears less the function of an inevitable movement toward some predetermined end and more like a shapeless lump of clay in the potter's hand. A truly humanistic approach, Schumpeter's evaluation leaves hope that there's always room at the top for the tinkerer, the visionary, or the risk-taker. In his scheme of things, the world beckons perpetually to a Walt Disney, an Estee Lauder, a Steven Jobs, or a Liz Claiborne, whose brain children never capitulate to mundane limitations.


Plausible Capitalism A capitalistic system that perpetually renews itself through growth.

Monopoly Literally, "single seller"; an economic situation in which one firm controls an entire market.

Circular Flow A static system which channels productivity and profits into an endless exchange.

Entrepreneur A risk-taker, or innovator, in the business world.