Entreprenuership, Economic Evolution, and the End of Capitalism

0:00Well, thank you everyone for coming and thank you to Lew Rockwell and the Mises Institute for the opportunity to give this paper. I should apologize in advance, I had to cut a good deal out of this paper to make it work for this presentation, so if it appears a little disjointed, that's the reason. Joseph Schumpeter has the unenviable distinction of being one of the most oft quoted, yet least understood economists in history. This is due in part to his ambiguous position between the Austrian economists and the various schools of neoclassicism, an ambiguity most evident when examining his extraordinary yet sometimes neglected work, Capitalism, Socialism and Democracy. Although there are many gems of economic insight in this book, the central thesis around which they are constructed is often dismissed as simply false. In a nutshell, this thesis is that capitalism's inherent strengths ultimately lead first to its decline and then to its collapse and replacement by socialism.

0:52The purpose of this paper, then, is to reconsider this thesis and attempt both to criticize and to update it. To that end, I first examine Schumpeter's theory of the entrepreneur, which provides much of the groundwork for his theory of capitalism. It is in his flawed conception of the entrepreneur wherein the seeds of his later thesis in regard to capitalist evolution are sown. However, by repairing Schumpeter's concept of the entrepreneur, i.e. by making it more Misesian, we may follow his line of reasoning and arrive at a thesis which is both more stable theoretically and, I think, more familiar to Misesians. In place of the claim that capitalism's inherent strengths will destroy it, we instead hope to show that capitalism will only bring about its own demise given the presence of a system of economic intervention, that is, given the partial subversion of the capitalist system.

1:37Let us turn to the thesis itself. Schumpeter's theory is first and foremost a theory of social change, or what he would call economic sociology. Schumpeter sums up his argument as follows, The actual and prospective performance of the capitalist system is such as to negative the idea of its breaking down under the weight of economic failure, but its very success undermines the social institutions which protect it and inevitably creates conditions in which will not be able to live and would strongly point to socialism as the heir apparent. End quote. More explicitly, capitalism is perceived as an essentially dynamic mechanism for economic change in society and perpetual change is in some sense capitalism's defining characteristic. The ceaseless process of change with its corresponding introduction and its necessary elimination of the old methods eventually produces a system of values in society which undermine the values of capitalism and thus lead to its replacement by a socialist system.

2:29Economically, capitalism eliminates the entrepreneurial function aided by the anti-capitalist sentiments of the intellectual class and transforms it into what is essentially a static state of affairs, once susceptible to socialist management. In short, quote, there will be nothing left for the entrepreneurs to do. Profits, and along with profits, the rate of interest would converge towards zero. The bourgeois strata that live on profits and interest would tend to disappear. The management of industry and trade would become a matter of current administration, and the personnel would unavoidably acquire the characteristics of a bureaucracy. Socialism of a very sober type would almost automatically come into being, end quote. To examine the possible merits of this thesis, we must first evaluate the Schumpeterian entrepreneur, because it is his fate that ultimately determines and the Fate of the Capitalist System. Schumpeter's contributions to the theory of the entrepreneur are among the most important of his career and serve both directly and indirectly as the foundation for much of his argument regarding capitalist evolution.

3:23Here, however, we will only discuss some of the major points. Schumpeterian entrepreneurship is most clearly described in his theory of economic development, where among other things he introduces his famous concept of creative destruction. There are, however, certain problems with this theory of the entrepreneur that require emphasis. As an aside, we should note that in this theory of entrepreneurship, the imprint of von Wieser is unmistakable, which in itself serves as a clue to the theories of Al-Razi and shortcomings. As mentioned above, for Schumpeter, the entrepreneur plays the most important role in capitalist society because he introduces change, which is the fundamental fact of capitalist life. When the entrepreneurial function becomes unnecessary then, or somehow altogether eliminated, it follows that the mechanism of change must grind to a halt and a period of economic stagnation be introduced. As Schumpeter puts it, quote, economically and sociologically, directly and indirectly, the bourgeoisie therefore depends on the entrepreneur, and as a class, lives and will die with him, end quote.

4:18This claim is true as far as it goes. What matters for us, though, is the claim that the capitalist system itself will produce this result. What then is the entrepreneurial function according to Schumpeter? As Kirzner observes, for Schumpeter, entrepreneurship is reserved for the brilliant, imaginative, daring, resourceful innovator. For Schumpeter, the entrepreneur is the driving force of all economic transformation under capitalism. He does this by carrying out new combinations, by which is meant that he introduces innovation, be it a new invention or merely a new production process. It is also important to note that the entrepreneur acts in isolation from the means of production in this model. That is, he does not direct production but enjoys a somewhat passive role. Once the innovation is introduced, for the entrepreneur, the work is essentially complete. We can already see in the above that the entrepreneurial function is at the very least rather narrowly defined, a fact that even Schumpeter acknowledges.

