It is “net revenues” that are available for discretionary uses — either for investing or consuming — or for taxation that does not reach the level of capital levies — that is the measure of national wealth used by Smith.  This is what a society can draw upon — without deferring maintenance or otherwise draining existing productive capital. It is available for all discretionary purposes — profound or frivolous — consumption or investment — private or government. It is a measure of economic power — either in terms of money or in its labor and commodity equivalents — that is available without diminishing the productive capacity and prospects of the nation.[6] Smith is also very aware of the vast economic power that accrues to nations and private entities as they build up their credit.[7]

2) Government Economic Policy

The superiority of market mechanisms over the administered alternatives that may be directed by government, private associations, experts or intellectuals is set forth by Smith with classic clarity. Each individual seeks to maximize his profits or wages by employing himself and his capital in the most valuable way. Regardless of human imperfections and limitations, the expertise that individuals gain concerning their own business and economic needs must inevitably be superior to that of any outsider.

Government restraints and other interference with domestic and foreign commerce are both foolish and dangerous.

“What is the species of domestic industry which his capital can employ, and of which the produce is likely to be of the greatest value, every individual, it is evident, can, in his local situation, judge much better than any statesman or lawgiver can do for him. The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it.”[8]

For over 200 years, advocates of mercantilism, communism, socialism, price controls, protectionism, industrial policy, social engineering and other administered alternatives have all rejected this wisdom. They have expended vast and varied efforts to improve on market results — and have all failed miserably — often with disastrous results that have blighted the lives of billions of people. Their "folly" was often vastly dangerous indeed.

All too frequently, administered policies are in reality efforts to promote political or personal interests above national interests. Competitive markets — even with competitive conditions that are far from perfect — provide a cornucopia of benefits and easily achieve results superior to the most elaborate administered alternatives. [DB]

Principles
by
David Ricardo[9]

Introduction:[10] Comments on Smith, Malthus, Say and Others.

David Ricardo's “On The Principles of Political Economy and Taxation” is concerned to a large extent with the intellectual discourse on economics during the first decades of the 19th century. Ricardo essentially follows and expands upon the concepts of Adam Smith. The concepts of Malthus[11] and Say[12] also appear prominently, and there are numerous references to the works of other contemporaries. While in general agreement with Smith with respect to basic principles, Ricardo has many differences with respect to particular market impacts and market adjustment sequences. Serious students thus must read the two treatises together. Ricardo’s points of agreement and difference with his other contemporaries — both as to matters of basic principle and particular impact — permeate his book. Much of this discourse is of only historic interest. Only the points of most current interest are covered here. 

The market adjustment process in relation to various economic factors is what Ricardo emphasizes. His numerous disagreements with Smith and others are generally over the particulars in this adjustment process. He distinguishes “market prices” from “natural prices.” He emphasizes how market prices are set at the margins of supply and demand, but insists that it is the costs of supply that dictate natural prices and thus, in the long haul, market prices, too.[13] Within market constraints, it is the least fertile ground under cultivation — the least fertile mines in production — the least productive capital in use — the subsistence wages of labor — that dictate prices, wages and the rent of landlords.[14]

Ricardo was an ardent Malthusian. He expressed great admiration for Malthus' "Essay on Population," but had several disagreements with Malthus' work on rent. Thus, population increases would always drive the wages of ordinary laborers back towards subsistence levels, no matter how productive and wealthy the rest of the economy should become.[15] Capital flows tend to equalize profit rates — subject to factors of risk and other difficulties.[16] The rate of profits depends on the “real” cheapness of labor, which depends on the cheapness of corn and other subsistence goods. However, with vast accumulations of capital, the amount of profits can increase even as the rate of profits declines.[17]

The interests of labor are thus viewed as in direct conflict with the interests of capital and even of the nation — a profound error. Ricardo gravely underestimated the ability of capitalism to thrive — increasing both real wages and wealth.

The most obvious weaknesses in this book and the works of the other economists of the classical era flow from Malthusian expectations. This fallacious view is the basic source of the pessimism about wage rates that afflicts classical economics. Malthusian limits on economic possibilities must have seemed quite reasonable during the Napoleonic Wars — a two-decade period when Great Britain was wracked with inflation and swamped with vast debts.

