Joseph Schumpeter is most famous for his answer to the question of what makes capitalism work so well. His answer is “creative destruction,” the process of new businesses entering the market and old businesses leaving. This simple idea has such explanatory power that it alone would make Schumpeter one of the most important economists of the 20th century. But now that I’ve read his book, Capitalism, Socialism and Democracy, published in 1942, I think Schumpeter is one of the greatest thinkers ever. Some of his most impressive feats are identifying certain economic and social phenomena so early. Back in the 1930s he made the case for why monopolies are actually not that bad (once they get big and powerful, some new thing comes along and disrupts them), he was worried about low-fertility when overpopulation was still the consensus concern, and he laid out the precise mechanics of elite overproduction 70 years before it would become a common-ish notion.

This article though will just focus on his famous prediction, that capitalism is doomed. The foundation of his argument is that capitalism is self-destructive. In short, capitalism changes the world and changes how we experience the world, and these changes happen to be the perfect ingredients for it’s own destruction.

Capitalists finding out who’s destroying capitalism:

The goal of this essay is to find out how well Schumpeter’s doom prediction holds up. But to begin, as any half-decent essay with a passing mention of capitalism does, we must first define “capitalism.” At his most straightforward, Schumpeter defines capitalism by explaining a type of society called a “commercial society.” Commercial society, he says, is “defined by an institutional pattern of which we need only mention two elements: private property in means of production and regulation of the productive process by private contract (or management or initiative).” Schumpeter explains that capitalism is a specific type of commercial society, but for the sake of this essay, we will just use his definition of commercial society to be equal to capitalism, which he himself said was fine.

Unfortunately though, this definition alone won’t suffice. Capitalism is complex, and Schumpeter insists that to understand it properly, it must be understood as a “…socio-psychological superstructure, if we wish to speak the Marxian language…” To give you an idea of Schumpeter’s commitment here, he begins this section with the following: “Fifty thousand years ago man confronted the dangers and opportunities of his environment…” We’re in for it. Schumpeter explains how rational thought and behavior allowed early man to progress. All he means by rational behavior is how, “individuals or groups go about dealing with a given situation, first, by trying to make the best of it… according to their own lights; second, by doing so according to those rules of consistency which we call logic…” Rational behaviors don’t occur in all places of our lives, but mainly in the “economic sphere.” In regard to early man, the economic sphere is the part of life concerned with survival. Schumpeter shares a made up example of one early man who uses a stick as a tool, which then breaks. In order to fix his broken tool, the early man does not recite a magic formula, but instead searches for the best way to join the fragments, or find a new, suitable stick. Rational action in the economic sphere at work! To give us a working definition for the “economic sphere” I would say it’s the parts of life concerned with securing your material means. A person searching for work is one such example. Casting a vote in an election is not though, because it’s about doing a civic duty and voicing your political beliefs (if not to others, at least to yourself)—not about securing your material means. This means a person searching for a job follows a more rational process than a person casting a vote, which is exactly the distinction we want to make.

But this isn’t capitalism yet. Schumpeter notes this process of rational behavior in the economic sphere is independent of capitalism. “So is the profit motive and self-interest,” he adds. “Pre-capitalist man is in fact no less ‘grabbing’ than capitalist man. Peasant serfs for instance or warrior lords assert their self-interest with a brutal energy all their own.” This is a crucial point on its own, and worth making note of. So many people today have an idea that capitalism is what drives greed, but we’ve always had greed. Capitalism can almost be thought of as the cones and lines we added around greed (i.e. self-interest) to channel it to better ends.

Back to Schumpeter. He says “capitalism develops rationality and adds a new edge to [it] in two interconnected ways.” The first way is using money as the unit of account so cost-profit calculations can be made. This leads us to another gem from Schumpeter, worthy of a block quote in its entirety.

…the cost profit calculus in turn reacts upon that rationality; by crystallizing and defining numerically, it powerfully propels the logic of enterprise. And thus defined and quantified for the economic sector, this type of logic or attitude or method then starts upon its conqueror’s career subjugating—rationalizing—man’s tools and philosophies, his medical practice, his picture of the cosmos, his outlook on life, everything in fact including his concepts of beauty and justice and his spiritual ambitions.

