Credit, Innovation, Creative Destruction and the benefits of Disequilibrium: A Schumpeterian view of the economy

Most newspapers, governments representatives, workers (white and blue), express their anger by trumpeting the end of laissez-faire capitalism. Well, we can’t really blame them for that, can’t we? This loss of faith in our capitalist society is without precedent in the post-cold war era. Many politicians will take advantage of the situation to increase the size of their apparatus, and history tells us that government (especially in Europe ) never reverts to the mean, it just keep building up in volume, complexity and inertia.

In these times of uncertainty and doubt, the best thing you might do to search for some comfort is to read the great Joseph Schumpeter again. “Prophet of Innovation”, a bibliography from Thomas Mc Craw, is a good way to start.

The main misunderstanding currently, is to believe that capitalism is about forever stability, cosiness and continuity. According to the great Schumpeter, the economy is all about breaking up old traditions and creating new ones, overthrowing established ways of thinking. Thus, capitalism’s main function as a constant promoter of change and innovation makes the (neo-classical) concept of a stable “equilibrium” misleading. According to Schumpeter, innovation requires continuous disequilibrium, led by entrepreneurs. He even wrote an article named “The Instability of Capitalism”.

“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 errors, the overcoming of resistance, factors lacking in the treadmill of routine.”

For Schumpeter, capitalism is all about credit and entrepreneurs (the main sources of innovation). Capitalism, with all its flaws, is the best promoter of meritocracy, for all classes. However, this process of “creative destruction” doesn’t come without some having to pay a price.

This is precisely what enabled the plane versus the railways, the automobile versus the horse-carrier, or the PC versus the typewriter, to succeed and in the process to improve the life of millions of users, employees and shareholders. The cost was paid by the shareholders, creditors and employees of the old “establishment”.

The more I look at the current situation the more his writing gains clarity and seems more present than ever. Look at Citibank, GM, look at the hundreds of newspapers around the world making use of thousands of journalists, most of them writing more or less the same stuff they source from the same agencies and going after the same advertisers, and the list goes on and on. Will anyone really miss Citibank or a GM? Twenty years ago some journalists were complaining about corporations that became too large and powerful, and now they finally get to be wiped out and everyone becomes nostalgic. Citibank is one of these pathetic corporations with no face, no name, where its annual reports seem ready made by a mix of too careful PR-agencies, legal and compliance departments , and where every employee seems to be “ersetzbar” (except the current CEO!).

Let it fail, and let the capitalism system work its way through it. Let smaller competitors of Citibank buy their best parts, go after their clients, or let their best teams strike on their own. The same can be said for GM, and many other dying dinosaurs. Let a new day begin!

Schumpeter also warned against trying to eliminate business cycles, and he attacked the policy of public bailouts of old-growth industries, a point that current politicians, with their quasi-religious belief in Keynesian economics, should take note.

Schumpeter also believed in the integration of history, sociology, and psychology into economics. Victor Niederhoffer's Daily Speculations website would definitely have pleased Joseph Schumpeter, who enjoyed few things more than coffee-style intellectual debate, and spent much time with his students to recreate something like the Viennese coffeehouse ambience of his youth.