Like the last review, in this one, I’ll focus on summarizing the argument and defining terms. I’m not enmeshed enough in the economics literature to form a strong critique or evaluation. But, when possible, I’ll draw connections to the entrepreneurship literature I’ve been reading lately.
The version I read is the Kindle version of the second edition. In the second preface, Schumpeter explains that this second edition doesn’t involve any changes to the original text, just an additional chapter to rebut critics of the first edition.
The book is about the future of capitalism. In the first part, Schumpeter “sums up, in a non-technical manner, what I have to say … on the subject of the Marxian doctrine.” Specifically, he’s interested in what Marx says about socialism. Schumpeter is (to put it mildly) not socialist, but he wants “to bear witness to this non-Marxist’s belief in the unique importance of that message, an importance that is completely independent of acceptance or rejection.” In the second part, he asks: “Can Capitalism Survive?” And, as he states in the first preface, he concludes “that a socialist form of society will inevitably emerge from an equally inevitable decomposition of capitalist society.” He concludes that “capitalism is being killed by its achievements.” This conclusion leads him to the third part: “Can Socialism Work?” Here, he surveys the various challenges that socialism faces. In the fourth part, “Socialism and Democracy,” he examines how the economic and political systems interact. Finally, in “A Historical Sketch of Socialist Parties,” he provides what he emphasizes is just a sketch of the question “from personal observation and from some very fragmentary research.”
So let’s see what we can mine from each part.
In Part I, Schumpeter examines “The Marxian Doctrine” from a non-Marxian perspective, giving Marx his due as a “prophet,” although sometimes denigrating Marxists in the process: “Marx was personally much too civilized to fall in with those vulgar professors of socialism who do not recognize a temple when they see it.” Rather than treating Marx as a prophet, Schumpeter says, we should “do a thing which is very objectionable to the faithful” and treat Marx as a sociologist whose work can be examined as independent parts. And Schumpeter argues that, contra many of Marx’s interpreters, “The economic interpretation of history does not mean that men are, consciously or unconsciously, wholly or primarily, actuated by economic motives. … He only tried to unveil the economic conditions which shape [religions, metaphysics, schools of art, ethical ideas and political volitions] and which account for their rise or fall. The whole of Max Weber’s facts and arguments fits perfectly into Marx’s system.”
Schumpeter also argues that “Marx’s philosophy is no more materialistic than Hegel’s, and his theory of history is not more materialistic than any other attempt to account for the historic process by the means at the command of empirical science.” Hmm.
“What the theory really says,” Schumpeter summarizes, “may be put into two propositions: (1) The forms or conditions of production are the fundamental determinant of social structures which in turn breed attitudes, actions and civilizations,” and “(2) The forms of production themselves have a logic of their own; that is to say, they change according to necessities inherent in them so as to produce their successors merely by their own working.” He adds that both propositions contain some truth and some working hypotheses. But he raises some objections. For instance, “Social structures, types and attitudes are coins that do not readily melt. Once they are formed they persist, possibly for centuries, and since different structures and types display different degrees of this ability to survive, we almost always find that actual group and national behavior more or less depart from what we might expect it to be if we tried to infer it from the dominant forms of the productive process.”
Later in the section, Schumpeter summarizes: “it is as reasonable to make … ownership the defining element [of class divisions in social structure] as it would be to define a soldier as a man who happens to have a gun.” Schumpeter asserts that the Marxian analysis “misses the salient point about social classes—the incessant rise and fall of individual families into and out of the upper strata. The facts I am alluding to are all obvious and indisputable. If they do not show on the Marxian canvas, the reason can only be in their non-Marxian implications.”
