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SCHUMPETER: CAPITALISM, SOCIALISM, DEMOCRACY

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Joseph Schumpeter (1883- 1950) was an Austrian economist who migrated to the United States
in the 1930s. He made various contributions to economics, notably his History of Economic
Analysis. Capitalism, Socialism and Democracy was first published during World War II, in
1942. It applies his expertise as an economist to the great political issues of the day: after the
depression of the 1930s the future of Capitalism was in question; the war was in defence of
democracy; America's ally and rival, the Soviet Union, claimed to be a socialist state.
Marxism
The book begins with a critique of Marx. The subtitle of part 1 is 'The Marxian Doctrine'. The
most interesting parts of it are chapter 2, 'Marx the Sociologist', and chapter 3 'Marx the
Economist'. Schumpeter's criticisms are well-informed and sympathetic. His sociological views
are like Weber's, and he is aware of the kinship between those views and the more sophisticated
versions of Marxism, such as is found in the letters Engels wrote in the 1890s. 'Nevertheless, the
question arises whether the economic interpretation of history is more than a convenient
approximation which must be expected to work less satisfactorily in some cases than it does in
others…. Social structures, types and attitudes are coins that do not readily melt. Once they are
formed they persist, possibly for centuries, and since different structures and types display
different degrees of this ability to survive, we almost always find that actual group and national
behaviour more or less departs from what we should expect it to be if we tried to infer it from the
dominant forms of the productive process… Such facts Marx did not overlook but he hardly
realized all their implications…. [Feudalism] influenced conditions of production, wants and
technology included But its simplest explanation is to be found in the function of military
leadership previously filled by the families and individuals who (retaining that function
however) became feudal landlords after the definitive conquest of the new territory. This does
not fit the Marxian schema at all well and could easily be so construed as to point in a different
direction. Facts of this nature can no doubt also be brought into the fold by means of auxiliary
hypotheses but the necessity of inserting such hypotheses is usually the beginning of the end of a
theory. Many other difficulties that arise in the course of attempts at historical interpretation by
means of the Marxian schema could be met by admitting some measure of interaction between
the sphere of production and other spheres of social life. [Footnote: 'In his later life, Engels
admitted that freely. Plekhanov went still further in that direction.] But the glamour of
fundamental truth that surrounds it depends precisely on the strictness and simplicity of the one-
way relation which it asserts' (Capitalism, Socialism and Democracy (London, 1954), pp. 12-13).
(The point made here – that the 'materialist theory of history' could be defended by introducing
'auxiliary hypotheses', but this is 'the beginning of the end' – was made more elaborately by
Schumpeter's compatriot, Karl Popper, who suggests that what differentiates scientific from non-