In fact, human fertility declines — rapidly — with modern prosperity, with modern education, electrification and the massive expansion of individual possibilities. There are few broom pusher — totally unskilled — jobs in a modern economy. Thus, many of the particulars of the market adjustment process that fill so many pages of the works of Ricardo and his contemporaries simply don't apply to modern conditions. Wages and other labor market costs do rise to capture a majority of the benefits of productivity increases.

More than three decades earlier, Smith was already able to discern that, over the course of the previous century, British labor had been able to appreciably increase the level at which it was “subsisting.” Ricardo recognized that “subsistence” levels were continuing to rise.[18] [DB]

Ricardo is a worthy follower of Adam Smith.

·         Ricardo provided the theoretical tools for analyzing economic problems and devising practical solutions for dealing with them. He emphasized the components of exchange values and the law of diminishing returns.[19]

·         Currency inflation and the national debt — problems recently arising from the Napoleonic Wars — are of particular interest to Ricardo;

·         As is agricultural protectionism — the Corn Laws.

Ricardo's analyses would be a powerful factor in the reinstatement of the gold standard and the repeal of the Corn Laws and the establishment of free trade in the decades after his death. These economic reforms played a prominent role in the great surge of economic power and wealth enjoyed by 19th century Great Britain. [DB]

·         International trade theory was the subject of Ricardo's greatest contribution.

Smith had argued simply that it was foolish to produce goods that others could produce and deliver more efficiently. Nations should concentrate on that which they could produce with an absolute advantage. Ricardo broadened this concept immensely — proving the profitability of production for which there is a "comparative advantage." All economies that are directed by competitive markets have comparative advantages — even if they have no absolute advantages in the goods they produce.[20]

·         Ricardo also analyzed economic distribution between rent, wages, profits and interest;[21]

·         The impacts of economic growth;[22] and

·         The impacts of various forms of taxation.[23]

Capital (Das Kapital)
by
Karl Marx[24]

Book I: Value Determined by an Abstract Labor Standard

Introduction to Book I:[25] Creation of a Propaganda Myth 

1) Economic Value

Of those who have waded through “Das Kapital,” few — especially among the “Marxists” — had the economic knowledge to evaluate it. Indeed, it is widely acknowledged that very few who call themselves “Marxists” have ever bothered to even read these books. This is quite understandable.

Das Kapital is about 2,000 densely paragraphed pages in the Foreign Languages Publishing House translation. It is composed of tediously interminable, repetitively and minutely detailed rationalizations, which are nevertheless obviously incomplete and irrational. About one quarter of Book I is dedicated to presenting the undoubted horribles of economic life in the 19th century and in the several centuries prior to that period. This is continued through Book II and Book III as well – which are almost 1500 pages. Much is again dedicated to the unavoidable horribles of the initial stages of economic industrial development. That such conditions are indeed unavoidable is demonstrated repeatedly by emerging market nations in modern times. The primary affect of this design is to smother in about 2,000 pages the many omissions and flaws of logic — and thus to shed much heat while providing little light. Yet, the concept of capitalism presented can all be accurately stated in a few paragraphs.

·        Only productive industrial labor adds value to the commodities produced. Labor itself is “a particular commodity” – “labour power” — that is saleable like a commodity — and is measurable in terms of an abstract labor standard — based on duration of average simple unskilled subsistence wage labor.[26] The “labor power” standard can be used as a unit of measure like the “horsepower” standard.[27]

·        Capitalists — as owners of capital — contribute no labor to commodities and thus contribute nothing of value to production.[28]

·        Commercial factors contribute no industrial labor to commodities, and thus contribute nothing of value to production. At most, they just prevent loss of value during circulation.[29]

·        Capitalist wealth is totally due to egregious misappropriations of productive assets beginning as far back as the period of the breakup of feudalism — “primitive accumulation” — or to the subsequent exploitation of laborers who have been separated from the means of production and thus made dependent on capital.[30]

·        Capitalists are thus entitled to nothing back from the productive process except the wages they pay for labor. Anything more that they receive constitutes “surplus value” that they have extracted by the unjust exploitation of labor.[31]

·        All capitalist expansion is achieved only by capitalizing the surplus value wrongfully obtained by the exploitation of labor.[32]