Under this theory, early capitalism (aka: rational behavior combined with a monetary unit of account) is responsible for… most of modernity. I think a form of this is basically true by tautology—that rational behavior is responsible for all of modernity—but once we add that cost-profit calculations must play a causal role (and thereby make this theory falsifiable), the theory is less stable. I did a quick analysis with Claude and the results are mixed. There are some examples of a causal relationship between cost-profit calculations and the emergence of other fields like statistics, modern law, and ethics (see Bentham), but there are clear counter examples too. Cost-profit calculations in Renaissance Italy didn’t exactly predate the scientific advancements also taking place, and there are also other instances in world history like in China or ancient Greece where modernizations occurred without a strong link to cost-profit calculations. But if we look back far enough, Schumpeter’s theory may not be so far off, since after all, the earliest known writing was for accounting.

The second way that capitalism adds to rationality is: “the men and the means… by creating the social space for a new class that stood upon individual achievement in the economic field.” During the feudal period, there were only two ways for a person to rise above their social class—i.e. grow to a position comparable to those of the ruling class—and that was through the church or through military achievement. “It was only when capitalist enterprise—first commercial and financial, then mining, finally industrial—unfolded its possibilities that supernormal ability and ambition began to turn to business as a third avenue.” And now that this new avenue was available, it was able to “draw most of the best brains and thus to generate further success—to generate additional steam for the rationalist engine.” Essentially capitalism adds the social freedoms necessary to allow anyone to gain the power and influence of the ruling class via their own commercial success. This may sound like a flaw of capitalism today, but it certainly beats the historical precedent which allowed class mobility only through the church or through conquest.

Now our review of Schumpeterian capitalism is complete. The normal definition of capitalism—private ownership of the means of production—is useful for drawing a boundary around the concept, but I think this lengthy analysis from Schumpeter is essential for understanding capitalism at a deeper level: where it comes from, why it’s so successful, and how it may end.

Why does capitalism self-destruct?

Below are Schumpeter’s five strongest arguments.

- Anti-capitalist resentment flourishes under capitalism

Schumpeter imagines the thoughts of an industrialist who wonders how an anti-capitalist social atmosphere could possibly take off. The industrialist thinks, surely the discerning workman, when assessing his own circumstances would realize that he experiences real benefits from his employment, and that he is far better off than any person of his relative social standing in all preceding history. Schumpeter says, well yes, of course, the workman is indeed much better off, but that doesn’t matter one bit. “It is an error to believe that political attack arises primarily from grievance and that it can be turned by justification. Political criticism cannot be met by rational argument.”

Here’s an economic example: Person A complains that people don’t get paid enough. Person B responds that throughout human history, the median person has actually never been paid better than they are right now. Person A is not particularly moved by this reply.

Whether or not Person A should think like this is irrelevant because, as it happens, Person A does. Where exactly do these criticisms come from in the first place though? Well, to go all the way back, criticism comes stems our rational nature. Schumpeter writes:

When the habit of rational analysis of, and rational behavior in the daily tasks of life has gone far enough, it turns back upon the mass of collective ideas and criticizes and to some extent “rationalizes” them by way of such questions as why there should be kings and popes or subordination or tithes or property.

The rational way of thinking, which set the very ground work for capitalism, begins to challenge capitalism itself. Here Schumpeter implies that rationality has a never-ending “question the status quo” directive built into it. This works great when the status quo is the economic system of feudal Europe, but not great when the status quo is the economic system we want to endure. I think this mirrors an idea expressed by Francis Fukuyama in the End of History:

Experience suggests that if men cannot struggle on behalf of a just cause… then they will struggle against the just cause. They will struggle for the sake of struggle. They will struggle, in other words, out of a certain boredom: for they cannot imagine living in a world without struggle.

Both Fukuyama and Schumpeter imply there is some set amount of criticism and struggle inherent in human nature, and it doesn’t depend on anything external to us. No matter how good things get, that criticism and struggle will still come out to attack whatever it can. Schumpeter explains further that discontent in the public originates, not from some specific feature of capitalism, but from the daily frictions and troubles that we’d all have to deal with in any way of life. And we tend to attribute these troubles and frictions we experience not to own shortcomings, but to the system we are in. It’s in responding to this discontent that capitalism fails so miserably.