In the third chapter of this section, Schumpeter evaluates Marx as an economist. He states:
The masses have not always felt themselves to be frustrated and exploited. But the intellectuals that formulated their views for them have always told them that they were, without necessarily meaning by it anything precise. Marx could not have done without the phrase even if he had wanted to. His merit and achievement were that he perceived the weakness of the various arguments by which the tutors of the mass mind before him had tried to show how exploitation came about and which even today supply the stock in trade of the ordinary radical. None of the usual slogans about bargaining power and cheating satisfied him. What he wanted to prove was that exploitation did not arise from individual situations occasionally and accidentally; but that it resulted from the very logic of the capitalist system, unavoidably and quite independently of any individual intention. This is how he did it. The brain, muscles and nerves of a laborer constitute, as it were, a fund or stock of potential labor (Arbeitskraft, usually translated not very satisfactorily by labor power). This fund or stock Marx looks upon as a sort of substance that exists in a definite quantity and in capitalist society is a commodity like any other. (my emphasis)
Schumpeter admires the “pedagogics” of this argument, but raises objections: (1) Marx’s theory assumes that “workmen, like machines, are being produced according to rational cost calculations,” which Schumpeter believes is obviously incorrect; (2) “perfectly competitive equilibrium cannot exist in a situation in which all capitalist-employers make exploitation gains” because all would try to expand production unsustainably; (3) Schumpeter asserts that the theory of surplus value assumes equilibrium, yet Marx says this equilibrium cannot be achieved in a capitalist system, which undergoes incessant change. And this third point, Schumpeter asserts, is pivotally important:
As a matter of fact, capitalist economy is not and cannot be stationary. Nor is it merely expanding in a steady manner. It is incessantly being revolutionized from within by new enterprise, i.e., by the intrusion of new commodities or new methods of production or new commercial opportunities into the industrial structure as it exists at any moment. Any existing structures and all the conditions of doing business are always in a process of change. Every situation is being upset before it has had time to work itself out. Economic progress, in capitalist society, means turmoil. And, as we shall see in the next part, in this turmoil competition works in a manner completely different from the way it would work in a stationary process, however perfectly competitive. Possibilities of gains to be reaped by producing new things or by producing old things more cheaply are constantly materializing and calling for new investments. These new products and new methods compete with the old products and old methods not on equal terms but at a decisive advantage that may mean death to the latter. This is how “progress” comes about in capitalist society. In order to escape being undersold, every firm is in the end compelled to follow suit, to invest in its turn and, in order to be able to do so, to plow back part of its profits, i.e., to accumulate. Thus, everyone else accumulates. (my emphasis)
Marx, Schumpeter argues, misses the boat here: “He had no adequate theory of enterprise and his failure to distinguish the entrepreneur from the capitalist, together with a faulty theoretical technique, accounts for many cases of non sequitur and mistakes.” Among other things, Schumpeter says, Marx “had no simple theory of business cycles,” although, granted, “he understood much of its mechanism.”
(As an aside: Schumpeter largely focuses on Marx rather than Engels. In footnote 25, Schumpeter makes the reason clear: “I observe that the few comments on Engels that are contained in this sketch are of a derogatory nature. This is unfortunate and not due to any intention to belittle the merits of that eminent man. I do think however that it should be frankly admitted that intellectually and especially as a theorist he stood far below Marx. We cannot even be sure that he always got the latter’s meaning. His interpretations must therefore be used with care.”)
But—and here’s the gateway to the rest of the book—Schumpeter says: “However, even though Marx’s facts and reasoning were still more at fault than they are, his result might nevertheless be true so far as it simply avers that capitalist evolution will destroy the foundations of capitalist society. I believe it is.”
In Part II, “Can Capitalism Survive?”, Schumpeter bluntly answers the question in the first paragraph: “No, I do not think that it can.”
Capitalism tends to spread goods at ever-lower prices: “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 effort.” Revolutions in economic activity “periodically reshape the existing structure of industry by introducing new means of production.” And as these revolutions are assimilated, we get cycles of groundswells followed by depression as “antiquated elements of the industrial structure” are eliminated. Through this cycle, “the capitalist process … progressively raises the standard of life of the masses,” although not steadily but in cycles. “Capitalist reality is first and last a process of change. In appraising the performance of competitive enterprise, the question whether it would or would not tend to maximize production in a perfectly equilibrated stationary condition of the economic process is hence almost, though not quite, irrelevant.”