·        Therefore, the capitalist ownership interest can be dispensed with without economic loss — with considerable justification — and with gain from the elimination of capitalist exploitative conduct.[33]

·        The natural course of capitalism is towards greater concentration of wealth and power. Continuous increases in productivity cause overproduction, squeeze profits, cause periodic economic crises, and make “redundant” an ever enlarging “reserve army” of unemployed and underemployed workers. Capitalists respond to these factors by mercilessly imposing ever-harsher working conditions and by squeezing more labor for lower wages from their workers.[34]

·        The plight of labor must thus inevitably worsen as capitalists greedily strive to maintain and increase their profits. Ultimately, an ever more numerous and aroused proletariat will overthrow their capitalist bosses and retake control of productive assets.[35]

There are obvious answers to this narrow Marxist view of the labor theory of value and the expectation of chronic capitalist crisis.

·        In the modern world, most of the value produced by labor and capital is attributable to management. This was true even well before the middle of the 19^th century.

·        Without the incentives of the ownership interest — and the signals provided by commercial and capitalist markets — good management is impossible. Indeed, so important are the ownership incentives that — even with market signals — government management is inherently inept.

·        In socialist nations that lack both ownership incentives and market signals, “government economic management” is an oxymoron.

·        That goods in the market are worth more than goods on manufacturers loading docks is observable fact. This additional value can only come from the commercial factors that bring goods to market.

·        Workers have in fact been visibly improving their lot in the advanced capitalist nations since the middle of the 18th century, and a growing middle class has been providing an ever widening array of goods and services that are clearly far more than just “luxuries.”

·        Increases in productivity always permit an economy to produce more goods and services than before — as well as new goods and services that previously could not be economically provided. The changes caused by increased productivity always bring more opportunities than hardships.

Smith evenhandedly recognized both the abuses and economic contributions of industrialists, financial institutions and merchants — with explanations that are both brief and remarkably clear.[36]

Marx, on the other hand, created a dense rationale for emphasizing the undoubted abuses and arguing that the capitalist ownership interest and capitalist commercial and financial systems do not contribute any value and can thus be dispensed with.

Schumpeter explained many of the glaring weaknesses in Marx’ doctrine[37] even while accepting Marx as “the one great socialist thinker” for providing the first comprehensive theory of socialism.[38]

Keynes’ “General Theory” is dependent on a host of important elements in Marx’ doctrine.[39] While rejecting Marx’ criticism of exchange values, private property, paper money and competitive markets,[40] Keynes is considerably less than an ardent defender of many of these basic concepts of capitalist markets.

Repeatedly, Marx' logic breaks down. To deal with these problems, Marx relies on semantics games based on definitions and redefinitions of terms that even Marx and Engels are ultimately forced to acknowledge as functionless.[41] Instead of definition being dependent on reality, reality is viewed as a malleable thing that can be made dependent on Marx’ definitions.

There are obvious important internal inconsistencies, a basic reliance on tautological reasoning, selective — one hand clapping — analyses of causation, numerous distinctions without practical difference, bald denials, and a host of omitted essential factors — as are presented repeatedly hereafter. They demonstrate that even Marx and Engels — although working feverishly on Das Kapital for about three decades — ultimately found it impossible to work logically with their own ideas. Their last resort was a “tail-wagging-the-dog” assertion. Working like a “law of nature” behind the scenes and totally hidden from mortal view, averages that are merely a mathematical artifact of prices and values suddenly cease being dependent variables and magically become the determining factor of those prices.[42]

Glaringly omitted from the Marx definition of economic value are all the factors that contribute to economic production of goods and services but that have no direct relation to industrial labor on commodities as defined by Marx. Marx perforce recognizes a few of these omissions — things that are bought and sold in the market — things that have a market price — like honor and conscience. Quite unscientifically, he has recourse to a tautology.

His narrow labor definition of value — limited to industrial labor use-values — is exclusive because other things of value in the market don't meet Marx’ definition. Things of value that don't involve industrial labor have no value because they don't involve industrial labor. Since the labor theory of value is scientific truth, it cannot be undermined even by a multitude of obvious exceptions some of which he expressly recognizes as not just of economic benefit but also as essential for capitalist market functions. Any value that doesn't conform to his definition of value must therefore be “imaginary.”[43] He is the Wizard of Oz exclaiming: “Pay no attention to those values behind the curtain.”

