Schumpeter on the Comparative efficiency of Socialism

by Matthew Helming, April 2002


 In Capitalism, Socialism, and Democracy, Joseph Schumpeter presents an argument for the “superiority of the socialist blueprint” (p.193) based upon the inefficiency of capitalism and the “superior rationality of socialism” (p.196). Schumpeter states that capitalism is abound with inefficiency that socialism would be able to avoid through central coordination and communication. For investigatory purposes we will limit our inspection of Schumpeter’s theory to a few narrowed aspects of his comparison of socialism and capitalism; innovation organization/coordination, perfect competition, and public/private sphere interaction. Although these subtitles may blur upon closer study, these themes are prevalent throughout Schumpeter’s work and hold very distinct roles within his spectrum of analysis. Using these three examples it is possible to illustrate the questions raised by Schumpeter’s theory, and more specifically, the question of economic motivation. For the purpose of clarity I will outline several definitions upon which Schumpeter founds his comparison,  between a commercial society and a socialist society.

  In Schumpeter’s words a commercial society “is defined by an institutional pattern of which we need only mention two elements: private property in means of production and regulation of the production process by private contract (or management or initiative)” (p.167). And the difference between commercial society and capitalist society is “credit creation, ….the financing of enterprise by bank credit, i.e. by money manufactured for that purpose” (p.167). Commercial society within Schumpeter’s definition does not have access to this credit creation, for the reason of eliminating monetary comparisons between the two systems and limiting them to economic output, or “productive efficiency”. (Note: lack of monetary incentive within Schumpeter’s construct)

  Socialist society is “designated by an institutional pattern in which the control over means of production and over production itself is vested with a central authority [where] the economic affairs of society belong to the public and not to the private sphere” (p.167).

 Note: Within Schumpeter’s examination commercial society and socialism are held to bare “blueprints” for purposes of simplicity and unilateral comparison based upon efficiency in organization and productive efficiency. The comparison does not include social welfare levels, income distribution, cultural impact of economic system, or transitional difficulty. Schumpeter addresses these issues separately from this analysis.

These definitions were included in order to present the construct in which Schumpeter’s argument resides as well as to specify the method of critique. Schumpeter’s socialist society theory is based largely upon assumptions that proclaim it sound within his construct of economic analysis, and only within it. This is not to say Schumpeter has constructed a flawed analysis, but a specific analysis, which he constructed for the purpose of narrowed comparison on the simplest of levels between two systems.

Assumptions made, Schumpeter’s theory of socialism is still farfetched and at times, contradictory to itself. It states that “capitalism, being essentially an evolutionary process, would become atrophic” and that eventually “profit and along with profit the rate of interest would converge toward zero” so that “socialism of a very sober type would almost automatically come into being” (p.131). Like Marx, Schumpeter also believes capitalism to be a state of evolution, one that is “by nature a form or method of economic change and not only never is but never can be stationary” (p.82). For Schumpeter, the destination is beyond, not in, capitalism. It is based upon this evolutionary outlook that Schumpeter builds his construct within which he analyses commercial society, and through this evolutionary outlook that he examines socialism as a successor to and not competitor with, capitalism. This is a crucial detail within Schumpeter’s analysis for he supposes that capitalism will reach a point where “the economic wants of humanity might some day be so completely satisfied that little motive would be left to push productive effort still further ahead” and that this “state satiety is no doubt very far off even if we keep within the present scheme of wants”(p.131). At some point capitalism will converge and the “present administration would unavoidably acquire the characteristics of a bureaucracy”(p.131) according to Schumpeter. With this scheme in mind it is possible to forget the transitional difficulties, and accept Schumpeter’s construct, and then to examine his theory.