scientific thought is that science challenges falsification by experience and does not evade the
test. See Popper, Conjectures and Refutations, pp. 34-37. Popper's views on this topic have led to
much discussion among philosophers of science, the outcome of which seems to be that it is not
possible to draw a line past which resort to auxiliary defensive hypotheses becomes
demonstrably unreasonable, i.e. that there is no clear demarcation line between science and non-
science; see Kilcullen, Sincerity and Truth: Essays on Arnauld, Bayle and Toleration, pp. 163-4.
For criticism of Popper's philosophy of science see David Stove, Popper and After.)
In 'Marx the Economist' Schumpeter criticises the labour theory of value from the standpoint of
modern economic theory (see my earlier lecture on the marginalist theory). The criticism boils
down to this: the labour theory does not account for values in exchange except on special and
unrealistic assumptions; if those assumptions are made, then the propositions of the labour
theory follow from the modern theory, which can thus explain all the labour theory can explain;
and the modern theory can explain things the labour theory cannot explain. See Capitalism,
Socialism and Democracy, pp. 24-9. Schumpeter also discusses various other aspects of Marx's
theory and draws up a list of merits and defects. 'Adherence to an analytical apparatus that had
always been inadequate and was in Marx's own day rapidly becoming obsolete, a long list of
conclusions that do not follow or are downright wrong; mistakes which if corrected change
essential inferences, sometimes into their opposites – all of this can be rightfully charged against
Marx'. But 'Through all that is faulty or even unscientific in his analysis runs a fundamental idea
that is neither – the idea of a theory… of the economic process… producing at every instant that
state which will of itself determine the next one' (ibid, p. 43). (Schumpeter says that Marx was
the first to try to do this. This is a surprising claim, that cannot be true except in some restricted
sense. Comte and Mill wanted sociology to establish laws of the succession of states of society,
and economists engaged in this project as early as Adam Smith.)
Capitalism
In part 2, 'Can Capitalism Survive?', Schumpeter goes on to argue that Marx is, in a way, right
after all: Capitalism will be transformed into socialism. But the transformation will not take
place in the way Marx envisages. There will be no economic crisis. Instead there will be a
growing crisis of legitimacy, due to the progress of rationalisation. (Note that legitimacy and
rationalisation are key concepts for Weber, whose influence is probably at work on Schumpeter.)
Capitalist societies will become socialistic because intellectuals will persistently advocate
change in a socialistic direction.
Its strength
As a preliminary, perhaps to make his conclusion seem more interestingly paradoxical,
Schumpeter emphasises the great strength of capitalism. It appeals to, and reinforces, 'a schema
of motives that is unsurpassed in simplicity and force. The promises of wealth and the threats of
destitution that it holds out, it redeems with ruthless promptitude… These promises are strong
enough to attract the large majority of supernormal brains and to identify success with business
success… They are addressed to ability, energy and supernormal capacity for work; but if there
were a way of measuring either that ability in general or the personal achievement that goes into
any particular success, the premiums actually paid out would probably not be found proportional
to either. Spectacular prizes much greater than would have been necessary to call forth the
particular effort are thrown to a small minority of winners, thus propelling much more
efficaciously than a more equal and more "just" distribution would, the activity of that large
majority of businessmen who receive in return a very modest compensation or nothing or less
than nothing, and yet do their utmost because they have the big prizes before their eyes and
overrate their chances of doing equally well… both business success and business failure are
ideally precise. Neither can be talked away.' (ibid., pp. 73-4). (Comment: if this is true then in
their old age most participants in the system will regard their life as having been wasted.)