The factors omitted from economic value — besides honor and conscience — are such obviously essential economic factors as

·         private property,

·         reliability,

·         courage,

·         variety,

·         savings,

·         financial independence,

·         financial security,

·         scarcity,

·         rarities like works of art and antiques,[44]

·         the absorption of risk,

·         the universe of financial services,

·         the time cost of money (interest rates),

·         the time cost of property and productive assets,

·         the productive incentives of the ownership interest,

·         the commercial activities that bring goods to market,

·         competition, without which efficient management is impossible,

·         all of the management tools available only to profit-seeking enterprises, without which efficient management of complex economic entities is impossible, and

·         all the signals provided by competitive commercial and capitalist markets, without which efficient management is impossible.

Two centuries of socialist experiments at all levels and within all kinds of government systems would fail abysmally because of their inability to efficiently function without such factors.

·         Deferred maintenance and inability to keep up with technological advances would be particular problems with socialist experiments at the national level due to the absence of such factors as ownership incentives and the time cost of money.

·         The factor of quality would prove difficult to evaluate — and variety an impossibility.

·         The lack of incentive for diligence would be a problem for all socialist enterprises that are managed in an egalitarian manner. Under egalitarian socialism, the average level of labor intensity would drop precipitously. In the Soviet Union, the workers would explain: “We pretend to work, and they pretend to pay us.”

·         A lack of competition would be a prescription for gross inefficiency in any system — including capitalist systems.

·         No other system is as reliant on ethics as capitalism. It runs on trust and reliability at every level — one of the primary reasons for its efficiency and success. That there are failures and scandals is not nearly so remarkable as the relative infrequency with which they occur.

·         The incentives of the ownership interest — which are peculiarly sensitive to the risks and rewards of enterprise — provide the only mechanism with which to even roughly balance optimism with pessimism — ambition with caution — greed with fear — to generate prudent action.

·         Exploitation of labor by the state in autocratic socialist systems would routinely prove far more onerous — and far more inescapable — than even the worst examples of exploitation by capitalists — and would invariably fail to produce promised levels of economic development.

With incredible naiveté, Marx — and the Marxists that came after him — would assume that socialist systems would solve all their managerial problems simply by employing managers and issuing socialist directives.[45] After all, who needs all those management processes of capitalism if they can all be replaced simply by the issuance of five-year plans?[46]

However, the impracticality of the Marxist abstract labor standard would be the most damaging weakness. For all his dense explanations:

·         Marx’ abstract labor standard of value can only be applied to simple tasks dictated by the pace of industrial machines.

·         Marx — and the Marxists who followed him — would fail to explain how his abstract labor standard of value would apply to the vast mass of real labor that — because of differences in talent, diligence or skill — rises above or falls below average unskilled levels, even when the pace of work is dictated by the pace of machinery.

·         Indeed, they would never be able to determine how much unskilled labor of each particular type and level of diligence is needed to reach subsistence labor levels.

·         Thus, rapid calculations of “undifferentiated human labor” values for each of the myriad of products and services produced in an economy would prove impossible. “Labor power” is not anything like the physically measurable “horsepower” standard which is applied in turn to physically measurable phenomena.[47]

As repeatedly pointed out herein, economics is, after all, a practical art by which scarce resources are allocated. Marx commits the ultimate sin in economics — he is not practical. Any concept of value that cannot be accurately and readily calculated is useless for the fundamental purpose of allocating scarce resources. Marx, himself, would repeatedly be forced to have resort to market prices as an approximation. Where there are no market prices — as in socialist experiments based on administered prices — it would remain impossible to evaluate real labor in terms of the standard labor unit devised by Marx.

Marx is attempting to clap with just one hand — consisting of factors of supply. True, that one hand is responsible for the clapping — but not alone — or even predominantly. And worse — Marx offers just half a hand — omitting for his propaganda purposes major factors even on the supply side.

The pricing mechanism of even modestly competitive capitalist markets easily proves far superior to all subsidization schemes and administered pricing alternatives. “Rationing by the purse” invariably proves to be the most efficient — and the fairest — method of allocating scarce resources. Capitalist systems, too, would prove grossly inefficient whenever administered prices were substituted for market prices — or whenever markets became almost totally uncompetitive.