The fueling force behind Schumpeter’s capitalism is a process he labels Creative Destruction. It is directly responsible for the dynamic nature of capitalism. Schumpeter attributes capitalism’s forward motion to innovation, saying “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” (p.83). It is this destructive process created by, and fueling, capitalism that he points to as a loss of efficiency within the commercial society. This organizational structure, as I will label it, Schumpeter points to as inefficiency that socialist society could and would correct upon its succession. The capitalist market system would be thrown out and given up for “an authority to do the evaluating” (p.184). Schumpeter relates that the cyclical problems so many point to as incessant in capitalism can be attributed to “the process of discarding the obsolete in capitalism-especially in competitive capitalism-[which] means temporary paralysis and losses that are in part functionless” (p.195). He goes on to say that the capitalist system lacks “planning of progress” (p.195) which he names “systematic coordination and orderly distribution in time of new ventures in all lines” (p.195). Schumpeter’s solution to this problem lies within the socialist society central board. He describes the problem of decision making, and more specifically that of decisions regarding “the uncertainties about the reaction of one’s actual and potential competitors and about how general business situations are going to shape” (p.186) as one that would be better handled by a socialist society. In capitalist society Schumpeter points to the Darwinist process that removes inefficiency and punishes incorrect decisions, and says that the “temporary paralysis” during decision correction or progression can be corrected or averted because “the managements of socialized industries and plants would be in a position to know exactly what the other fellows propose to do and nothing would prevent them from getting together for concerted action” (p.186). Although at first examination this seems to be simply oligopoly, Schumpeter assures that it is merely “coordinated progression”.  He ends his description of the “socialist blueprint” stating that “the central board could, and to a certain extent would unavoidably, act as a clearing house of all information and as a coordinator of decisions—at least as much as an all embracing cartel bureau would” and that this would “immensely reduce the amount of work to be done in the workshops of managerial brains and much less intelligence would be necessary to run such a system than is required to steer a concern of any importance through the waves and breakers of the capitalist sea” (p.186). Schumpeter’s socialist society blueprint would theoretically be able to eliminate the friction and loss associated with commercial society. This is an incredible boast for a socialist society, but nonetheless an important one for Schumpeter’s construct.

As restricted and narrow as Schumpeter’s construct for argument is, his coordination of progression theory is almost acceptable. The assumption Schumpeter accepts with this central board is that the market’s innovative selectiveness can be duplicated. Let us be reminded that Schumpeter points to this innovative selectiveness as destructiveness. He states that the market tears down old structures, only to put new ones up, and then tear them down again. It is this destruction that results in inefficiency of production, according to Schumpeter. The question posed against that view is this; can progression be coordinated? The reason the market generates innovative friction is because there is no restriction as to what ideas can be used or implemented. Failure is what narrows the field of utilizable ideas and the next innovation. Can innovative progression be selected, coordinated, and standardized, to a system in a manner that would duplicate a free market? Naturally, most economists would rebuff this assumption with the notion of perfect competition and that it cannot be duplicated. Schumpeter counters this with what he calls “bloodless perfect competition”.  

 The second point of analysis of the Schumpeterian construct concerns his assumption of a lack of perfect competition within the commercial society due to creative destruction, which he argues makes perfect competition both impossible, and non-existent. Schumpeter argues that perfect competition will not be attained in the commercial world because “profit economies rely on the absence of perfect competition” (p.87). Schumpeter later explains the theory of “bloodless perfect competition” as one that “turns upon whether or not individual firms can, by their single-handed action, influence the prices of their products and of their cost factors” (p.183). If this condition does not exist, or to say if a firm is unable to do such a thing, and if “each firm is a mere drop in an ocean and therefore has to accept the prices that rule in the market” (p.183) perfect competition is present. (To be perfectly clear Schumpeter sees no perfect competition within the big business economics of his day, which he sees as increasing coordination among firms.) In the perfectly competitive situation a firm competes on a standard level with all firms in its industry. Firms are held to prices and output levels. Rewards go to the firm that is able to innovate production, increase quality, and in some way command consumer preference for their product. Perfect competition is the vehicle for this innovation in industrial production. Although it may not exist in completeness in commercial society, many of its principles do affect the market. Schumpeter argues that perfect competition would exist in his socialist blueprint because it “can be shown that in this case the mass effect of the passive reaction of all individual firms will result in market prices and volumes of output displaying certain formal properties that are similar to those of the indices of economic significance and volumes of output in our blueprint of a socialist economy” (p.183). According to Schumpeter, within this socialist blueprint, perfect competition not only exists, but is maintained. At what point can the activity of a firm be labeled passive? This statement can only be advanced upon the grounds that firms accept passivity in economic activity and coordination from a central power.  I would argue passivity only when a firm is handed its targets and production possibilities, along with a progressive innovation schedule. Schumpeter then says that in the things “that really matter—in the principles governing the formation of incomes, the selection of industrial leaders, the allocation of initiative and responsibility, the definition of success and failure—in everything that constitutes the physiognomy of competitive capitalism, the blueprint is the very opposite of perfect competition” (p.183). Perfect competition depends upon the independent activity of firms and even more importantly upon independent economic operators who make decisions for themselves and then test them in the marketplace. Schumpeter proposes that an “authority would have to do all the evaluating i.e., to determine the indices of significance for all consumers’ goods” and that “in any normal situation it would command information sufficient to enable it to come at first throw fairly close to the correct quantities of output in the major lines of production, and the rest would be a matter of adjustments by informed trial and error” (p.185). Schumpeter simplifies the activity of capitalist free market, known to some as perfect competition, to “informed trial and error” which can be duplicated within the socialist blueprint for “there is in this respect no very fundamental difference between socialist and commercial economies” because both systems strive to reach a “rational” or “optimal” goal, and because managers in both systems face the same problems.

