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Unlike Adam Smith or Karl Marx, who saw only the good or the bad in capitalism, economist Joseph Alois Schumpeter recognised both the good and the bad

I was told by someone from Lien Aid - a non-profit organisation that aims to improve the quality of life for rural communities in Asia by providing water and sanitation - that some of the world’s poorest people pay the highest prices for water. And not only that, they have to trudge a road long and hard to buy it.

Meanwhile, the recent increase in food prices is again hitting the poorest the hardest. Statistics in many countries, Singapore included, show the rich are getting richer and the poor are getting poorer. Per capita income in the 20 richest countries is 37 times that in the 20 poorest. Despite big gains in China and India, significant sections of these countries have yet to share the fruits of capitalism.

Two of the greatest thinkers have come to polar conclusions when trying to grapple with these issues. Adam Smith (1723-1790) saw the market economy as a near-ideal system. On the other hand, Karl Marx (1818-1883) saw capitalism as a way for the rich to oppress the poor, and hence denounced it as an unpleasant interval on the inevitable path to socialism.

A third thinker - having the benefit of being born later and the opportunity to study capitalism in its 20th-century state of maturity - arrived at a far superior conclusion. And it is on his work that much of today’s thinking about capitalism is based.

Joseph Alois Schumpeter (1883-1950), who was born in a town near Prague but grew up in Austria, was one of the greatest economists who ever lived, according to his biographer Thomas McCraw. ‘He was to capitalism what Freud was to the mind: someone whose ideas have become so ubiquitous and ingrained that we cannot separate his foundational thoughts from our own,’ wrote Mr McCraw, a Pulitzer Prize winner.

Schumpeter’s emphasis was on innovation, entrepreneurship, business strategy and ‘creative destruction’. ‘Specialists in the analysis of business identify him closely with the first two of these terms. He helped to popularise the third, and coined the fourth himself,’ said Mr McCraw.

Unlike Smith or Marx, who saw only the good or the bad in capitalism, Schumpeter recognised the good and the bad. He knew that creative destruction fosters economic growth, but also that it undercuts cherished human values. He saw that poverty brings misery, but also that prosperity cannot assure peace of mind.

As noted by Mr McCraw, at its worst, capitalism reduces all human relationships to crass calculations of personal costs and benefits. ‘It elevates material values over spiritual ones, despoils the environment and exploits the foulest aspects of human nature.’

But despite its flaws, capitalism alone has fostered the scientific, technical and medical innovations that have raised humanity from a state where life was solitary, poor, nasty, brutish and short, Mr McCraw added.

If only capitalism could somehow be brought into balance with nobler human purposes. Until today, there has been no perfect solution to the problem.

However, events during Schumpeter’s lifetime, and in the past 60 years, have shown that capitalism can take very diverse forms in different settings. He once wrote of ‘the infinitely complex organism of capitalist society’. A social and cultural system as much as an economic one, capitalism can work for either good ends or bad. It can be moral, immoral, or - most often - amoral. Everything depends on the context, mainly the degree to which a group or nation can maximise the creative components while mitigating the destructive side-effects.

Going through the book, one will recognise that many of the economic policies prescribed by Schumpeter have been adopted by Singapore, and countries like Japan, Korea and Taiwan. The tremendous achievement in terms of the wealth created by these nations is evidence of Schumpeter’s genius.

I chanced upon the book Prophet of Innovation - Joseph Schumpeter and Creative Destruction by Mr McCraw during a recent visit to the Bishan Community Library. I am half-way through the book, but have already found Schumpeter’s observations on issues ranging from entrepreneurship to psychology to ring so true that even today, many of us - whether employee, manager or entrepreneur - can derive useful insights from them.

So in today’s column, I thought I’d share some of Schumpeter’s observations.

On capitalism

Capitalism’s economic bounties so enhanced the life of the average person that they far offset its negative effects. What was the bankruptcy of an individual entrepreneur, or the obsolescence of a few thousand craftsmen, compared to the greater freedom and comfort of millions of people with access to new and inexpensive goods? (This can be used to argue for globalisation as well.)

‘It is the cheap cloth, the cheap cotton and rayon fabric, boots, motorcars and so on that are the typical achievement of capitalist production, and not as a rule improvements that would mean much to the rich man. Queen Elizabeth owned silk stockings (in the 16th century). The capitalist achievement does not typically consist in providing more silk stockings for queens but in bringing them within the reach of factory girls in return for steadily decreasing amounts of efforts… the capitalist process, not by coincidence but by virtue of its mechanism, progressively raises the standard of life of the masses.’