The economic impact of government intervention to assist a needy few inevitably pushes up costs in the pertinent markets to the point where practically everybody becomes dependent on government to access those markets. Major segments of the vital health care industry are providing a prominent example — and are staggering under the burdens of administered pricing procedures. The costs of education are being driven out of reach by government subsidies. Housing costs repeatedly balloon uncontrollably due to tax and credit subsidies. The costs of public governance rise out of control in many jurisdictions.

Rationalization is not reason! Das Kapital is a massive exercise in rationalization almost entirely devoid of reason. It is useful only as a propaganda myth, at which it proved spectacularly successful.  Nevertheless, this Marx propaganda myth remains relevant into the 21^st century. A substantial number of Marx’ concepts were adopted by John Maynard Keynes for his General Theory, and many are still widely accepted uncritically.[48]

The propaganda purpose of his book becomes apparent even before it begins. Marx starts right off in his Preface to the second edition by invoking the science propaganda ploy[49] — a common practice for him by that time. After all, who can doubt the word of “science?” However, the approximately one dozen forecasts made in Book I on the basis of Marx’ “scientific investigations” turn out to be almost entirely in error as do all but a couple of the expectations expressed in the other two Books. It is the most basic principle of science that, when forecasts go wrong, something must be amiss with the theory.[50] What could it be?

Book III: Profits, Interest, Rent, and Labor Use Values[64]

Introduction to Book III:[65] Making Value Disappear

Marx finally confronts his fundamental irresolvable problem in Book III. There are numerous processes and incentives in the capitalist system that obviously contribute greatly to its productivity yet don't involve industrial labor. For his propaganda purposes, Marx must disparage them and maintain his view that they contribute no “value.” Of course, he fails. He throws up numerous examples of capitalist abuses and confusing clouds of obscuring detail about the business cycle. This provides much grist for Marx' propaganda mill and an emotional smokescreen with which the weaknesses of Das Kapital are hidden.

“Profits” — frequently now by name — but still frequently confounded with surplus value — finally comes front and center under consideration in Book III. Much of Book III is concerned with the relationship of these two concepts, and with interest and rent — but not ground rent on raw land — as forms of profit. “Profits” are redefined in Book III to show its close relationship with surplus value. However, this merely shifts the tendency to confound profits with surplus value to a tendency to confound “profits” as redefined by Marx with “profits” as normally defined.[66] His redefinition of the term reduces it to a concept with No functional applicability in capitalist economics. His definitions and redefinitions of other terms compound this problem. Both Marx and Engels continuously trip up when applying “profits” as Marx redefines that term to phenomena that can only be explained by “profits” as normally defined.

Even worse, with his expanded definition of “profits” Marx is left without any concept for explaining the maximum rate possible for capital expansion — the heart and soul of Marx' “scientific investigations.” In Book III, he illogically equates the “rate of profit” as he defines it with the degree of self-expansion of capital.[67]

Differences in the productivity of individual capitalists also begin to gain recognition in Book III. Yet, Marx still expects a general collapse. He generally deals with capitalist facilities as homogeneous masses, all of which might collapse together as overproduction and overcapacity squeeze profits. He mentions differences among producers only in passing while discussing other things. He similarly — but just in passing — even provides recognition of the productive importance of the ownership interest — apparently oblivious that this is inconsistent with his continued denial that it contributes to value.

Marx’ abstract labor theory of value has no visible impact on individual capitalists or industries, Marx and Engels perforce repeatedly acknowledge. Marx asserts instead that its impacts exist only as broad economic averages for an entire economy.

In a desperate tail-wagging-the-dog argument, Marx and Engels assert that these averages somehow determine their constituent parts instead of being, as averages always are, mere dependent variables – mathematical calculations determined by their parts. Very conveniently, these impacts are too attenuated to be demonstrated.[68] His “scientific” hypothesis cannot be tested. Unfortunately for Marx, repeated efforts at demonstrating some functional role for this and his other concepts all clearly fail.[69]

Engels considered Book III the most important of the Books of Das Kapital. Book III has more of Engels in it than any other Book, although he assures us that his arrangements, supplementations and additions were all carefully in line with the notes and thoughts of Karl Marx.[70] However, Schumpeter advises caution due to doubts about whether Engels’ contributions and Marx’ notes reflected Marx’ mature considered opinions.[71]