5:08The final cornerstone of Schumpeter's entrepreneurial theory that we will address is closely related to his general equilibrium concept. Schumpeter argued for a circular flow concept of the economic process, essentially a variation of Volrasian general equilibrium. Change is only introduced to the model through the entrepreneurs, who launch various economic innovations which they finance exclusively through credit created especially for the entrepreneurs by banks. Once introduced, innovations inspire imitations and competitions between the alternatives bids the rate of profit down to zero. Thus entrepreneurial profit tends towards zero and is zero in the long run. Eventually, the economy adjusts to this disequilibrating innovation and returns to another Volrazian equilibrium state. This is all opposed of course to the thinking of Boehm-Bawerk or Mises who hold that new sustainable investments must come from past saving.

5:54Contrary to this position, Schumpeter argues that, quote, the entrepreneur does not save in order to obtain the means which he needs, nor does he accumulate any goods before he begins to produce, end quote. He merely plays a sort of game with credit created upon his request. Quote, the entrepreneur is never the risk bearer. The one who gives credit comes to grief if the undertaking fails. For although any property possessed by the entrepreneur may be liable, yet such possession of wealth is not essential, even though advantageous. Risk-taking is in no case an element of the entrepreneurial function. The Above highlights the central problem with this theory, to which we now turn. The problem in question is the assertion that the entrepreneur does not bear uncertainty in the marketplace. Without uncertainty, we can perhaps explain entrepreneurial success, but we cannot explain entrepreneurial loss.

6:43Or more correctly, this theory is simply not interested in trying to explain it. Accordingly, one-half of the entrepreneur's economic function disappears from the analysis. In this case, it is simply ruled out by this somewhat pedantic focus on successful innovations. What is more, we lose sight of a fundamental economic problem, the social function of bankruptcy. Without an explicit acknowledgement that entrepreneurs bear uncertainty and the corresponding realization that entrepreneurs can easily fail in their endeavors and thus squander society's resources, it is relatively easy to accept a static circular flow model of the economic affairs, one that is susceptible to socialist economic planning. As we will see, much of Schumpeter's argument rests upon this point. Our analysis of some of the problems of the Schumpeterian entrepreneur leads nicely into an examination of his theory of capitalist evolution, which is in many ways an extension of his theory of entrepreneurship. There are three major arguments upon which Schumpeter's thesis turns. First, the obsolescence and disappearance of the entrepreneurs, second,

7:37the bureaucratization of firms, and third, the destruction of certain social protections of capitalism. We will deal with these in turn, starting with the disappearance of the According to Schumpeter, the elimination of the entrepreneurs occurs due to the bureaucratization of the entrepreneurial process, that is, the method through which innovation itself is reduced to routine. Schumpeter is actually quite vague on the issue of how this process is to take place, but we can make an educated guess and assume that he simply means that innovation will eventually become such a trivial task in the economy that it may easily be orchestrated by a bureaucratic planner. The first question we must ask then is, can progress, that is, economic adjustments to the future, be made a matter of routine in a capitalist economy? The short answer is, no, they cannot.

8:22The problem with this argument is closely related to the problem of uncertainty alluded to above. As Mises points out, quote, every action is embedded in the flux of time and therefore involves a speculation, end quote. All plans are subject to error on the part of actors, and entrepreneurial forecasts are no exception. A successful bureaucratization, however, would require a consistently accurate forecast as to what innovations will be required at particular times and places. However, it is precisely the presence of uncertainty that makes continued success so difficult for entrepreneurs. Rothbard sums this point up nicely, quote, Inventions, innovations, technological developments, by their very nature, by definition, cannot be predicted in advance, and therefore cannot be centrally and bureaucratically planned. Not only does no one know what will be invented when, no one knows who will do the inventing. Bureaucracy, incompetent enough to plan a stationary system, is vastly more incompetent at planning a progressive one."

9:14In addition, Professor Holzman makes an important epistemological point in this regard when he observes that we can never really know how many entrepreneurial opportunities actually exist, or, for that matter, how many fail to be created. This is not to say that correct anticipations of consumer wants cannot occur, or that it is impossible to plan for future production based upon as yet unrealized patterns of preference. All we mean is simply that any such plans are tentative and subject to error. But to make progress a matter of routine would require constant accuracy and entrepreneurial forecasting, something that is assumed by Schumpeter's entrepreneurial theory, but which, viewed in the light of praxeology and the constant threat of error in human action, is an impossibility. In dealing with the uncertain future, acting man cannot plan in any way beyond what is meant by the ordinary uses of that term. That is, man cannot do better than to act proposively in the face of uncertainty.