This brings us to Schumpeter’s famous notion of creative destruction. First, he asserts that competition is vital: “As soon as we go into details and inquire into the individual items in which progress was most conspicuous, the trail leads not to the doors of those firms that work under conditions of comparatively free competition but precisely to the doors of the large concerns— which, as in the case of agricultural machinery, also account for much of the progress in the competitive sector— and a shocking suspicion dawns upon us that big business may have had more to do with creating that standard of life than with keeping it down.”
Next, he links competition to the dynamic nature of capitalism:
The essential point to grasp is that in dealing with capitalism we are dealing with an evolutionary process. It may seem strange that anyone can fail to see so obvious a fact which moreover was long ago emphasized by Karl Marx. Yet that fragmentary analysis which yields the bulk of our propositions about the functioning of modern capitalism persistently neglects it. Let us restate the point and see how it bears upon our problem. Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary. And this evolutionary character of the capitalist process is not merely due to the fact that economic life goes on in a social and natural environment which changes and by its change alters the data of economic action; this fact is important and these changes (wars, revolutions and so on) often condition industrial change, but they are not its prime movers. Nor is this evolutionary character due to a quasi-automatic increase in population and capital or to the vagaries of monetary systems of which exactly the same thing holds true. 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 that capitalist enterprise creates. (my emphasis)
That is, capitalist enterprise changes, not just due to external conditions, but internally:
The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U. S. Steel illustrate the same process of industrial mutation— if I may use that biological term— that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This 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.
He adds: “Every piece of business strategy acquires its true significance only against the background of that process and within the situation created by it. It must be seen in its role in the perennial gale of creative destruction; it cannot be understood irrespective of it or, in fact, on the hypothesis that there is a perennial lull.” That creative destruction goes well beyond price competition: “Economists are at long last emerging from the stage in which price competition was all they saw. As soon as quality competition and sales effort are admitted into the sacred precincts of theory, the price variable is ousted from its dominant position.”
Given that internal impulse to change (creative destruction), restrictive practices such as monopolies “may do much to steady the ship and to alleviate temporary difficulties.”
As Schumpeter looks ahead, in his chapter “Crumbling Walls,” he essentially sees capitalism as inevitably making itself obsolete:
In our discussion of the theory of vanishing investment opportunity, a reservation was made in favor of the possibility that 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. Such a state of satiety is no doubt very far off even if we keep within the present scheme of wants; and if we take account of the fact that, as higher standards of life are attained, these wants automatically expand and new wants emerge or are created, satiety becomes a flying goal, particularly if we include leisure among consumers’ goods. However, let us glance at that possibility, assuming, still more unrealistically, that methods of production have reached a state of perfection which does not admit of further improvement.
A more or less stationary state would ensue. Capitalism, being essentially an evolutionary process, would become atrophic. There would be nothing left for entrepreneurs to do. They would find themselves in much the same situation as generals would in a society perfectly sure of permanent peace. Profits and along with profits the rate of interest would converge toward 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. Human energy would turn away from business. Other than economic pursuits would attract the brains and provide the adventure. (my emphasis)
And later in the chapter:
if capitalist evolution— “progress”— either ceases or becomes completely automatic, the economic basis of the industrial bourgeoisie will be reduced eventually to wages such as are paid for current administrative work excepting remnants of quasirents and monopoloid gains that may be expected to linger on for some time. Since capitalist enterprise, by its very achievements, tends to automatize progress, we conclude that it tends to make itself superfluous— to break to pieces under the pressure of its own success.
Schumpeter sees this eventuality itself in the terms of creative destruction, and like Marx, sees economic and sociological conditions as two parts of the same whole:
The capitalist process not only destroys its own institutional framework but it also creates the conditions for another. Destruction may not be the right word after all. Perhaps I should have spoken of transformation. The outcome of the process is not simply a void that could be filled by whatever might happen to turn up; things and souls are transformed in such a way as to become increasingly amenable to the socialist form of life.
Between socialism as we defined it and democracy as we defined it there is no necessary relation: the one can exist without the other. At the same time there is no incompatibility: in appropriate states of the social environment the socialist engine can be run on democratic principles. But observe that these simple statements depend upon our view about what socialism and democracy are. Therefore they mean not only less than, but also something different from, what either party to the contest has in mind.
