Schumpeter’s Market: Enterprise and Evolution

Published by EH.NET (September 2005)

David Reisman, Schumpeter’s Market: Enterprise and Evolution. Cheltenham, UK: Edward Elgar, 2004. vii + 294 pp. $120 (hardcover), ISBN: 1-84376-164-5.

Reviewed for EH.NET by Frederic Sautet, Mercatus Center, George Mason University.

Over the last two decades, Joseph Schumpeter’s work has experienced a resurgence of interest. Not only are Schumpeterian models of economic growth now explored by many academics (e.g. the works of Richard Lipsey and Kenneth Carlaw), but also some economists are starting to realize that the multi-disciplinary approach to economics, as Schumpeter practiced it, may be more fruitful than it was once thought.

In the last decade or so, several biographies and intellectual histories of Schumpeter have been published (e.g. the works of Richard Swedberg and Yuichi Shionoya), along with many articles on his life and work. David Reisman’s book, Schumpeter’s Market, is a welcome addition to this growing field of research on Schumpeter’s work and his influence in modern day economics.

Reisman’s book is an intellectual history of the work of Schumpeter with a special focus on “three irreducible constructs”: market, enterprise and evolution. Reisman’s impressive knowledge of Schumpeter’s intellectual output enables him to trace the evolution of Schumpeter’s life-long themes. It is not an easy task to present a picture of Schumpeter’s vision, as there are many tensions and complexities in his intellectual history. While Reisman provides the reader with ample details about Schumpeter’s work, the book misses an overall explanation of the tensions and complexities of his work.

After a short introduction, Reisman presents, in chapter 2, what he calls Schumpeter’s vision. This vision is two-fold. On the one hand, it is made of a substrate: the capitalist system based on free exchange and the existence of markets. On the other hand, it is made of culture, ideas, values, polity and what makes the civilization of capitalism. One cannot study one without the other, and the task at hand for the economist, as Schumpeter saw it, is to understand how the two interact. This is what makes Schumpeter’s vision appealing: economics to be well practiced must reinvent itself and grow beyond its boundaries.

Reisman explains that Schumpeter, while against socialism and the socialists, never claimed to have any solution to the practical problems of the world. Schumpeter was a historical determinist who, like Marx and Engels before him, thought that socialism was inevitable. As Schumpeter put it: “There is inherent in the capitalist system a tendency toward self-destruction” (p. 189). This, along with the theme of capitalism and innovation, was the most recurrent idea in Schumpeter’s work. In Reisman’s words: “Capitalism was under threat in 1950 as it had been under threat in 1918. Schumpeter throughout the whole of his academic career was predicting the end” (p. 208).

Paradoxically perhaps, Marx and Schumpeter had much in common agreeing on historical analysis and on the direction the world would take in the decades to come. However, Schumpeter did not follow Marx on the economics, as it was clear in his mind that the capitalist system worked better than Marx thought. To Schumpeter, the market was not subject to the various problems enumerated by Marx (e.g. the falling rate of profit). But, the tension was there: while Schumpeter defended capitalism against Marx, he also explained that it contained the seeds of its own destruction.

Chapter 3 presents the fundamental issues that Schumpeter discussed throughout his life. Schumpeter held that a pre-analytic vision was necessary for any science to take place. (This idea is crucial to the explanation of entrepreneurial activity as Kirzner has argued in his work: entrepreneurs do not grope at random, they act on some sort of a pre-scientific hunch.)

Reisman explains that Schumpeter also had a love affair with Walras, whom he considered as the greatest theoretician of economics. However (and paradoxically), Schumpeter saw comparative statics ? la Walras as a world away from actual situations in which change was without end.

Finally, economic sociology and economic history are two other fields that Schumpeter avidly explored. He saw the first one as the study of institutions, structured relationships, conventions, etc and the second one as necessary to understand causation and mechanisms in the present world.

Chapter 4 considers capitalism in Schumpeter’s writings as well as the role of entrepreneurship (and innovation, which he saw as identical). The essence of capitalism is creative destruction and the entrepreneur is its source. Entrepreneurship is the essential engine which propels the world; it is what makes economic evolution possible. Schumpeter, explains Reisman, identifies the entrepreneur as the agent of change in the social system. However, the main function of entrepreneurship is to put into practice, not to create from nothing. The entrepreneur innovates, which consists in getting things done. This relates to a very important distinction in Schumpeter’s work: invention may lead to innovation but the latter doesn’t necessarily proceed from the former.

