The economy after

Why is the world economy still weak?

Virtually all analysts blame the global recession of 2008-9 on the financial collapse at that time – and for good reason.  In Kazakhstan, the government took over some of the largest financial institutions – including BTA and Allianz banks – to dissuade foreign investors from yanking their funds out of the finance sector, which could have brought on a general default.      

Yet, five years later, the world’s largest economies still ail.  The United States economy grows by less than 2% per year; Japan’s is stagnant; the euro area is contracting slightly.  Even the BRICs are disappointing: Brazil, 1.4%; Russia, 2.9%; India, 4.5%; China, 7.9%.  What gives?

In the gloomy postwar period, the idiosyncratic  economist Joseph Schumpeter suggested that capitalism would so succeed that it would fail. 

For economic growth, we should thank the entrepreneur who newly organizes production, Schumpeter said.  Price competition is anemic; it is the entrepreneur who blasts markets wide open. The airplane, the telephone, the automobile, the computer: Those remake the economy, not Red Tag Specials.

Economists are not always cognizant of this.  “…The problem that is usually being visualized is how capitalism administers existing structures, whereas the relevant problem is how it creates and destroys them,” Schumpeter wrote.  “….A theoretical construction which neglects this essential element of the case neglects all that is most typically capitalist about it; even if correct in logic as well as in fact, it is like Hamlet without the Danish prince.”

Let’s play ‘Monopoly’

Far from the economist’s paragon of an economy of many small firms, entrepreneurs construct monopolies.  Innovation in the rayon industry enabled three firms to control 90% of U.S. production soon after World War I, noted Schumpeter, an economic historian.  With a lockhold on the market for a unique product, the entrepreneur will sock the consumer with high prices.  Schumpeter thus doubts the neoclassical conclusion that economic profits are a sign that resources – what we use in production – are allocated inefficiently.  If Microsoft makes economic profits by selling Windows – which used to be a given -- then it must not face enough competition, say the neoclassical economists; the profits, which are due to scarcity, signal that the market is not producing enough operating systems to satisfy consumers.  Schumpeter counters that the entrepreneur must anticipate economic profits before he will risk innovation.  Profits that look inefficient in the short run may stimulate economic growth in the long run.  The very precariousness of these profits leads the monopoly to erect barriers to entry in the short run; the barriers do not create the profits but result from them.  Even if a hurdle could somehow generate profits, these would attract the debilitating attentions of rivals soon enough.   

In a sense, we become creatures of the entrepreneur.  “It is…the producer who as a rule initiates economic change, and consumers are educated by him if necessary; they are, as it were, taught to want new things….” So it may not be surprising that we don't really want the entrepreneur.  He doesn't fit into the comfortable society that he has made possible for us.  Unlike us, he is not a hedonist, since the diminishing satisfaction of another dollar consumed would long ago have discouraged his pursuit of billions.  He is instead driven by the terrifying desires to conquer others and to found a dynasty comparable to a “medieval lordship.”  “Successful innovation is…a task sui generis.  It is a feat not of intellect, but of will.  It is a special case of the social phenomenon of leadership.”

Even his “joy of creating” threatens the comfort that we take in familiar surroundings.   His independence, his penchant for taking risks, frighten us; we just want to hang onto our pleasant lives.  “…Stabilized capitalism is a contradiction in terms.” 

So, over time, we drive him out of existence, probably through government regulation.  “There would be nothing left for entrepreneurs to do.” Profits would vanish.  The rate of interest would fall to zero, since the only function of interest is to divert resources from conventional uses toward entrepreneurial ones; rentiers would pass from the scene.  Capitalism would lead to affluence, but affluence would lead to timidity – and that, in turn, to socialism.  “The true pacemakers of socialism were not the intellectuals or agitators who preached it but the Vanderbilts, Carnegies and Rockefellers.”  Although Schumpeter thought that socialism would survive, he did not enthuse over the prospect. For him, socialism was the land of the lotus eaters.