10:04Continuing on this line of argument, Schumpeter goes on to claim that,

10:22in Predictable Ways." What he misses, of course, with this argument is that it is not merely the creation of particular goods or processes that matters for the entrepreneur. It is not the knowledge and employment of new methods per se, which are economically relevant, or for that matter, how these processes are first discovered. What matters is only whether the product can be sold on the market at prices that exceed costs. By emphasizing only successful entrepreneurs, Schumpeter loses sight of failed endeavors, and this focuses on physical products and processes and the and the psychological traits of the entrepreneur rather than the important problem of uncertainty bearing. The second major claim in Schumpeter's argument is that as capitalist society evolves, firms tend to bureaucratize themselves, leading away from the competitive capitalism into the sort of planned progress mentioned above. Schumpeter believed that capitalism eventually enters a period characterized by the absence of entrepreneurial control over resources, or in other words, the transformation of business into bureaucratized firms run by committees

11:16and Managers who Engage Exclusively in Administrative Work. This leads innovation also to become less personal and more bureaucratic. Entrepreneurial endeavor loses its dangers and tends to be carried out as a matter of course on the advice of specialists. The problem with the above assertion is that in the capitalist system firms are bound by the forces of economic calculation. Any move away from calculation results in the rapid disappearance of capital values and the eventual bankruptcy of the firm. As Dr. Klein has pointed out, calculation limits both the size of firms and their internal Management Policies. However, calculation only performs this function when consumer sovereignty is allowed due influence on the price system, for it is from consumers that capital receives its value. Calculation cannot serve its purpose where consumers' values are not permitted to determine the price of capital on the market. But for now, we need only note that the level of bureaucratization in market firms tends to an optimum through calculation and cannot grow to the point where calculation may be simply disregarded, precisely

12:10It is not surprising that Schumpeter would have failed to take proper account of the role of calculation. In dealing with calculation in regard to socialism, he displays a somewhat superficial understanding of the arguments of Mises, focusing instead on the mathematical approach to economic equilibrium solutions. Schumpeter's position appears to stem from his undue emphasis on circular flow equilibrium. It is very easy to imagine the planning of The Third and final reason for the decay of capitalism has to do with the erosion of certain social protections which society affords the capitalist system, the most important of which is of course the institution of private property. Capitalism, asserts Schumpeter, attacks all social practices and institutions by the very nature of its incessant process of creative destruction.

13:06will turn upon itself, will attack its own institutions. Specifically, Schumpeter argues, as many Austrians do, that capitalism rationalizes society's economic conduct. Capitalist practice turns the unit of money into a tool of rational cost-profit calculations. Calculation, then, is the tool used to analyze the viability of alternative methods of the production and distribution of goods in society. According to Schumpeter, this analysis in turn leads to the spread of a critical attitude in society that seeks to rationalize all social institutions. It is this attitude that eventually turns against the basic values of a capitalist society, the foremost of which is private property. The implication is that property is just as easy an institution to discard as any of those institutions which capitalism has rendered obsolete in the past.

13:51However, Schumpeter failed to recognize that ownership is an essential component of the calculation process and cannot proceed without it. This is the fundamental point regarding the impossibility of socialist calculation. As just mentioned, this point eluded Schumpeter, leading him to a flawed theory of calculation, one that led him falsely to believe in the possibility of a calculating socialist economy. His obsession with the transition between different states of Volrasy and equilibrium forced him to concentrate on the disequilibrating action of his always successful entrepreneur and the shift between different production functions instead of the role of the money unit and ownership for appraisement and calculation. Had he realized this rule of property, however, he would have been forced to admit the impossibility of capitalism rationalizing itself away in this manner, because the process would require the institution of property to contradict its own economic function.

14:40Given then that none of Schumpeter's arguments withstand economic criticism, we must now discover if we can salvage anything from the argument. We have seen that Schumpeter's theory of entrepreneurship is lacking, and that if we view his theory of capitalism in light of a more correct theory of entrepreneurship, we come to the conclusion that his argument is fatally flawed. However, what if we replace the capitalist system in Schumpeter's argument with a system of economic interventionism? Under these conditions, I believe we can breathe new life into the argument. By inserting a Misesian entrepreneur, one who bears market uncertainty into Schumpeter's system, we develop something of a parallel to Mises' argument that interventionism leads to socialism. From the first, our conclusion should be somewhat obvious. In the interventionist economy, state controls over the marketplace can guarantee all of Schumpeter's conditions for the decline of capitalism, albeit in a manner slightly different than that which he perceived.

15:26Here's Schumpeter's three major arguments, beginning with the possibility of eliminating the entrepreneurial function from society. If we acknowledge that state intervention by necessity redistributes wealth and distorts the market structure in certain identifiable ways, no matter which particular sort of intervention we focus on, whether price controls, patent privileges, etc., the general principle of economic development remains the same. And I see my time is up, so I'm going to actually have to cut out the last major section of What emerges from this alternative understanding of Schumpeter's thesis should be neither surprising nor entirely original. Had Schumpeter had a more complete theory of the entrepreneur, he would have, I believe, formulated a theory with a more Misesian tone. Ultimately, the idea that when economic freedom is infringed upon, that social change would be both dramatic and deep-seated is a commonplace, and perhaps even a basic assumption in most Austrian writing. But it is in some sense a new entry in the thought of Joseph Schumpeter.

16:23to answer to Schumpeter's thesis, but as Schumpeter himself would say, history sometimes indulges in jokes of questionable taste.