In Book III, Marx finally attacks the problem of “profits” directly and aggressively. Supplemented by Engels, he finally deals at length with profits in its varying forms as industrial and mercantile profits, as interest and as rent. With some semantics slight-of-hand, he radically redefines the terms “profits” and “total capital,” and then pretends that they describe the same phenomena as when normally defined.[72]

Nevertheless, Book III is the least read — perhaps because it is a daunting 890 pages in length — not counting Engels' usual 20-page Preface. Book IV, produced well after Engels' death, is primarily an account of the history of the theory of surplus value and — mercifully — of so little import as to be readily disregarded.

In particular, Marx failed to fulfill his long-standing promise to provide an explanation of financial capital and competitive markets that reconciled their obvious roles in capitalist productivity with the contention by Marx that they added no value to capitalist production. For example, Section 2 of Chapter 6 of Book III begins with the acknowledgement that world markets and the credit system are essential to an understanding of the capitalist system, and provides assurance that they will be covered in the “continuation” of Book III after “the general nature of capital” is explained.[73]

Marx does, in fact, herein provide voluminous material on the monetary and financing mechanisms of capitalism and their uses. Yet again, he resorts to a distinction without a difference as his ultimate propaganda ploy. The financial system bestows many “benefits” on the productive and distributional systems, but no “value.”[74] He fails to explain how these financial mechanisms can be so useful — indeed, admittedly essential — and yet not contribute to the “value” created by the system. He hides this failure behind his usual emotional smokescreen by instead passionately and repeatedly emphasizing the abuses and periodic failures of the system.

Marx’ view of overhead and commercial activities is similarly in obvious error. As repeatedly pointed out herein, even in the terminology devised by Marx, all activities that contribute to most efficiently bring goods to market must contribute to the value of those goods.

The coverage of rents is the most logical part of Das Kapital. It is also the subject with which Marx is most in agreement with Adam Smith. Unlike Smith, however, Marx — as is expected — emphasizes the problems and costs of private ownership of land while disparaging the benefits — indeed, the essentiality — of private property.[75]

The General Theory
by
John M. Keynes[76]

Introduction:[77] Keynesian Theory

1) A General Theory 

In the source of Keynesian theory, “The General Theory of Employment, Interest, and Money,” John Maynard Keynes purports to provide a “general theory” for self-regulating capitalist market systems.  He asserts that his theory is applicable generally in all economic circumstances. Classical concepts, on the other hand, operate only in those rare “special” circumstances where full employment is possible.[78]

However, it is Keynesian theory that — if applicable at all — is applicable only in very narrow circumstances — like the “special” circumstances of the depths of the Great Depression when political leaders proved incapable of reforming the fundamental policy stupidities that prevented recovery.

Keynes nevertheless successfully convinced multitudes of supposedly knowledgeable economists to accept a series of black-is-white arguments.

·        Savings became bad and deficits became good, and the prudent accumulation of reserves for foreseeable and unforeseeable contingencies was imprudently responsible for disastrous consequences whenever the economy was below “full employment” levels.[79]

·        The accumulation of capital assets becomes another economic obstacle rather than an economic advantage.[80]

·        Investment and employment is stimulated by inflation and hindered by price declines.[81]

·        Securities market liquidity becomes more of a problem than an advantage.[82]

·        The greater ease of manipulating closed economic systems gives them an advantage over those open under free trade policies.[83]

Marxian stupidities were invoked with approval with disconcerting frequency, although in only one instance explicitly crediting Marx.[84] Although controversy over war debts and other international debts and trade war protectionism was raging around him,[85] Keynes has not a word to offer about the obvious roles of such government policies in the business cycle in general and the Great Depression in particular. Instead, he focuses this major analytical effort on the point in the infinite chain of economic cause and effect where governments can intervene with money to avoid having to confront politically fraught policies.[86] He concentrates on some narrow economic factors and ignores the factors of political economy that might discomfort the politicians.

Over a century of capitalist economic history was thus ignored, as were all arguments to the contrary, until Keynesian theories were put to the test in the 1970s — and predictably failed miserably wherever pursued.  Nevertheless, Keynesian concepts are once again popular and in use in the 21^st century — especially in the United States under the Bush (II) and Obama administrations. They remain very popular with political leaders, since they provide intellectual cover for doing what political leaders have always done when seeking to put off confronting the often politically fraught real fundamental problems that afflict an economy.