Schumpeter defends certain modern developments that have reduced the competitiveness of the
capitalist economy. The neo-classical economists' analyses of the efficient allocation of
resources in an equilibrium state are not of much practical interest, since conditions change so
rapidly that the system never settles into equilibrium. The capitalist economy is swept by a
'perennial gale of creative destruction' (p. 84), a gale of innovation. 'A system – any system,
economic or other – that at every given point of time fully utilizes its possibilities to the best
advantage may yet in the long run be inferior to a system that does so at no given point of time,
because the latter's failure to do so may be a condition for the level or speed of long-run
performance' (ibid., p. 83). Monopolistic or oligopolistic practices or regulation may (may)
contribute to long-run performance by encouraging innovation and other investment; unless the
innovator believes that it will be possible to monopolize the advantage of innovation for a time,
innovation will seem too risky. Compare patents, which encourage invention by promising
inventors a temporary monopoly. 'Restrictions of this type are, in the conditions of the perennial
gale, incidents, often unavoidable incidents, of a long-run process of expansion which they
protect rather than impede' (p. 88). 'Largest-scale plans could in many cases not materialize at all
if it were not known from the outset that competition will be discouraged' (p. 89). 'Perfectly free
entry into a new field may make it impossible to enter it at all. The introduction of new methods
of production and new commodities is hardly conceivable with perfect – and perfectly prompt –
competition from the start' (p. 104-5). However, 'our argument does not cover all cases of
restrictive or regulating strategy, many of which no doubt have that injurious effect on the long-
run development of output which is uncritically attributed to all of them… Rational… regulation
by public authority turns out to be an extremely delicate problem' (p. 91). Schumpeter has much
else to say to those who believe that to deregulate and privatise, establish level playing fields
etc., so as to foster maximum competition in the market place is the way to achieve economic
efficiency.
Its decomposition
But despite its strength Capitalism will be replaced by some form of Socialism. Schumpeter's
argument to this conclusion will be found in chapters 11 -14.
He begins (ch. 11, 'The civilization of capitalism') with a discussion strongly reminiscent of
Weber of the connections between rationalism and capitalism: (1) Capitalism was produced by
the urge to rationalize economic activity; (2) its success reinforces rationalism, and gives it a
bent in certain directions – rationality comes to mean thinking for yourself, seeking individual
self-interest, quantification, calculation, empirical science, positivism; (3) the spread of
rationality in such a sense undermines traditional values and institutions, and eventually (4)
undermines bourgeois values and institutions, i.e. undermines the legitimacy of capitalism itself.
As the development of capitalism proceeds the entrepreneur becomes obsolescent. (What
Schumpeter says here is reminiscent of Weber on the 'routinisation of charisma'.) The modern
giant corporation has corporate planning and research and development sections in which the
firm's bureaucracy does what entrepreneurs did. 'Innovation itself is being reduced to routine' (p.
132). Schumpeter argues that 'this affects the position of the entire bourgeois stratum' (p. 134),
even though the typical bourgeois is not an entrepreneur.
The development of capitalism eventually destroys the remnants of the feudal ruling class which
it needs to carry on the functions of government, and especially to provide government functions
with glamour and prestige. (Cf. Walter Bagehot, The English Constitution, ch. 2, 'The
Monarchy'.) 'Without protection by some non-bourgeois group [in Weber's terms a status group],
the bourgeoisie is politically helpless and unable not only to lead its nation but even to take care
of its particular class interest' (p. 138). Destroying non-bourgeois strata was a matter 'of
removing partners of the capitalist stratum, symbiosis with whom was an essential element of the

capitalist schema… We might well wonder whether it is quite correct to look upon capitalism as a
social form sui generis or, in fact, as anything else but the last stage of the decomposition of
what we have called feudalism. On the whole, I am inclined to believe that its peculiarities
suffice to make a type, and to accept that symbiosis of classes which owe their existence to
different epochs and processes as the rule rather than as an exception… But there is no great
objection that I can see to the opposite view' (p. 139).
Further, the progress of capitalism reduces the importance of the small producer and trader, and
thereby erodes the meaning of 'property' and 'free contract', since property belonging to a giant
corporation and contracts entered into with such a corporation do not have the same concreteness
of meaning. 'This evaporation of what we may term the material substance of property – its
visible and touchable reality – affects no only the attitude of holders but also that of the workmen
and of the public in general. Dematerialized, defunctionalized and absentee ownership does not
impress and call forth moral allegiance as the vital form of property did' (p. 142).
Intellectuals constitute a group 'whose interest it is to work up and organize resentment, to nurse
it, to voice it and to lead it' (p. 145) against bourgeois institutions weakened by the developments
just described. Intellectuals are 'people who wield the power of the spoken and the written word'
in the 'absence of direct responsibility for practical affairs' (p. 147). The intellectual's 'main
chance of asserting himself lies in his actual or potential nuisance value' (p. 147). Capitalism
encouraged the growth and activity of the intellectual class by providing 'the support of the
collective patron, the bourgeois public' (p. 149). The bourgeoisie may now wish to curb
intellectual criticism of capitalism, but they cannot do so effectively. If a government tries to
curb their criticism, 'the bourgeois stratum, however strongly disapproving some of their doings,
will rally behind them because the freedom it disapproves cannot be crushed without also
crushing the freedom it approves… In defending the intellectuals as a group – not of course every
individual – the bourgeoisie defends itself and its scheme of life. Only a government of non-
bourgeois nature and non-bourgeois creed – under modern circumstances only a socialist or
fascist one – is strong enough to discipline them. In order to do that it would have to change
typically bourgeois institutions and drastically reduce the individual freedom of all strata of the
nation. And such a government is not likely – it would not even be able – to stop short of private
enterprise' (p. 150). The expansion of higher education leads to the unemployment, under-
employment or mis-employment of educated people; they become bitter critics of capitalist
society.
'Labour never craved intellectual leadership but intellectuals invaded labour politics. They…
supplied theories and slogans… radicalized it' (pp. 153-4). The worker distrust intellectuals: 'In
order to get hold of him and to compete with non-intellectual leaders, the intellectual is driven to
courses entirely unnecessary to the latter who can afford to frown. Having no genuine authority
and feeling always in danger of being unceremoniously told to mind his own business, he must
flatter, promise and incite, nurse left wings and scowling minorities, sponsor doubtful or
submarginal cases, appeal to fringe ends, profess himself ready to obey – in short, behave toward
the masses as his predecessors behaved first toward their ecclesiastical superiors, later toward
princes and other individual patrons, still later toward the collective master of bourgeois
complexion' (p. 154).
'The social atmosphere… explains why public policy grows more and more hostile to capitalist
interests' (p. 154).
Bourgeois motivation also tends to die out from internal causes: One, mentioned above, is the
evaporation of the substance of property. Another is the disintegration of the bourgeois family –
unwillingness to sacrifice career and comfort to parenthood, consequent lack of interest in a

