Capitalism's Collapse: A Response To David Simon, Part I

Via Facebook, I have been directed to an article in The Guardian in which one David Simon puts forth an argument that "capitalism" defeated communism, and will next defeat "itself" by defeating "democracy."

To some leftists and youngsters, I suppose this argument seems novel and compelling. The problem is that the matter was given thorough treatment at the turn of the (last) century by Josef Schumpeter and others.

I'd like to tackle Simon's arguments directly, but before I do, I'd like to tell a brief story about the Schumpeterian critique of "capitalism" as I remember learning it. I do have a couple of very well-educated experts in this field occasionally reading this blog, so I should add one disclaimer: I might not have it exactly right, and you're free to correct me. What's important to me (a layman) is moreso the thrust of the matter than the academic particulars.

The Stationary Waves Guide To Schumpeter's Critique Of Capitalism
Again, this is the argument as I remember it, not necessarily as it actually was. Your best bet here is simply to consult the source material. I did, but that was fifteen years ago. And since I don't have to call this stuff up regularly in a professional context, you will hopefully forgive me of a few inaccuracies.

Schumpeter studied economics during a time when the Marxist-Weberian "German Historical School" reigned supreme in academic Germany/Austria. A few of the Historical School's ideas were important contributions to political theory - in particular, Max Weber's ideas about power dynamics and their impact on social interaction - but the vast majority of their economic ideas were grounded in logical error, empirical inaccuracy, methodological error, and theoretical unsoundness. To gain a better understanding of the particulars of their errors, I recommend starting with Mises' Epistemological Problems of Economics.

This period of academic history was not solely about the German Historical School's dominance over academic discourse, but also about the emergence of the Austrian School, and the so-called "Marginal Revolution" more generally.

It was in this setting that Schumpeter found himself coming of age. He was well-versed in Marxist dogma, and also well-versed in economic marginalism. Thus, he had a unique and whole picture of the full body of economic theory developed up to that point in time. He was also a gifted mind who had many remarkable ideas himself. Thus, he began to craft a certain vision of economics...

To the chagrin of many of his free-market contemporaries, Schumpeter appreciated some of Marx's critiques of capitalism. Schumpeter agreed with Marx this much: he agreed that capitalism would eventually collapse under its own weight. Schumpeter greatly disagreed with Marx about the mechanisms of that collapse, however.

And so does everyone with even a minimal understanding of economics. Marx's argument was that, as business owners continued to invest more money in capital factors of production, their produce would continue to decrease in value. That's because Marx believed that the value of a product was based on the human labor that went into producing it.

To really wrap your head around this error, consider a farmer who plants a potato seed. According to the argument laid out by Marx and Engels in Das Kapital, that potato is worth more money (i.e. has a higher intrinsic value) if it is planted using a man's bare hands than if the farmer has access to a hoe and a little bag of seeds attached to his belt. That's because the hoe and the bag are both forms of productive capital. What is a 1-hour job with your bare hands becomes a 15-minute job with a hoe. 15 minutes is 25% of an hour. The value of the resulting potato is thus 25% less than it was prior to the investment in productive capital.

The problem gets worse as the farmer modernizes even further. He buys a larger plot of land and starts using heavy farm machinery to plant and sow potatoes. A day's work used to yield him several bushels of potatoes. Now he produces thousands. More production, but less labor input, in the Marxist model, means that the potatoes themselves are less valuable. That's obviously not correct*.

Schumpeter did not subscribe to the same intellectual errors that Marx did. Still, he empathized with the idea that capitalism would out-grow and destroy itself. In Schumpeter's model, however, the mechanism for collapse is not an ever-diminished labor-value, but rather the very profound insight that large companies are less dynamic than small ones. Therein lies an important contribution to the body of economic knowledge.

In the Schumpeterian world, human progress relies on "entrepreneurs," creative individuals who can anticipate market trends and invest in new ideas to drive additional economic progress. First, they develop a new idea (or borrow one from someone else). Next, they bring the idea to market, and because they have guessed correctly, they make a killing. Their business operations grow and grow until what started out as a small, ambitious idea has matured into a large-scale operation. You can think of it like Apple Computers, where it starts out in somebody's garage, and after a decade it has become one of the largest and most highly valued companies in the world.

At that point, according to Schumpeter, things reach a new tipping point. Large corporations can very effectively mass-produce an existing product. But developing new products becomes difficult because their existing corporate structure cannot easily adapt to new business models. Imagine if Apple suddenly started selling microprocessors. They would have to invest in all-new factory technology, train new staff, fire old staff, and so on. They may be able to do this, but it takes time.

On the other hand, a small entrepreneur can start up a small-scale microprocessor manufacturing operation much more easily, provided he or she can raise the initial funds. Schumpeter observed that it would be easier for new entrepreneurs to adapt to new trends and capitalize on them than it would be for large corporations to do so. He thought this was a healthy process. It was a bit of a life-cycle: entrepreneur makes good, grows big, becomes a dinosaur, and ultimately loses the race to the next generation of entrepreneurs.

But Schumpeter also predicted that large corporations would eventually become so large and powerful that they would eventually stamp out all competing new entrepreneurs. Nor would they be able to provide fora for those new entrepreneurs from within the corporate structure. As such, Schumpeter thought capitalism would eventually become hostile to innovation and collapse under the weight of an enduring, sluggish stagnation.

If you think this sounds eerily prophetic, you're not alone.

It's important to keep all this in mind because when you read a piece like David Simon's Guardian article, you might be tempted to suggest that Simon and Schumpeter are really saying the same thing. But really, they're not.

Simon is making an argument more like Marx's. In fact, Simon states outright (emphasis mine):
You know if you've read Capital or if you've got the Cliff Notes, you know that his imaginings of how classical Marxism – of how his logic would work when applied – kind of devolve into such nonsense as the withering away of the state and platitudes like that. But he was really sharp about what goes wrong when capital wins unequivocally, when it gets everything it asks for.
For David Simon, then, it really is a Marxist story, and not a Schumpeterian one. The main problem with Simon's article is that he embraces a view that has been soundly rejected by modern economics as a discipline for nearly 150 years. Meanwhile, Schumpeter offers a view that is equally and oppositely endorsed by economists of all ideological stripes.

In my next post in this series, I will attempt to tackle the specifics of Simon's argument and show why he is wrong about economics and capitalism, and why his views are out-of-date to the tune of five or six generations of academic thinkers.

* I encourage you to read Marx & Engels criticism of capital investment and understand this for yourselves.