Schumpeter’s Vision

This article was written by Sparsh Jain, Intern at Rewired – Summer 2018

The speed and disruptiveness of today’s technological innovation can be overwhelming, and for a long time, I was mistaken to be fearful of these qualities even though they actually lie at the core of what makes capitalism such a powerful engine for progress and growth. That said, today’s capitalism is radically different from that of the past and can even be overwhelming at times, but the solution is not to mould it into something that is less alarming, but to change the way we look at capitalism itself into something that resonates with us more. Perhaps no one has done this better than an Austrian economist named Joseph Schumpeter who, almost a century ago, devised a way of looking at the capitalist economy in a way that rings truer today more than ever before.

Schumpeter’s model of the capitalist economy revolves around the idea of “creative destruction”. It refers to the process in which technology and innovation create new ways of doing things and, in the process, leave the old ways behind. His theory begins with the economy being in a static/circular flow, where employment and competition is stable. And then Entrepreneurs – who he insists are the drivers of capitalism – carry out new innovations which break the economy out of its static/circular flow and set it on a new, dynamic path. Examples of this are plentiful. Factories destroyed farming in the same way Amazon is destroying brick-and-mortar stores.

Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary… The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates”. Creative destruction “incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.” – Capitalism, Socialism and Democracy, 1942

In this visionary theory, Schumpeter predicts four things about the modern economy.

  • Disruption: Said to be the most influential business idea of the early 21st century, the concept of Disruption drives the model that Schumpeter created in the 30s, over half of a century before Clayton Christensen would “coin” the phrase in 1997.
  • Monopolies: Schumpeter liked monopolies. He argued that the most successful engine for innovation and the goal for every budding entrepreneur should be a large-scale big business because it is adaptive to the forces of creative destruction, can adjust for changes in technology and has the resources and discipline to invest in the long-term. Depending on which side you agree with, it can be argued that today’s biggest tech companies are, like Schumpeter says, engines for innovation and growth. They lower prices, increase efficiency and are some of the key players in the innovation of technologies such as self-driving cars and artificial intelligence.
  • Entrepreneurs: Schumpeter positions entrepreneurs as the central driving force of capitalism. And indeed they have become superstars. Innovators the likes of Elon Musk and Mark Zuckerberg are popular, powerful and inspire millions to flock to the rapidly expanding start-up scene.
  • Innovation: Schumpeter sees innovation as the essence of capitalism. And indeed it feels as though everyone is talking about technology these days. Everyone loves to chuck words like “machine learning” into their blog articles and every budding entrepreneur is trying to think of an app that could make them millions. At the same time, tech behemoths compete in the race for the next big invention, while universities and think tanks conduct groundbreaking research.

Schumpeter’s theory of creative destruction is groundbreaking and manages to give a straightforward model of capitalism while preserving its internal dynamism. But some of his other ideas are actually quite unsettling. One of his most famous chapters is titled. “Can capitalism survive?”. In the first sentence he answers, “No. I do not think it can.” Like Marx, he prophesied that the elements at the core of capitalism would ultimately lead to its demise, but instead of communism, Schumpeter believed that this would pave the way for socialism. Interestingly, Schumpeter is not a socialist or a communist and passionately championed capitalism even in the 30s, one of its darkest decades, nonetheless he maintains that we must focus on the “facts and arguments” that lead to his striking conclusion.

Schumpeter’s argument for the demise of capitalism is dense and complex, but nonetheless his ideas are fascinating and provocative and still raise important questions about the state of capitalism today. His argument revolves around 2 claims:

The first is essentially that the entrepreneurial function will erode as the economy turns into a big machine. He explains how rationalization is something inherent in capitalist thinking due to its quantitative and logical nature. This very instinct will lead to monopolistic structures which will sever the link between owners and controllers leading to the new lords of business becoming managers, depersonalised owners and private bureaucrats who undermine the function and the position of the entrepreneur as the hero of capitalism. The last nail in the coffin comes as monopolistic structures gain political power and shift government into a form of corporatism.