 It is this extreme distillation of capitalism to an organization in which firms passively accept that they cannot change prices that is unbelievable. It is also irrational to believe that a socialist board could preside over a once free market system and provide the same outcome that was achieved in that free market through coordinated decisions. New “decisions” are what provide innovation, advantage, and evolution, of production and consumption. They are made with an inherent risk of failure, and the possibility of financial reward, and so provide an incentive, or return on risk. Schumpeter proposes that this process can be harnessed and recreated and these decisions that “cause temporary paralysis” eliminated and streamlined within the socialist blueprint. Schumpeter proposes this elimination of decision making risk is helpful because “a minor advantage that is also implied in the superior rationality of the socialist plan results from the fact that in the capitalist order improvements occur as a rule in individual concern and take time and meet resistance in spreading” (p.196). Schumpeter would combat this resistance to spreading that he claims is inefficient, justifiably so, for “there [are] often a large number of firms that cling to old methods or are otherwise of substandard efficiency” (p.196), with “improvement [that] could be theoretically spread by decree” which would eliminate this inefficient action and “promptly eliminate substandard practice” (p.196). The reason that a firm makes a change in production process or an “improvement” is to gain an advantage over that of its fellow competitors and to make a profit for doing so. How can an advantage be coordinated? Innovation is not innovation if every economic operator implements it at the same time. Schumpeter points to the weakness of this argument with his own statement “that possible superiorities might in practice turn into actual inferiorities [and] must be kept in mind throughout” (p.197). 

The third point of analysis of the Schumpeterian construct pertains to the separation of public and private spheres which he labels an “outstanding feature of commercial society” (p.197). It is a two part concept in that there is friction between the public and private sphere, as well as a state that lives off of revenue generated by the private sphere. He attributes frictional loss of productivity to this schema because not every individual within the capitalist or commercial society is oriented toward economic production. This loss comes from being “organized as well as run on different and often conflicting principles, productive of different and often incompatible standards” (p.197). Schumpeter points to government interference as a source of paralysis to the capitalist engine and that it is only occasionally responsible for “increases in productive efficiency” (p.197) where the socialist central board “would stand a greater chance of being so” (p.197). Schumpeter sees loss produced by the friction between public and private spheres that would not exist within the socialist blueprint. These losses he attributes to “merely protective activities” which result in “unproductive employment of many of the best brains” (p.198). The loss for Schumpeter is not monetary, as in the fees paid to lawyers who put a “considerable amount of work…into the struggle of business with the state and its organs” (p.198), but it is a social loss due to the diversion of powerful minds that could be better utilized innovating economic production. These losses are amounted to a “considerable” (p.197) loss by Schumpeter due to “incessant inquiry and prosecution” (p.198) which hampers the forces that drives business. In the commercial society the legal profession is driven by the same forces that drive business, pursuit of profit. Again, motivation to earn profit is the driving force here. In the capitalist society there is no restriction of economic activity, and industrious agents exploit all possibilities and opportunities, to comparative advantage, thus the creation of a legal profession.

The second part of Schumpeter’s objection to this separation of public from private is the notion of taxation, during which “revenue which was being produced in the private sphere for private purposes had to be deflected from these purposes by political force” (p.198). Schumpeter points to this relationship as one of resistance, where the apparatus of taxation solicits funds from the private firm or industry against its will, and the ensuing struggle between the two is a great waste of  efficiency and has only worked to produce protective measures on the part of the private sphere against the public sphere. Schumpeter argues that this would not occur in the socialist state “since it would control all sources of revenue, [and] taxes could vanish…” (p.198).   This makes sense when examining the system from Schumpeter’s point of view, for there would be no income in the socialist blueprint and “it would be clearly absurd for the central board to pay out incomes first and, after having done so, to run after the recipients in order to recover part of them” (p.199). Commercial society’s decentralization and resulting friction ensures decentralization of decision making as well as promotion of economic operation in an independent setting where firms can operate as they please, undirected. Schumpeter’s proposed socialist blueprint of coordination and unilateral effort towards economic productivity is an attempt to eliminate frictional losses associated with failure of ideas, conflicting policy, and taxation which he labels as “inevitably in the nature of an injury to the productive process” (p.198). Finally, Schumpeter labels taxation as “one of the most significant titles of superiority that can be advanced in favor of the socialist plan” (p.199).

