Ha-Joon Chang - Economics - The User's Guide

One-sentence summary: Capitalism is a powerful vehicle of economic progress, but it will atrophy, as firms become larger and more bureaucratic .

Joseph Schumpeter (1883–1950) is not one of the biggest names in the history of economics. But his thoughts were original enough to have a whole school named after him – the Schumpeterian, or neo-Schumpeterian, school. [92] The prefix ‘neo’ is debatable. The differences between the two are much less than those between, for example, the Classical school and the Neoclassical school. (Not even Adam Smith has a school named after him.)

Like the Austrians, Schumpeter worked under the shadow of the Marxist school – so much so that the first four chapters of his magnum opus, Capitalism, Socialism, and Democracy (henceforth CSD ), published in 1942, are devoted to Marx. [93] They are named, ‘Marx the Prophet’, ‘Marx the Economist’, ‘Marx the Sociologist’ and ‘Marx the Teacher’. Joan Robinson, the famous Keynesian economist, once famously quipped that Schumpeter was just ‘Marx with the adjectives changed’.

Gales of creative destruction: Schumpeter’s theory of capitalist development

Schumpeter developed Marx’s emphasis on the role of technological development as the driving force of capitalism. He argued that capitalism develops through innovationsby entrepreneurs, namely, the creation of new production technologies, new products and new markets. Innovations give the successful entrepreneurs temporary monopolies in their respective markets, allowing them to earn exceptional profit, which he called the entrepreneurial profit. Over time, their competitors imitate the innovations, forcing everyone’s profit down to the ‘normal’ level; just think about the way in which there are now so many products in the tablet computer market, once an almost exclusive domain of the Apple iPad.

This competition driven by technological innovations, in Schumpeter’s view, is much more powerful and important than Neoclassical price competition – producers trying to undercut each other with lower prices, by increasing the efficiency with which they use given technologies. He argued that competition through innovation is ‘as much more effective than [price competition] as a bombardment is in comparison with forcing a door’.

On this, Schumpeter has proven prescient. He argued that no firm, however entrenched it may look, is safe from these ‘gales of creative destruction’ in the long run. The decline of companies like IBM and General Motors, or the disappearance of Kodak, which at their peaks dominated the world in their respective industries, demonstrates the power of competition through innovation.

Why did Schumpeter predict the atrophy of capitalism and why was he wrong?

Despite being such a believer in the dynamism of capitalism, Schumpeter was not optimistic about its future. In CSD , he observed that, with the growing scale of capitalist firms and the application of scientific principles in technological innovation (the emergence of ‘corporate labs’), entrepreneurs were making way for professional managers, whom he disparagingly called the ‘executive types’. With the bureaucratization of the management of its firms, capitalism would lose its dynamism, which ultimately rests on the vision and the drive of charismatic heroes called entrepreneurs. Capitalism would slowly wither away and morph into socialism, rather than meeting the violent death predicted by Marx.

Schumpeter’s prediction has not come true. Capitalism has become actually more dynamic since his gloomy foretelling of its death. He made such an incorrect prediction because he had failed to see how entrepreneurship was fast becoming a collective endeavour, involving not just the visionary entrepreneur but also many other actors inside and outside the firm.

Much of technological progress in complex modern industries happens through incremental innovationsoriginating from pragmatic attempts to solve problems arising in the production process. This means that even production-line workers are involved in innovation. Indeed, Japanese automobile firms, especially Toyota, have benefited from a production method that maximizes worker inputs into the innovation process. Gone are the days when a genius like James Watt or Thomas Edison could (almost) singlehandedly perfect new technologies. That is not all. When they innovate, firms draw on research output and research funding provided by various noncommercial actors – the government, universities and charitable foundations. The whole society is now involved in innovation.

Having failed to appreciate the role of all these ‘other guys’ in the innovation process, Schumpeter came to the mistaken conclusion that the diminishing room for individual entrepreneurs will make capitalism less dynamic and atrophy.

Fortunately, Schumpeter’s intellectual heirs (sometimes called the neo-Schumpeterian school) have overcome this limitation in his theory, especially through the national system of innovationapproach, which looks at interactions between different actors in the innovation process – firms, universities, governments, and others. [94] Leading members of the school, which is sometimes called evolutionary economics, are, in alphabetical order, Mario Cimoli, Giovanni Dosi, the late Christopher Freeman, Bengt-Åke Lundvall, Richard Nelson and Sidney Winter. Having said that, the (neo-) Schumpeterian school may be criticized for focusing overly on technology and innovation and relatively neglecting other economic issues, such as labour, finance and macroeconomics. To be fair, other schools too focus on particular issues, but the Schumpeterian school exhibits a narrower focus than most.

One-sentence summary: What is good for individuals may not be good for the whole economy .

Born in the same year as Schumpeter and sharing the honour of having a whole school named after him is John Maynard Keynes (1883–1946). In terms of intellectual influence, there is no comparison between the two. Keynes was arguably the most important economist of the twentieth century. He redefined the subject by inventing the field of macroeconomics – the branch of economics that analyses the whole economy as an entity that is different from the sum total of its parts.

Before Keynes, most people agreed with Adam Smith when he said, ‘What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom.’ And some people still do. David Cameron, the British prime minister, said in October 2011 that all Britons should try to pay off their credit card debts, without realizing that demand in the British economy would collapse if a sufficient number of people actually heeded his advice and reduced spending to pay off their debts. He simply did not understand that one person’s spending is another’s income – until he was forced by his advisors to withdraw the embarrassing remark.

Rejecting this view, Keynes sought to explain how there could be unemployed workers, idle factories and unsold products for prolonged periods when markets are supposed to equate supply and demand.

Why is there unemployment?: the Keynesian explanation

Keynes started from the obvious observation that an economy doesn’t consume all that it produces. The difference – that is, savings – needs to be invested, if everything that has been produced is to be sold and if all productive inputs, including the labour service of workers, are to be employed (this is known as full employment).