The second factor he claims will destroy capitalism is discontent from citizens and attacks from intellectuals. Schumpeter believes that that no system based on the destruction of the old order can keep everyone happy, and as it becomes increasingly dynamic it will inevitably lead a trail of unemployed or underemployed people who rationalise their anger into moral disapproval of the capitalist order. Schumpeter also argues that because the forces of creative destruction only harm producers, consumers actually find it very difficult to recognise how vital this system is in maintaining their standard of living. Schumpeter believes that this will provoke the intellectuals: a group that critiques social matters and stands up for the interests of other classes and is often antagonistic towards capitalism. Coupled with the easy dissemination of information and education that capitalism’s focus on freedom and innovation provides, this discontent grows. As before, the final nail in the coffin comes as parliaments increasingly elect social democratic parties who vote for restrictions on entrepreneurship, bigger welfare states and more social protection.

Thus, “Secular improvement that is taken for granted coupled with individual insecurity that is acutely resented is of course the best recipe for breeding social unrest,” and with these two developments, we see the demise of capitalism.

I am not qualified to judge the academic merit of Schumpeter’s argument, but I still think it is important to look at how it holds up today. Regarding the first point about a lack of innovation, there are indeed some signs pointing in this direction. The monopoly/regulation debate is raging as Facebook continues to buy its competitors, Google is forced to pay billions of euros in fines and the recently we have seen the implementation of the GDPR. And while we haven’t arrived at corporatism yet, the big tech companies have come to acquire large amounts of power to influence politics, i.e. Tencent.

I quite like his second point about backlash and intellectuals. Despite being unscientific, it is actually quite poetic and simple to grasp. Schumpeter was a proponent of economics based on people and history more than numbers. Thus, the importance of his analysis is that it is deeply human. His point about how capitalism cannot survive because it thrives on the destruction of the old order is only rooted in the irrefutable fact that humans don’t like change. His point about how people will push the government to stifle innovation is exactly how human fear and insecurity works: when people get scared they stop believing that the system works and try to control their own destiny regardless of the fine-tuned conditions they muck up in the process. We’re already seeing this to an extent as the big tech monopolies face increasing criticism. I especially liked his point about how people don’t realise how vital capitalism is in securing a person’s standard of living. I remember feeling particularly enlightened after reading opinion pieces on the Guardian titled “Was Capitalism worth it all along?” on my 13-inch Macbook Pro with retina display, kept awake with my Dolce Gusto Nescafe capsule coffee machine while listening to music with my noise-cancelling Bose Headphones.

The brilliance of Schumpeter’s model lies in its ability to portray capitalism it all of its hectic and dynamic glory, while still illustrating the concepts of innovation and entrepreneurship as the driving forces of the capitalist process. Moreover, it also shifted the way I looked at capitalism. In this day and age, where the alarming dynamism of our economy feels overwhelming and out of our control, Schumpeter’s model teaches you to embrace these “gales of creative destruction” for they are the driving force of a system that thrives on finding solutions and improving society.

A brief guide to becoming a meaningful part of the capitalist order

Wellingtonians – from what I’ve seen – have little interest in solving global problems or towards contributing towards a brighter future. More than innovation and progress, they are driven by maintaining the same standard of living as their parents. This extreme insularity has made them largely ignorant of technology which is a shame because technological innovation is showing signs of being the greatest engine for growth we have ever seen. This does not mean that we should all become programmers, but it means that students from all disciplines should be concerned about the future be it relating to policy or the ethics of bioengineering. Polemic aside, I think Wellingtonians have a moral duty to treat themselves as the guardians of the future. This is in NO WAY related to talent or intelligence, but because they are fortunate enough to have access to lots of resources that other people don’t.

Thus, Wellingtonians need to begin to understand what drives the contemporary capitalist order so that they can become meaningful parts of it. A brilliant guide to understanding the problems of the future comes from a chapter in Joseph Schumpeter’s Capitalism, Socialism and Democracy titled “Can Capitalism Survive?” Schumpeter doesn’t believe so and cites two reasons why: broadly summarised he believes that the spirit of innovation will erode and capitalism will come under attack from intellectuals and the general public. The engine of innovation is impossible to stop so we must realise that change and disruption are imminent and that our role lies in making sure that those forces push us in the right direction.