Understandably, Schumpeter sees taxation, and the required apparatus created to carry it out, as a loss because it works simply to get revenue from individuals and firms who do not want to give it up to the state. And as a result a legal profession and institution has grown up around the struggle between the public and private spheres enabling and furthering the struggle, which he deems a waste of productivity. The question advanced by this writer is how can you include taxation within a construct of analysis of capitalism that doesn’t use social welfare as a measure? Of course without social welfare taxation appears to be a useless and hindering apparatus that generates revenue for the state. Taxation is an aspect of Schumpeter’s comparison of blueprints that is hard to include and understand without giving it a justifiable reason for being there, as is the question of democracy within socialism. And for this reason I reiterate that Schumpeter makes no case for socialist economy, merely for the idea of it based upon the assumptions and definitions included in the beginning of this paper.

Schumpeter’s construct of socialist society is fascinating, because under the presuppositions made by him, it is logical and possible. However, the assumptions within this construct raise problems that need to be addressed, namely that of motivation for economic agents. Schumpeter assumes a labor force that will become completely satiated by economic output and will eventually run into a proverbial wall of production which would “attract the brains and provide the adventure” (p.131) away from economic output. Given Schumpeter’s theory of creative destruction, it is safe to say that he believes in and understands the capitalist process, but guesses as to its destination when he proposes socialism as an evolutionary possibility. 

Within the Schumpeterian construct, or “socialist society blueprint”, there are several problems of major concern that are belittled by assumption. Organizational innovation, or coordination of progression, perfect competition, and private/public sphere interaction, all assume a society that will operate without some sort of motivation or incentive, and through some central coordination. Despite the many social questions of motivation, possibility, and welfare (even though left out of Schumpeter’s model), there are still efficiency questions to examine. Schumpeter reminds us that his examination restricts “economic efficiency of a system…to productive efficiency” (p.188). Schumpeter claims that socialist society could handle all of the problems faced by capitalist society, but in a more efficient manner through central coordination of decision making and innovation, and through reduction of friction between the public and private spheres that produce so much social loss within commercial society. The problem, as demonstrated above, is the driving force behind this socialist blueprint of Schumpeter’s. Capitalism is clearly driven by a volatile force of “creation and destruction” that allows the testing of new ideas and methods of production without screening. The screen is failure and eventually removal via financial insolvency. Schumpeter claims to be able to harness this volatility and spread it through decree among all members of the socialist society so that productive efficiency is always at maximum. Not only will this goal be possible through central communication of ideas and innovations planned to be implemented by individual firms, but through careful planning and execution of the innovations as they are released, all cyclical evils of commercial society can be not just combated, but averted through steadily planned growth.  Two questions arise when examining this: 1)If commercial society evolves to a state of economic bliss so satisfying that all people turn their attention from the pursuit of profit to the pursuit of “adventure” who would remain to work within this coordinated “bloodless perfect competition” with no incentive? And 2) Given this system could be implemented, what economic agent would report an innovation to a central board that would not only return it no reward, but would make public the advantage it had gained on fellow competitors? Schumpeter counters that people will do so for the greater good, but still the question of motivation persists within his construct. Capitalism accepts and utilizes human nature as it is, with consumers acting to maximize their own utility, it does not try to change that basic behavior which cannot be changed. Schumpeter argues that “human nature… a given set of propensities to feel and to act, may be altered by changes in the social environment… [and]…human nature is certainly malleable to some extent” (p.203). This is a large assumption, impossible to answer yes or no to, to base the socialist blueprint upon, and one that lends itself easily to criticism. 

 At the very center of commercial society is conflict that powers new innovation, and exists within all relationships public and private. The reason it succeeds is because conflict is generated in the pursuit of economic reward, an incentive returned to the person or agent that implements it through the taking of a risk. Schumpeter’s central board would have to select what ideas to try, and at the least coordinate their release to combat cyclical fluctuation of boom and bust which he proposes the central board would do. Can this be done in a way to reproduce the economic performance of capitalism? Would it be possible to predict the innovations and ideas that would attract consumers? Can Schumpeter’s social blueprint dictate consumer preference, the ruler within commercial society, and mold it to a socialist will of unilateral growth? Schumpeter’s model is clearly a very interesting examination of socialism and in some places offers very different and insightful looks at capitalist inefficiencies, but leaves questions to be asked. This paper does not presume to say outright that Schumpeter is wrong or arrived at his conclusions incorrectly, merely that there are many questions raised that provoke closer inspection of Schumpeter’s ideas and “blueprints”.



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