Schumptoberfest Mark VII, The Gales of Creative Destruction

In the second post here, I will simply concentrate on Chapter VII of Capitalism, Socialism, and Democracy, and try to tie together some themes for the weekend.  For our purposes, I have numbered the paragraphs 1-13.

As we proceed into this chapter, it is probably useful to keep in mind that at the time of this writing, the national income accounts and measurement of economic output were even more primitive than they are today.  So, one question is how did economists in 1942 think about “growth” and “output”?

The null hypothesis is immediately stated in the opening sentence of the chapter — that there is some question that “capitalist reality” stifles economic growth.  I take “capitalist reality” to mean the consolidation of firms and increasing concentration of industries as they mature.  This is going to get at the essence of a “Schumpeterian Hypothesis,” (see the last sentence of paragraph two for a germination of this idea — “big business may have had more to do with creating that standard of life than keeping it down.” We’ll get to the efficiency implications of this in a bit, but for the moment note that he offers two possible rationales for the antagonism toward large firms.   One is the idea that growth occurs despite the “managing bourgeoisie” (that is, monopolists restricting output and jacking prices).  The second is that this worked for a while, but it cannot proceed indefinitely.

He then touches on the dangers of partial equilibrium analysis and bluntly states that capitalism is an “evolutionary process” (paragraph 4).  Indeed, capitalism is economic change.  These changes are not driven by exogenous change, and the entire system is one of disequilibriating phenomenon — “[t]his process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in and what every capitalist concern has got to live in (paragraphs 5 and 6).

So, let’s pause here and think about the implications of this statement.  Schumpeter is essentially rejecting the idea that capitalism is about allocative efficiency properties that perfect competition generates; instead, he argues, it is about change.  Think about where change comes from in the perfectly competitive model — change in fixed costs, change in variable costs, change in policy, change in demand.  Where is the entrepreneur?  Where is the new idea?  Where do these cost changes come from?  Are these more interesting questions than we get in our price theory course?

That is quite a statement to proceed from, and Schumpeter gets at some of the implications in the next few paragraphs, so note that game theory had not been developed (paragraph 9), and that the field of industrial organization is certainly interested in many of these other dimensions of competition that have nothing to do with price competition.  Indeed, paragraph 10 includes the oft-cited blockbuster:

But in capitalist reality as distinguished from its textbook picture, it is not that kind of competition which counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organization (the largest-scale unit of control for instance)–competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives.

This is certainly a revelation, and it is probably going to be hard to catch your breath after that.  However, as we head to the finish line, notice his mention of retail trade and try to think about reconciling price competition with the evolution of retail trade in your lifetime.

Next up is Professor Galambos’ brief on the economics of innovation.  This is pretty self contained and I will touch on it briefly before delving into the the Teece piece.  I recommend you familiarize yourself with Galambos and take a close look at those first eight pages of Teece’s piece.  As you read, think about how what Teece is saying fits together with Chapter VII of Schumpeter.  Is Teece dismissive of Schumpeter?  How does market structure and innovation really work?