home of the old type. 'The family and the family home used to be the mainspring of the typically
bourgeois kind of profit motive'; without that motive the bourgeois 'loses the capitalist ethics that
enjoins working for the future irrespective of whether or not one is going to harvest the crop
oneself' (p. 160); 'The businessman's time-horizon shrinks, roughly, to his own life-expectation'
(p. 161).
'The capitalist process not only destroys its own institutional framework but it also creates the
conditions for another…. The outcome of the process is not simply a void that could be filled by
whatever might happen to turn up; things and souls are transformed in such a way as to become
increasingly amenable to the socialist form of life… In both of these respects Marx's vision was
right' (p. 162).
Socialism
If Socialism is coming it becomes interesting to ask: Can socialism work? Can it take a
democratic form? Yes, Schumpeter answers to both questions.
Part 3 is entitled 'Can Socialism Work?'. The most important section is chapter 16, 'The socialist
blueprint'. This answers the economists' objection that central planning cannot set rational
priorities among the competing possible uses of the factors of production. Schumpeter shows
that Socialism could adopt the market as the planning mechanism. Suppose the publicly-owned
means of production are managed by managers who are instructed to aim at making a profit for
their enterprise (the profit would of course belong not to them or to private owners or
shareholders, but to the community); then the central board managing the allocation of
productive factors will auction them off to factories etc. according to what they bid, factories etc.
will produce what consumers will buy, consumer income will be wages from employment,
employees will seek good wages, firms will offer wages according to prospective profitability,
and so on as in the capitalist economy. What this argument shows is that from an economist's
viewpoint there is nothing to choose between private enterprise and socialism: a market
economy can exist whether the means of production are privately or socially owned. So
socialism is as workable economically as capitalism.
Democracy
And democracy is workable, and under socialism will continue to be workable, if we understand
it by analogy with the market: i.e. if we think of it as competition for voter support between
political 'firms'. This is the argument of part 4, 'Socialism and Democracy'. See especially
chapter 22, 'Another theory of democracy'. (For development see Anthony Downs, An Economic
Theory of Democracy.)
'Market socialism' and democracy understood as competition between parties became popular
demands in eastern Europe and the Soviet Union as the Communist regimes collapsed.

Further reading on Schumpeter

Elliott, J. 'Marx and Schumpeter on Capitalism's Creative Destruction', The Quarterly Journal of
Economics (HB/1/.Q3), 95 (1980), pp. 45-68
Heilbroner, R, 'Was Schumpeter Right?', Social Research (H/1/.S53), 48 (1981), pp. 456-71download (4)

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