Keynes provides a rationale for pursuing short-term relief from fundamental economic problems by the age-old means of budgetary deficits and monetary inflation. That's why the politicians favor Keynesian economists — and they become “authoritative voices” that provide people with authoritative misinformation on economic matters. Unfortunately, such palliatives must ultimately make matters considerably worse unless the fundamental problems of the moment are in the private sector where they can be eliminated by the creative destruction of market forces. Unfortunately, the “long-term” consequences of Keynesian policies always arrive within a decade of substantial implementation of Keynesian policies.

Capitalism, Socialism, and Democracy
by
Joseph A. Schumpeter[115]

Introduction:[116] The Broad Relevance of Schumpeter

1) The Government Directed Business Cycle

Industrial policy, socialist and entitlement welfare state programs and the broad spreading of moral hazard credit guarantees over the commanding heights of the private economy were widespread responses to economic difficulties in the first decade of the twenty-first century. That government policies and agencies played a primary role in the boom and bust of the Credit Crunch recession of 2007-2009, and that government profligacy played the predominant role in Europe's sovereign debt crises, quietly disappeared from media coverage and commentary. Blame and regulatory attention concentrated instead on the very real excesses of the private financial sector.

Meanwhile, Fannie Mae and Freddie Mac, the affordable housing laws and tax and credit policies that distort the housing and mortgage markets remained in existence, as did the Federal Reserve’s commitment to artificially low interest rates. In Europe, it was the pain and anguish of austerity efforts that was emphasized rather than the government profligacy that ultimately made austerity absolutely essential.

Indeed, the private sector business cycle is a modern fiction. In the United States, government policies have played important and often predominant roles in every economic contraction since WW-I. This includes the Great Depression, the Keynesian inflationary morass of the 1970s, and the two bubble crises of the first decade of the 21^st century. All too frequently, what government policy destroyed in response to recent crises was the right to fail.

Thus, the social and political tendencies identified and described by Joseph A. Schumpeter in “Capitalism, Socialism, and Democracy” in 1942 continue to undermine capitalism even after the collapse of the socialist alternatives to market mechanisms that those tendencies had favored.
  

2) Socialist Expectations

Joseph A. Schumpeter was a committed socialist with decades of scholarship in socialist history, practice and theory. “Capitalism, Socialism and Democracy,” the source of his theory of creative destruction in capitalist systems, is thus about socialism, not capitalism.[117]

Schumpeter admired Karl Marx as the first to provide a systematic analysis of socialism. Marx was “the one great socialist thinker,” according to Schumpeter.[118]  Marx established socialist theory as a principled doctrine attached to a class movement. Marx recognized the working class as “an existing or potential source of social power.” Marx also recognized the favorable tendencies that supported socialism as a serious political factor.[119] Schumpeter thus accepts Marx' theory as “scientific.”

However, Schumpeter expressly rejects Marx' doctrine.[120] Admiration did not blind Schumpeter to the glaring weaknesses in many of Marx’ most important doctrinal elements. Schumpeter found many inadequacies in Marx' analytical methodology, including “a long list of conclusions that do not follow or are downright wrong; mistakes which if corrected change essential inferences, sometimes into their opposites.”[121] Schumpeter points out that the labor movement, for one prominent example, is not necessarily socialist and clearly benefits over time from capitalist economic development.

Marx, too, is thus revealed to be as utopian as the utopian socialists both Marx and Schumpeter despised. Marx’ theory is mere “ideology,” Schumpeter asserts. It is “unrealistic dreaming.”[122] Since the early trade union movement was viewed during Marx' time as a diversion, and thus a competitor of socialism, communism was then just a movement of squabbling intellectuals.[123]

Marx readily acknowledged the productivity of capitalism and thus based his prophecy of capitalist demise precisely on its great productivity. Marx expected that the capitalist drive for capital accumulation and profits would run into a cul-de-sac of overproduction and squeezed profits and ultimately chronic crisis. The result would be an increasingly militant workforce exploited under increasingly harsh working conditions. There would also be an enlarged and militant reserve army of unemployed and underemployed workers that would be ready, willing and able to participate in the triumph of communism.[124]