For whom the bell tolls

The entrepreneur colludes in his own extinction by providing the means of replacing him – information about innovating that can generate a routine.  “The more accurately…we learn to know the natural and social world, the more perfect our control of facts becomes; and the greater the extent, with time and progressive rationalization, within which things can be simply calculated, and indeed quickly and reliably calculated, the more the significance of [the entrepreneurial] function decreases.”  “…Innovation itself is being reduced to routine.”  The rise of the corporation was evidence of this trend; divested of managerial duties, the owner’s attitude becomes “more distant, less personal, more rationalized.”  In not the most prescient of comparisons, Schumpeter suggests that the entrepreneur will become enervated, “just as the importance of the military commander has already diminished.”  Business management will resemble a bureaucracy. Most important, the leader will yield to the mundane: “The perfectly bureaucratized giant industrial unit not only ousts the small or medium-sized firm and ‘expropriates’ its owners, but in the end it also ousts the entrepreneur and expropriates the bourgeoisie as a class which in the process stands to lose not only its income but also what is infinitely more important, its function.”  Capitalism would destroy the old order just as surely as it had created it.

The decline of the entrepreneur will gentle the business cycle and retard economic growth.  Output also stabilizes because the number of large firms grows with cumulative innovations over time.  New entrepreneurs can then introduce their innovations by taking over existing large firms rather than by driving small ones into bankruptcy. 

When the entrepreneur finally was dead, then the affluence of the society that he had created could easily provide a surplus from which to support those who could no longer find the jobs that had once been created by his gambles.

Schumpeter summarizes his argument: “Capitalism, whilst economically stable, and even gaining in stability, creates, by rationalizing the human mind, a mentality and a way of life incompatible with its own fundamental conditions, motives and social institutions, and will be changed, although not by economic necessity and probably at even some sacrifice of economic welfare, into an order of things which it will be merely matter of taste and terminology to call Socialism or not.” The Keynesian notion that more consumption could salvage an economy from depression was, in fact, a product of capitalism itself, which had created a class too affluent to worry about saving for the future.

Schumpeter – a failed banker himself -- did not deny the importance of banks.  The entrepreneur must turn to them to create credit for her; otherwise, she will not be able to bid away resources from normal production.  It is the banker, not the entrepreneur, who truly assumes risk – and maybe too much of it, judging from 2008.  At the same time, the re-regulation of banks ensuing from 2008 may block entrepreneurial breakthroughs that could resuscitate a comatose economy – in a Schumpeterian perspective, at least. 

The most contrarian argument of this contrarian Austrian is that we should view today’s economy against the long sweep of social forces and history.     -- Leon Taylor, tayloralmaty@gmail.com

Notes

1.  The reported rates of economic growth are in gross domestic product, adjusted for inflation, and come from the back pages of The Economist.

2.  All quotes are from Schumpeter’s writings.

“…Danish prince”: Capitalism, socialism and democracy, pages 84-6

Rayon industry: Business cycles, page 316.

“want new things”:  The theory of economic development, page 65.

 

“medieval lordship”:  The theory of economic development, page 93

“phenomenon of leadership”: “The instability of capitalism,” page 379

“joy of creating”:  The theory of economic development, pages 93-4

“contradiction in terms”:  Business cycles, page 405.

“entrepreneurs to do”:  Capitalism, socialism and democracy, page 131

“Carnegies and Rockfellers”: Capitalism, socialism and democracy, page 134 

“function decreases”:  The theory of economic development, pages 85-6

“more rationalized”:  Business cycles, page 282

“military commander has already diminished”:  The theory of economic development, page 86

“infinitely more important, its function”:  Capitalism, socialism and democracy, page 134

Driving small firms bankrupt:  “The explanation of the business cycle”, page 299.

“call Socialism or not”:  “The instability of capitalism”, 385-386.

Good reading (all from Schumpeter)

Business cycles: A theoretical, historical, and statistical analysis of the capitalist process.. New York: McGraw-Hill.  Abridged.  1964 [1939].

Capitalism, socialism and democracy.  New York: Harper.  Third edition.  2008 [1950].

“The explanation of the business cycle”.  Economica 21.  December 1927.  

“The instability of capitalism”.   The Economic Journal 38.  September 1928

The theory of economic development: An inquiry into profits, capital, credit, interest, and the business cycle.  New Jersey: Transaction.  1982 [1911].