In Politics and Markets 1, using Charles Lindblom’s model, I discussed how capitalism can undermine democracy. Let’s turn this around and look at how democracy can undermine capitalism.
The influential economist Joseph Schumpeter finished his career at Harvard University. While at Harvard he published his most popular work: Capitalism, Socialism and Democracy. Schumpeter was a true believer in the brilliance and benefits of capitalism but pessimistic about its long term survival in a democracy.
Schumpeter understood the importance of ideology from reading Karl Marx (they both worked at the British Museum but in different centuries). Marx had a strong sociological influence on Schumpeter, but the mathematical school was Schumpeter’s ideal. Schumpeter was enamored with the general equilibrium theory developed by the mathematical economist Leon Walras. (I got my introduction to mathematical economics in Bent Hansen’s class on general equilibrium as a graduate student at U.C. Berkeley.) General equilibrium is a mathematical snapshot of a perfectly balanced static economic system. Walras proved that such an equilibrium is theoretically possible even though no economy ever gets there since things are always changing.
Schumpeter believed capitalism is the greatest engine of innovation and that it outperforms any other system of wealth creation because of his concept of creative destruction: entrepreneurs disrupt old industries allowing new technologies to replace outdated ones. Growth comes from rapid disruptive change, not stability with incremental change. Milton Friedman and Friedrich Hayek share Schumpeter’s faith that the capitalist system maximizes economic growth. This is the foundation of modern conservative economics.
But, Schumpeter doesn’t stop there. Ironically, in Schumpeter’s view the great success of capitalism ultimately destroys capitalism itself. Capitalism creates wealth, science, technology, education, and a large middle class and those very forces turn against capitalism. As societies grow wealthier, intellectuals and professionals question the benefits of capitalism. Big corporations replace small entrepreneurial firms. Bureaucracy kills the entrepreneurial spirit. Workers demand equality and security. Political majorities support redistribution and planning.
This sounds similar to Lindblom: corporate concentration, decline of independent entrepreneurs, power in fewer hands. Lindblom uses these observations to show how capitalism destroys democracy. Schumpeter shows how capitalism creates its own critics, especially in the educated classes.
Democracy shifts toward socialism: more public services, higher taxes, workers’ rights, regulation, and social systems. There is a slow evolution toward democratic socialism as the system becomes bureaucratic, rule-bound, less dynamic and more stable. This is similar to modern Scandinavian social democracy.
Schumpeter and Lindblom agree that citizens are mostly followers. Policy is made by elites. Democracy is not “the people deciding.” It is politicians competing for votes, just as firms compete for customers. Voters choose leaders, but don’t control policy. As firms grow in size, the business decision makers change from the individual entrepreneur to bureaucrats and business elites who then hold the real power.
Schumpeter, like Lindblom, predicted that capitalism would evolve away from small, competitive firms and toward giant corporations, monopolies and oligopolies, and corporate bureaucracies. Instead of the heroic entrepreneur we get managers, shareholders, corporate planners, and market power. This supports Lindblom’s argument that big business gains influence and shapes government policy.
Unlike Friedman and Hayek, Schumpeter did not think capitalism guarantees political freedom forever. Unlike Marx, he saw capitalism as immensely productive, not doomed from crises. Unike the socialists, he believed socialism would come not from class revolution, but from slow political evolution in democratic societies.
Schumpeter’s predictions have held up well. Capitalism has produced unprecedented innovation, but monopolies and tech giants have come to dominate markets. Many modern democracies have evolved toward social welfare states. Politics is professionalized, not participatory. Workers and intellectuals demand more equality and security. Public trust in capitalism has weakened.
Schumpeter might well look at the modern U.S. and say: capitalism is still innovative, but increasingly oligopolistic and politically contentious. He might also look to Scandinavia and point out that this is what he predicted, capitalism evolving into democratic socialism without revolution.
Schumpeter explains how capitalism destabilizes itself, why democracy tends to push societies toward social welfare and away from pure free markets. So, here is the dilemma. If capitalism is the most efficient economic system for producing the things we want, how can we protect democracy and capitalism from the destabilizing forces that capitalism itself unleashes? Or, to put it in terms our would be King can understand: How can we prevent the chicken that lays the golden eggs from self-destructing?
Stay tuned.