On staying on top

Schumpeter pointed out that most of the wealthy families that led society at the midpoint of the 19th century were no longer on top three generations later. The reason lies in the incessant dynamism and competitive innovations that occur within capitalist business.

It is never enough simply to plough back profits into the family business. No company, Schumpeter said, can ever retain a position at the top of its industry without doing very much more than this - ‘without blazing new trails, without being devoted, heart and soul, to the business alone’.

The sound practices of saving, living frugally and maintaining the company on a solid foundation would not suffice. Any company following these routines - however admirable they seem at first glance - will soon be overtaken by aggressive, risk-taking, competitive entrepreneurs, he said. ‘The introduction of new production methods, the opening up of new markets - indeed, the successful carrying through of new business combinations in general - all these imply risk, trial and error, the overcoming of resistance, factors lacking in the treadmill of routine.’

He concluded by saying: ‘As to the question why this is so, it is answered by the theory of entrepreneurial profits.’ Newcomers to an industry will bring fresh ideas, can earn much higher profits and drive incumbents out of business - through the simple device of fixing on economic growth as their sole objective.

It is very hard to continue to stay on top. Most successful people, especially once they become wealthy, do not want to continue obsessing over economic growth. They come to abhor the relentless demands of continuous innovation. They want to enjoy themselves and live a more rounded life. For these reasons, great enterprises typically outgrow the abilities of founding families to sustain their top position. ‘Mere husbanding of already existing resources, no matter how painstaking, is always characteristic of a declining position,’ according to Schumpeter. (This applies, too, to people who invest their money only in the safest of instruments.)

On entrepreneurs

Entrepreneurs are ‘the pivot on which everything turns’. Their projects are the well-spring of new jobs, higher incomes and general economic progress.

Entrepreneurs need ‘extraordinary physical and nervous energy’. The best of them can sustain their efforts on a high level only if they have ‘that special kind of ‘vision’… concentration on business to the exclusion of other interests, cool and hard-headed shrewdness - traits by no means irreconcilable with passion’.

And entrepreneurs working in very large corporations must have even more talents. They must know how to ‘woo support’ among their colleagues, ‘handle men with consummate skill’, and give others ample credit for the organisation’s achievements.

On social mobility

‘The persistence of class position is an illusion … Class barriers must be surmountable, at the bottom as well as at the top.’ The key to a higher class position is for an individual to strike out ‘along unconventional paths. This has always been the case, but never so much as in the world of capitalism.’

Most industrial families have risen from the ranks of workmen and craftsmen ‘because one of their members has done something novel’, and this is ‘virtually the only method by which they can make the great leap out of their class’.

As Abraham Lincoln noted, singularly talented people almost always strike out in bold new directions. ‘Towering genius disdains a beaten path. It seeks regions hitherto unexplored … It thirsts and burns for distinction.’

Other issues

Other observations made by Schumpeter include:
Credit is absolutely essential to the functioning of the capitalist system. From the Latin root credo - ‘I believe’ - credit represents a wager on a better future. Entrepreneurs and consumers undertake innovative projects and make expensive purchases (houses, for example) that require far greater resources than those lying at hand. In the absence of credit, both consumers and entrepreneurs would suffer endless frustrations.
Capitalism’s defining trait of constant change and innovation makes the whole idea of a capitalist ‘equilibrium’ misleading. The only equilibrium is a constant state of disequilibrium.
In capitalist economies, rewards and punishment for good and bad judgement come quickly and cruelly.
Innovation itself is primarily ‘a feat not of intellect, but of will… a special case of social phenomenon of leadership’.
The barriers to innovation consist of ‘the resistances and uncertainties incident to doing what has not been done before’.

That capitalism is the most effective system to create wealth is beyond doubt. But it appears we are now heading towards a crunch. We have on our hands a potential food crisis. Also, the world’s resources are depleting fast. Global warming is a serious issue. So is terrorism. And bankers behaving like lemmings remain a threat.

As Mr McCraw puts it, simply relying on the ‘invisible hand’ is no longer sufficient. Modern capitalism must be actively nurtured and controlled, with sophistication and resolve. ‘Without constant promotion by entrepreneurs and careful monitoring by regulators (a necessity much underestimated by many advocates of free market, including Schumpeter himself), it cannot achieve or maintain its full potential.

‘Like the actual engines that loom so large in creative destruction - steam, electric, diesel, gasoline, jet - the capitalist engine can slow down, sputter, overheat, explode, or die.’

Capitalism is still evolving.

Source : Business Times - 31 May 2008