I. In setting forth our conclusions we had better begin with the relation between democracy and the capitalist order of things.
The ideology of democracy as reflected by the classical doctrine rests on a rationalist scheme of human action and of the values of life. By virtue of a previous argument (Chapter XI) this fact would in itself suffice to suggest that it is of bourgeois origin. History clearly confirms this suggestion: historically, the modern democracy rose along with capitalism, and in causal connection with it. But the same holds true for democratic practice: democracy in the sense of our theory of competitive leadership presided over the process of political and institutional change by which the bourgeoisie reshaped, and from its own point of view rationalized, the social and political structure that preceded its ascendancy: the democratic method was the political tool of that reconstruction. We have seen that the democratic method works, particularly well, also in certain extra- and pre-capitalist societies. But modern democracy is a product of the capitalist process.
Whether or not democracy is one of those products of capitalism which are to die out with it is of course another question. And still another is how well or ill capitalist society qualifies for the task of working the democratic method it evolved. (my emphasis)
And let’s leave it there, not covering the final section, “A Historical Sketch of Socialist Parties.”
Like Marx, Schumpeter takes up economics, but within a sociological framework. He’s interested in the questions of how societies evolve and how different economic frameworks work within those sociological conditions. Although he’s certainly not Marxist in the economic sense, he sees definite insights in Marx’s thought and seeks to understand what the Marxian framework can and can’t do. And his notion of creative destruction attempts to address the question of dynamism that he believes Marx doesn’t account for. I don’t pretend to do justice to this book, but I do suggest picking it up—it’s interesting in its own right, but it’s also enormously influential for entrepreneurs and tells us a lot about how they see their worth.
In my last few reviews, I’ve felt compelled to say that I’m not an ethnographer, nor am I an entrepreneur. At the risk of sounding like Dr. McCoy, I’m not an economist either. But I wanted to read this book because it’s a classic for entrepreneurs. In this review, I’ll focus mainly on the terms and concepts that have made their way into the entrepreneur lexicon. Since I’m reading the Kindle version, I won’t use page numbers.
Schumpeter defines economic development as “only such changes in economic life as are not forced upon it from without but arise by its own initiative, from within,” and argues that “Development in our sense is then defined by the carrying out of new combinations.” He continues, “This concept covers the following five cases: (1) The introduction of a new good … (2) The introduction of a new method of production … (3) The opening of a new market … (4) The conquest of a new source of supply of raw materials or half-manufactured goods … (5) The carrying out of the new organization of any industry.” These all will sound familiar to entrepreneurs today: they are potential component claims in the complex argument of the entrepreneur’s pitch.
Combining “new combinations of the means of production” and credit, Schumpeter says, yields “the fundamental phenomenon of economic development. The carrying out of new combinations we call ‘enterprise'; the individuals whose function it is to carry them out we call ‘entrepreneurs.'” He adds that “we call entrepreneurs not only those ‘independent’ businessmen in an exchange economy who are usually so designated, but all who actually fulfil the function by which we define the concept, even if they are, as is becoming the rule, ‘dependent’ employees of the company, like managers, members of the boards of directors, and so forth, or even if their actual power to perform an entrepreneurial function has other foundations, such as the control of a majority of shares.”
Yet “our concept is narrower than the traditional one in that it does not include all heads of firms or managers or industrialists who merely may operate an established business, bur only those who actually perform that function.” And a few pages later: “whatever the type, everyone is an entrepreneur only when he actually ‘carries out new combinations,’ and loses that character as soon as he has built up his business, when he settles down to running it as other people run their businesses.” The functions are different: “Carrying out a new plan and acting according to a customary one are things as different as making a road and walking along it.”
Critically, entrepreneurs are not the same as inventors. “As long as they are not carried into practice, inventions are economically irrelevant. And to carry any improvement into effect is a task entirely different from the inventing of it, and a task, moreover, requiring entirely different aptitudes. Although entrepreneurs of course may be inventors just as they may be capitalists, they are inventors not by nature of their function but by coincidence and vice versa.”
“Capital,” Schumpeter says, “is nothing but the lever by which the entrepreneur subjects to his control the concrete goods which he needs, nothing but a means of diverting the factors of production to new uses, or dictating a new direction to production. This is the only function of capital” (His emphasis).