In Chapter 5 Reisman presents Schumpeter’s view of the role of the large corporation. While Schumpeter defends the dynamic of market capitalism, he also argues that capitalism is inexorably evolving towards corporate capitalism, which will ultimately lead to its demise. Big corporations will sooner or later be stifled by their bureaucratic structures, which will tend to suppress inner entrepreneurial activity. Schumpeter also believed that the large corporation is a powerful engine of technological advance. In other words, market structure (i.e. oligopoly or monopoly) does make a difference to innovation. Reisman is quick to point out that this hypothesis (i.e. monopoly leads to innovation) has not been proven. Scherer for instance conducted a number of studies to find a relationship between firm size and productive research and development but couldn’t find any. However, Schumpeter also argued that innovation leads firms to be monopolists, at least for a while, and thus market structure is both a cause and a consequence of innovation. What Schumpeter, in his vision of the role of the big corporation, seems to overlook is the innovative role of the small firm. Reisman justly argues, in a very Hayekian fashion, that the small firm has local knowledge and is often at the origin of major innovative changes (e.g. Apple Computer and Xerox Corporation).

The sociology of capitalism is the subject of chapter 6. First, Reisman shows Schumpeter’s interest for social class analysis. While agreeing with Marx that class conflict deserves attention, Schumpeter also makes the point that the social mobility found in the capitalist system reduces the scope for class conflict. Clearly capitalist entrepreneurs need proletarians and vice versa.

Second, Schumpeter, arguing against Marxism and Leninism, contends that capitalism is not the cause of aggression, militarism and conquest. Imperialism in Schumpeter’s view is a survival from the pre-capitalist age of economic evolution. Aggression is not part of the system of exchange of market capitalism but a left-over from the tribal past.

Finally, Reisman goes over the motives for entrepreneurial activity. Clearly, entrepreneurs, in Schumpeter’s work, are motivated by pecuniary success. However, this is not the only motive, the entrepreneur also has the will to conquer, the impulse to fight and the desire to compete for the sake of it. Schumpeter’s sociology of entrepreneurship, remarks Reisman, is in some ways similar to that of Veblen. Although the entrepreneur may want to succeed to afford conspicuous consumption, he may also have other final motives in mind, such as showing his intrinsic value as a superior man to others. Schumpeter sees the desire of a better future for one’s own family as running deep in homo economicus, and this may be the most important entrepreneurial motive. A discussion of the role of profit (in relationship to entrepreneurship) in a disequilibrium situation is missing here — especially as Schumpeter’s cycle theory assumes entrepreneurship in a world without profit.

Chapters 7, 8 and 9 discuss the issue of socialism at greater length. While Schumpeter goes out of his way to defend capitalism, he also argues in favor of historical determinism: socialism will inexorably win the final battle. Big business bureaucracy is here to stay and the evolution from corporation to state will take place. Corporate capitalism develops and will become the dominant mode of organization. The paradox that Schumpeter tries to unveil is that “capitalism fails because it succeeds” (p. 132). Entrepreneurs are ousted and the bourgeoisie is expropriated. Schumpeter does not think that there could be a “third way” between capitalism and socialism. Capitalism bears the seeds of its own destruction and thus the only way in the end will be socialism.

There are problems with Schumpeter’s view of course. For instance, Reisman mentions that even Galbraith thought that Schumpeter had failed to grasp the differences between business bureaucracies and state bureaucracies. Moreover, Schumpeter seemed to have been influenced by the work of Berle and Means on ownership and control in the corporation and dismisses completely the role private ownership plays in maintaining competition alive through the capture of profits. It is not true that big corporations are kept out of the gale of creative destruction. Reisman explains that the small-firm sector is always a potential danger for any firm in the market. But he fails to mention the crucial work of Henri Manne, which addressed the issues raised by Berle and Means on the one hand, and Schumpeter on the other regarding the future of the joint-stock corporation.

Schumpeter would have retorted that it is not only the economic deficiencies of capitalism that will bring its own end; it is also because of the superiority of socialism. Socialism has a comparative advantage in the area of productive efficiency. Schumpeter seems to subscribe to the view that capitalism implies “anarchy of production,” a problem that socialism through careful planning can take care of.