The first two broad considerations are:

  • Understanding the history of innovation: Understanding the effects of the industrial revolution and the computer revolution in relation to society has been extremely helpful in understanding what kind of problems routinely show up and which solutions work. A good example of this is in “The Second Machine Age” by Andrew McAfee and Erik Brynjolfsson who explained that the introduction of electricity into US factories did not produce increases in labour productivity for at least two decades. The reason lies in the fact that despite the new technology, the same layouts and processes were being used. This is a classic lesson that teaches us that the presence of technology alone doesn’t create growth, which comes by adapting the processes and methods around it.
  • The role of the government: Understanding the role of government in the past, present and future is also key to understanding how to get the most out of technology. This is a massive debate. Some say it should step out of the way and let innovators do all the work and some say that government needs to become bigger and more active to minimise the destruction that an increasingly dynamic capitalism would leave in its wake.

The big bulk of your research should be seen along the lines of the two arguments Schumpeter gave for the demise of Capitalism.

  1. How to ensure innovation:

A lot of ensuring innovation has to do with business practices, particularly maintaining competition. The issue of monopolies and how to regulate them is a big bulk of this issue. This is a massive debate, but there are a few things that are important to mention. Firstly, because I think transparency and privacy are things that seem pretty agreeable on all fronts, the crux of this debate is about finding a balance where monopoles may continue innovation without suppressing it elsewhere. This leads to two considerations:

  • Understanding the history of monopoly practices: Monopoly apologist Peter Thiel said that “the history of progress is a history of better monopoly businesses replacing incumbents.” And there is indeed a lot to learn from the history of antitrust regulations. Starting from Sherman Antitrust Act and going through the big cases of the 20th century (US Steel, AT&T, IBM and Microsoft) is crucial in understanding how our way of dealing with monopolies has changed. It also tells a lot about how our monopolies have changed themselves: today’s monopolies lower prices, push innovation and have shorter lifespans, with the average having fallen from 67 years in the 1920s to just 15 years today.
  • Understanding what kind of monopoly practices are actually threats: Like Schumpeter, Peter Thiel agrees that contrary to a state of perfect competition, creative monopolies with incentives to grow can be good for society. Whereas monopolies that show rent-seeking behaviour and aim to increase their own wealth without actually creating new wealth through innovation or solving a new problem deserve their bad reputation.

Further areas of research on the topic of ensuring innovation

  • How to prevent unrest and criticism
  • The second area of research was regarding Schumpeter’s idea of discontent and criticism from the people and intellectuals. This is an important conversation not only in the risks it poses to capitalism but also as a moral duty to help people who have, through no particular fault of their own, become victims to creative destruction. This essentially revolves around inequality, unemployment and underemployment which have become bigger problems as despite soaring labour productivity, private employment and median wage have remained stagnant for decades. One area of inquiry here is regarding the cause of this. Some people cite unequal ownership of capital, decreased social mobility or lack of education. Either way, understanding the causes will help with the solution. Two solutions particularly interest me:

    • Education: There is lots of talk about education in today’s knowledge economy and many people see it as crucial to solving lots of social problems and increasing economic growth. Apart from making it accessible to everyone, the education itself must change. Education must be response to changes in demand for particular skills. Picasso said of computers: “But they are useless. They can only give you answers.” And the quickest way to really put it is that we need to train students to ask questions instead of recite equations. Equally important is to pair education with companies, laws and institutions which can support it.
    • Universal Basic Income (UBI): UBI is an extremely interesting topic and is unique to have found support and criticism from both left and right wing thinkers. It’s too big of a debate to sum up right now but it is a crucial one that asks a lot of interesting questions. People like Erik Brynjolfsson and Peter McAfee oppose it because they believe that having a job is important for personal growth, whereas people like Andrew Yang believe it encourages entrepreneurship by giving people the safety net of a guaranteed income.


    Posted on: July 7, 2018

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