- Responding to societal discontent - Part 1: Capitalists are not politicians

Capitalists and politicians are different people, which means that they don’t have the ability to ensure capitalism remains. This statement would be mocked 100 different ways today, but I think Schumpeter’s point rings true, at least when looking at other historical systems of economy and governance. Before capitalism, kings (or any other kind of ruler) were the ones who set policy and owned the means of production. But under capitalism, the owners of the means of production are not the ones setting policy. However intertwined capitalists and politicians may be today, they are not the same people, which to Schumpeter, makes a big difference, and makes capitalism far less stable. It’s why capitalist countries are still able to pass laws in direct opposition to capitalism, like large tax hikes or the nationalization of private industries. Schumpeter’s larger claim here is not just that capitalists and politicians happen to be different people by happenstance, but instead that the differences of the capitalist types and politician types are irreconcilable. The strength of capitalists is in their business acumen and rational decision-making, which is in direct opposition to the strengths of the politician, provocative rhetoric and schmoozing. The capitalist’s superpower renders him powerless in the political arena.

- Responding to societal discontent - Part 2: Capitalism lacks a moral ideal

In order for a social system to survive, it must provide some sort of emotional, moral, or spiritual aspect for the public to latch on to. Fascist and communist systems, for instance, provide a moral ideal (however twisted) for the public to follow, but capitalism does not. This particular argument has been made countless times about liberalism too.

When you add ever-rising standards of living and increased leisure time to the mix, Schumpeter claims discontent grows even stronger. He refers to this as one of the tritest, oldest and unfortunately true facts about the world: “Secular improvement that is taken for granted and coupled with individual insecurity that is acutely resented is of course the best recipe for breeding social unrest.” A charming quote, and I’d agree that the increased leisure time certainly exacerbates social unrest, but I’m not sure about the increased standard of living, since this would imply that if living standards decreased instead, there would be less social unrest… which seems hard to square. Regardless, I think it is clearly true that rising living standards are absolutely not the silver bullet to quelling discontent, and capitalism as a whole has no solution either.

- The intellectual class stirs this discontent into active hostility

While societal discontent will always occur, active hostility requires a distinct impetus. That impetus is a group of people, the intellectuals, “whose interest it is to work up and organize resentment, to nurse it, to voice it, and to lead it.” Thus begins Schumpeter’s examination of the “Sociology of the Intellectual.” Intellectuals, according to Schumpeter, are those who wield the power of the spoken or written word, who have no direct responsibility for practical affairs (i.e. they have little contact with the economic sphere, aka securing their material means). They generally don’t have first-hand knowledge of the things they comment on, and the topics they opine on tend to be many, ranging from politics, economics, science, religion, and culture. Their commentary is often critical, partially due to the nature of being an on-looker in whatever field they are commenting on, and partially because this is the best way to garner attention and assert oneself.

And capitalism allows intellectuals to flourish. Schumpeter writes, “if the monastery gave birth to the intellectual of the medieval world, it was capitalism that let him loose and presented him with the printing press.” There are three main ways capitalism helps the intellectual class grow more powerful. The first is through technological innovation. Schumpeter talks of the cheap books, newspapers, and radio that now allow intellectuals to reach the public so easily, and today with social media their reach has only grown. The second way is due to the nature of capitalists and their love for individual freedom. Capitalists cannot prosecute the intellectual class who opposes them because this would undermine the institution of individual freedom, and therefore undermine capitalists themselves. Capitalists are stuck between a rock and a hard place. Only a socialist or fascist government, says Schumpeter, is strong enough to discipline intellectuals. If only Schumpeter knew how much he’d be proven right on this 80 years later. The third way is capitalism’s “vigorous expansion of the educational apparatus and particularly the facilities of higher education.” In this section, Schumpeter impressively lays out the elite overproduction hypothesis. Through capitalism’s wealth creation, more and more people are able to pursue higher education. And the pursuit of higher education is somewhat outside the economic sphere (i.e. not concerned with securing one’s material means), which means it is not calibrated to the job market, and we end up with more educated people than desirable jobs meant for the educated class. Hostility ensues.