As Reisman points out, Schumpeter does not seem to grasp the informational challenge to obtain productive efficiency. He ignored the arguments put forward by Mises and Hayek in the socialist calculation debate and focused exclusively on the ideas of Barone, Lange, and Lerner on market socialism. Schumpeter’s socialism is based on the Ministry (i.e. the central planning board) deciding the quantity supplied. Reisman notes that Schumpeter never explains where this mysterious supply comes from. Moreover, Schumpeter seems to underestimate the latitude politicians and civil servants would have to impose their choices instead of some supply that would maximize social utility. There is no political economy of socialism in Schumpeter’s view.

Here, Reisman underemphasizes the importance of the socialist economic calculation debate in the 1930s. In Mises’ view, no economic calculation by the central planning board is possible in the absence of individual property rights on the means of production. The problem of market socialism is not the result to be obtained (i.e. minimizing average cost and equalizing marginal cost to price) but the idea that the results could be obtained outside the market system. No economist interested in the debate would have ignored Mises’s and Hayek’s position. The fact that Schumpeter ignored it is very strange to say the least and deserves an explanation, which is missing in Reisman’s book.

At the end of the day, explains Schumpeter, socialism offers a “new cultural world.” What eventually drives people to socialism is its appeal as a social system: people will stand for the equality socialism will provide, while they will turn down the values of capitalism. Capitalism is dependent on cultural continuity for its success, but this is also its main vulnerability.

Chapters 10 and 11 dig more deeply into the mechanisms that transform capitalism and lead to a socialist commonwealth. Schumpeter thought that the weakening of the aristocracy in Europe would lead to a decline in the ethos of self-discipline and leadership. In destroying its own feudal roots, capitalism undermined itself. Moreover, it led to the rise of a new intellectual class living off the production of capitalists and entrepreneurs. This was the result of too much education and inevitably led to over-qualified people with low-paying jobs. Those who chose to become intellectuals became naturally hostile to capitalism.

The decline of the family and family values reduced the time-horizon of businessmen and their will to fight the rise of the bureaucracy. More importantly perhaps, Schumpeter warns of the danger of increased taxation, public expenditure, and government regulation, as it creates unintended consequences that will call for more taxation and spending.

When one looks at the whole picture: the fall of the aristocracy, the rise of the intelligentsia, the emergence of the big corporation, and the lack of cultural appeal of capitalism for the masses; the future is very gloomy. Reisman correctly points out that Schumpeter failed to see the robustness of the capitalist system, and the extent to which opinion leaders and intellectuals are dependent on democracy for their own survival. Even at the height of the 1930s when half of Europe was turning away from democratic and liberal principles, the masses of Western Europe and North America were not inspired by the totalitarian Russian revolution. Reisman has a point, but he underestimates the threat lobby groups may represent for the future of the liberal democratic order. He should have discussed here the rent-seeking society argument developed by the Virginia public choice school and by Mancur Olson in his work on the logic of collective action. In some ways, Schumpeter could be considered as a forerunner of the public choice literature.

Reisman also argues against Schumpeter (and Mises for that matter) that the middle of the road is possible, as the last fifty years have shown. Social democracy is an alternative to socialism: “Fettered capitalism functions adequately even if not reasonably well” (p. 218). It remains to be seen whether the social problems (such as high unemployment, soon-to-be bankrupt public retirement schemes, etc) that plague many Western European countries are part of what Reisman calls a “well functioning economy.” The answer is rather that both Schumpeter and Mises were right: there is no middle of the road policy in the long run. The difference between these two authors is that Mises (and Hayek as well as many other Austrian economists) never thought that pure capitalism inexorably degenerated into socialism.

The last two Chapters (12 and 13) focus essentially on the economics of Schumpeter and his theories of growth and cycles. Schumpeter stood firmly against the rising tide of Keynesianism. Investment will never be deficient because creative destruction will always be at work. Laissez-faire meant that entrepreneurial forces would always be unleashed for the betterment of the masses. Reisman provides this very interesting quote from Schumpeter written at the height of the Great Depression in Europe in 1931: “The capitalist system as such needs neither regulation nor planning, in a depression or outside of a depression, in order to function. … It operates on its own, and with results unprecedented in economic history. The logical solution for a series of serious shortcomings would not be an increase but a reduction in State intervention” (p. 234).