Once the new combinations have been carried out, Schumpeter says, “the new process of production will be repeated. And for this entrepreneurial activity is no longer necessary.” Entrepreneurship in his sense is fleeting, an innovative stage that leads to stable production, and an entrepreneur who is not engaged in this stage is no longer an entrepreneur.
At the end of the book, Schumpeter responds to critics. Most interesting for me was the criticism: “why is it that economic development in our sense does not proceed evenly as a tree grows, but as it were jerkily; why does it display those characteristic ups and downs?” And he answers: “exclusively because the new combinations are not, as one would expect according to general principles of probability, evenly distributed through time—in such a way that equal intervals of time could be chosen, in each of which the carrying out of one new combination would fall—but appear, if at all, discontinuously in groups or swarms.” Schumpeter argues that these swarms are due to three things: (1) “the vast majority of new combinations will not grow out of the old firms or immediately take their place, but appear side by side, and compete, with them.” (2) An en masse increase in entrepreneurial demand “signifies a very substantial increase in purchasing power all over the business sphere.” (3) trying new combinations results in more errors. “Why do entrepreneurs appear, not continuously… but in clusters? Exclusively because the appearance of one or a few entrepreneurs facilitates the appearance of others, and these the appearance of more, in ever-increasing numbers” (his emphasis). One or two entrepreneurs lead, and once they are successful, others rush in.
I found the book interesting, although hard to get through in spots. My real interest is in how entrepreneurs see opportunity and how they argue in ways that help others see it. And for those purposes, Schumpeter’s foundational work has been helpful. I wouldn’t call this book a page-turner, but if you’re interested in entrepreneurship and how entrepreneurs argue, it’s a must read.
The Startup Owner’s Manual: The Step-By-Step Guide for Building a Great CompanyBy Steve Blank and Bob DorfI just reviewed Steve Blank’s Four Steps to the Epiphany. Blank’s coauthor on this book, Bob Dorf, “critiqued the early versions of Steve’s F…
Just a side note here before I start on the review itself. This book is subtitled “The book that launched the Lean Startup revolution,” and indeed Steve Blank taught and supported Eric Reis, whose The Lean Startup made the term famous. The book is cited quite a bit and is de rigeur in the startup world. I read this book in fall 2014, and when I decided to cite it for some research I’m working on, I realized that Blank had self-published it. Based on my own experience with a self-published book that is not nearly as famous I’m sure Blank has turned this and his other book into handsome income-producing assets.
That’s what Blank excels at, of course: helping people to identify a hypothesis about a market’s need, test and iterate that hypothesis, then execute a plan to fill that need. In this book, Blank argues that customer development—the process of identifying a potential market segment, developing a hypothesis about what it needs, validating and iterating that hypothesis, and executing—occurs in four sequential but iterated stages: (1) customer discovery, (2) customer validation, (3) customer creation, and (4) company building. In steps 1-2 (the “Search” phase), entrepreneurs search for the right business model and test value propositions as hypotheses; in steps 3-4 (the “Execute” phase), entrepreneurs execute based on the business model and the validated value proposition. That is, in rhetorical terms, the essential claim is established in the first two steps, then serves as the foundation for the last two steps.
To develop that hypothesis, Blank advocates calling at least 100 potential customers. He provides scripts and examples to help you figure out how to make such a call, how to extract actual feedback (as opposed to brush-offs), and how to apply it. He discusses when one must pivot and even how to structure one’s organization to make it more nimble so that pivots can be executed more swiftly. Throughout, he draws on a deep well of experience, including both successes and failures, and he is quite candid about the latter.
I’m not planning to start a high-tech organization soon, but if I were, this would be a good playbook to follow. If you’re interested in becoming an entrepreneur, or studying how entrepreneurs make their arguments, this is an essential read.
Practical Ethnography: A Guide to Doing Ethnography in the Private SectorBy Sam LadnerI don’t remember where I ran across the link to Sam Ladner’s page on her upcoming book project, but I was intrigued. A researcher at Microsoft, Ladner wanted to reach…