- Capitalism destroys its own ideals

In this section Schumpeter notes four ways in which capitalism erodes capitalist traits and ways of thinking. Things like individualism, self-reliance, the entrepreneurial spirit and so on. The first way this occurs is quite a Marxian observation. Schumpeter says capitalism tends to squeeze out the small producer and trader. “What [capitalism] did to the pre-capitalist-strata it also does—and by the same competitive mechanism—to the lower strata of the capitalist industry.” The rise of big business is making the small entrepreneur disappear. This means fewer people see themselves as the capitalist and more see themselves as the worker, thereby they are less able to feel the advantages of self-ownership, whether or not they make more money as a worker than they did as a small entrepreneur, since what matters is the loss of their capitalist spirit. Second, the bureaucratized labor contract, which consists of a set number of hours per week, routine pay, standard benefits, etc. reduces the amount of individual choice each worker has, which undermines their individuality and ability to freely choose. Third, “the capitalist process, by substituting a mere parcel of shares for the walls of and the machines in a factory, takes the life out of the idea of property.” With fewer people physically experiencing the property they have ownership of, fewer people will be able to really internalize the benefits of property ownership. Lastly, Schumpeter argues that entrepreneurship itself is being automated and bureaucratized away. Just as the car is mass produced in a factory, so will the formation of new ideas and companies. Entrepreneurship then becomes a shadow of itself. No longer is it the work of the plucky go-getter trying to prove himself, but instead we get systemized business creation and committee meetings.

Schumpeter’s main argument in this section is that by optimizing for efficiency and profit—a clear goal of capitalism—people’s attachment to ideas of self-ownership, individuality, freedom, owning property, and entrepreneurship itself, begins to loosen, which is clearly bad because these are the very ideas capitalism stands upon.

- Shifting toward short-term thinking

Capitalism is partially built upon a long-term view, that we work, save, and invest today, so that we have money in the future and can leave something long-lasting for posterity. Schumpeter believed that more and more people were beginning to rationalize this away. What’s the point of building something long-lasting if I’m not going to be around to reap its rewards? Schumpeter thought that religion and the traditional family structure pushed people toward this long-term thinking, but as more people leave religion, and fewer people have kids (a phenomenon he noticed in 1935!) the capitalist instinct to save and invest would fade.

So why is capitalism still alive?

A lot of Schumpeter’s arguments ring true. There is in fact a lot societal discontent around capitalism, and even working generally. Capitalism indeed lacks the political power and moral guidance of past social systems. The intellectual class tends to be very anti-capitalist. People are certainly having fewer kids. Despite these massive headwinds, capitalism sticks around.1 Why?

To start, I think one of his critiques of capitalism is actually a strength: the lack of overt political power. It’s true that the capitalist class isn’t calling all the shots—it’s why we still have taxes and labor unions and antitrust laws. I think this is good! Not these particular policies necessarily, but the fact that these policies have the potential to be implemented. We the people need to express ourselves, to feel heard, and to feel like we have a way to make the social system we live under into a better one. There aren’t any authoritarian regimes today that have lasted as long as the American capitalist/democratic regime has. The hope is that we adopt enough of these “anti-capitalist” policies in order to satisfy the desires of people who call for change, but that the policies aren’t destructive enough to actually ruin capitalism. I think we’ve done a pretty good job at toeing this line in America.

Second, I think one of Schumpeter’s arguments just turned out wrong, the one about the erosion of individualism, freedom of choice, and the entrepreneurial spirit. Looking at the data, from 2006 to 2026 the number of annual new High Propensity Business Applications (businesses that are likely to hire employees) stays fairly consistent, with a slight upward trend. But beyond the quantitative data, I think the institution of entrepreneurship has never been stronger, and is by no means fading away as Schumpeter indicated. Startup founders are now celebrities, with the VC class not far behind them, the startup journey is now a common plot in movies and TV, and business leaders have more political clout than ever. The entrepreneur is the modern day mythic hero. I think what Schumpeter got wrong here is just how powerful the entrepreneurial mythos could become if the basic pillars of capitalism could hold, which they did.

Perhaps capitalism is hanging on by a thread though. Perhaps the next election will finally be the coup de grâce. Perhaps there have already been a few times where, unbeknownst to us, the difference between capitalism remaining and capitalism falling was pure blind luck. Just a historical contingency. Unfortunately, we’ll never know, but the one point of evidence we do have is that capitalism today is still alive and well! I’m glad Schumpeter was not proved right on this one, at least not yet that is, and I think he would be glad too.

Is it ok to assume capitalism is still here in America? I think yes, clearly. It’s not laissez-faire, but America’s definitely much closer to capitalism than socialism. Most productive assets (i.e. businesses) are privately owned. Creative destruction is still creating and still destroying.