Schumpeter criticized Keynes’ General Theory for not being general at all but entirely specific (to a situation of crisis such as the Great Depression). However, by the time he published Capitalism, Socialism and Democracy in 1942, Keynesian principles had already swept the department of economics at Harvard.

Reisman notes that in the 1930s Schumpeter held the view that the way out of a crisis is through less government (as in the quote above). However, Schumpeter also promoted emergency spending as a possible solution to very serious crisis (and remember that he did not want to take policy positions). Schumpeter added a section to the second edition of Capitalism, Socialism and Democracy in 1946, in which he made that point. “Schumpeter late in life,” Reisman explains, “appears to have developed a tendency towards Keynesianism” (p. 237).

Schumpeter’s cycle theory is well known. It starts in a situation of equilibrium. The basic idea is that some firm innovates, and this disrupts the equilibrium in place. Because of its success and the monopoly rents it derives, the firm’s activities attract other firms, which all engage in the same activity. The important detail is that entrepreneurial activity is entirely financed by bank credit, which fosters the boom. At some stage, there is over-supply of output. This triggers a fall in prices in order to liquidate the stocks and this leads to the bust. In Schumpeter’s view, it is the innovators demanding money who create the cycle and not the loose bank rules. In this sense, cycles are inherently part of capitalism.

There are many problems with Schumpeter’s cycle theory. As Reisman points out, Schumpeter blamed the entrepreneur rather than the banking system because he did not believe that bank credit could cause disruptions between the monetary and the real spheres. Some economists criticized him for holding this view because the cycle has to have a pure monetary component. Schumpeter does not explain why there is a clustering of entrepreneurial errors. Austrian economists such as Mises and Rothbard have based their theory of the business cycle on the clustering of entrepreneurial errors induced by bank credit. This clustering cannot be the result of general entrepreneurial activity, as it is inconsistent with the nature of entrepreneurship; it must be the result of false price signals that entrepreneurs follow. Reisman should have explored this avenue in greater detail, as it is the most powerful criticism of Schumpeter’s cycle theory.

Schumpeter’s cycle theory is also a theory of innovation. It begins in a Walrasian general equilibrium with a zero interest rate (no time preference), no savings, and given consumer values and tastes. In such an environment, the only possible source of change is technology via entrepreneurship. Schumpeter has been hailed for his insights into economic development when his main contribution was simply to imagine a way out of the Walrasian box of his own making. In the absence of profits in equilibrium, it is difficult to understand how any entrepreneurship could take place. Moreover, in the absence of savings, capitalists cannot finance entrepreneurial activity and thus one has to resort to pure bank credit. What Schumpeter demonstrated as being inherent to capitalism was a feature of his own model. There again, Reisman neglects to explore this crucial problem of Schumpeter’s theory.

This book will be a reference to economists interested in the complexities of Schumpeter’s work, especially in so far as markets, firms and evolution are concerned. Overall however, the organization of the chapters is somewhat confusing: there are repetitions of the same themes in different places for no obvious reason (e.g. the issues of aristocracy and intelligentsia are introduced and discussed in various chapters). A different arrangement of the chapters may have facilitated the reading of the book. This being said, it does reflect the complexity of the evolution of Schumpeter’s thought.

Moreover, one has to wait for the conclusion to obtain an overview of the tensions and contradictions of Schumpeter’s work. A chapter summarizing Schumpeter’s views and the complexity of his thought is missing. An explanation of the major tension of his career (identified in chapter 2) is needed somewhere towards the end (the idea of the inevitable coming of socialism while capitalism is the superior social system). Instead Reisman provides pieces throughout the book without recapitulating.

Schumpeter had a vision of economics and social science that was more encompassing than most others in his days. Reisman — who is Professor of Economics at the Nanyang Technological University, Singapore and Professor Emeritus of Economics at the University of Surrey, UK — does a good job at presenting the complexity of Schumpeter’s thought, but he leaves the reader somewhat alone to figure out the reason why Schumpeter’s vision never entirely succeeded.

Frederic Sautet is a Senior Research Fellow at the Mercatus Center at George Mason University. His publications include An Entrepreneurial Theory of the Firm published by Routledge in 2000. He is also the editor of the Mercatus Policy Series.