The processes of “creative destruction” undermine Marx’ expectation. Schumpeter explains that competition would continuously drive out the outmoded, the poorly managed and the poorly placed so that profitable capitalist production would always be possible for the survivors and for new capitalist enterprises.[125] Marx' explanation of the ultimate collapse of capitalism is obviously untenable, according to Schumpeter, but capitalism was probably doomed nevertheless.[126]

Schumpeter viewed the demise of capitalism as a tentative probability while Marx' viewed it as a “scientific” certainty.[127] It is a central thesis of Schumpeter's book that capitalism will ultimately destroy its own foundations not in its economic evolution but in its sociological evolution. Capitalism would ultimately be undermined not by some inevitable economic collapse but by its continued massive success. It would eventually achieve a “mature capitalism” state of full capitalization and an economic “stationary state” that would lay the groundwork for socialist takeover.[128] “Capitalism is being killed by its achievements.”[129]

Sociological and political factors based on envy — “immiserization” — and redistributionist fervor would probably result in a political turn to socialism at some point in the future, Schumpeter explains.[130] He recognizes tendencies favoring socialism already existing in the New Deal government, in its bureaucracy and political classes.[131] Efficiencies of scale of an increasingly concentrated capitalist system would undermine all of the smaller competitors and a mature capitalist system would reach a point of development that left little scope for entrepreneurial activity, facilitating the socialist takeover. He expected innovation to be dominated by the “increasing mechanization of industrial progress (teamwork) in research departments,” leaving little scope for the individual entrepreneur or small innovative enterprise.[132]

A segment on creative destruction occupying about one quarter of this book was included by Schumpeter for the purpose of explaining why Marx' expectation of a capitalist collapse due to chronic overproduction and profit squeeze would not come to pass.[133] However, it was communist and socialist systems worldwide that collapsed. These experiments were not benign. They suffered catastrophic failures that blighted the lives of billions of people for several generations during the 20th century.[134] Thus, about three quarters of Schumpeter's “Capitalism, Socialism, and Democracy,” are today of apparently little more than historic interest. All that today is left of major significance would seem to be just the segment on the capitalist creative destruction process that keeps competitive capitalism eternally vibrant.[135] For this, Schumpeter is correctly included with Smith and Ricardo in the pantheon of immortal contributors to capitalist theory. Smith did recognize the creative destruction process,[136] but it is Schumpeter who explained it in some detail, emphasized its importance and provided its name.

Both communism and socialism achieved widespread often-fervent acceptance among intellectuals in the years between the world wars. These intellectuals were all too often willfully blind to glaring weaknesses. Marxian doctrine had achieved little influence in the U.S. before WW-I.[137] Ultimately, of course, it was the markets that had the last word. Believers whose analytical capabilities were thus revealed to be grossly deficient doggedly kept the faith until brutally mugged by reality. Marx was revealed as a false god. Schumpeter, too, exhibited a total lack of understanding of the infinite possibilities of capitalism and entrepreneurship.[138] In this he was just like Marx and Keynes and so many other left wing intellectuals, and was similarly mugged by reality.

It is more than a little ironic that the short creative destruction segment added to explain continued capitalist economic success became the basis for Schumpeter's fame as a theorist of capitalism, while his major work and decades of scholarship on socialist theory is today dead and buried for all but a few economic scholars. Somehow, Schumpeter failed to realize that his creative destruction process must ultimately doom all socialist schemes. The expected “mature capitalism” period of full capitalization and an economic “stationary state” that would lay the groundwork for socialism seemed reasonable during the Great Depression, but was and remains an impossibility.[139]

However, the sociological and political processes that Schumpeter expected would lead to a socialist transformation were very accurately described by Schumpeter. These processes continue to be vital factors in the persistent advances of redistributionist fervor and industrial policy, commanding heights government enterprise capitalism, and the entitlement welfare state. The socialist gods— the sociological and political trends explained by Schumpeter— survived the widespread demise of socialism to become the gods of the entitlement welfare state. They thus continue to threaten private enterprise capitalism in the 21st century. For this reason, the bulk of Schumpeter’s "Capitalism, Socialism, and Democracy" on socialism actually retains considerable relevancy.