The Schumpeter Curse

Some would consider that Joseph Schumpeter is to “capitalism” what Albert Einstein is to “physics”. Schumpeter is associated with the concept of "creative destruction" that occurs as new innovations overtake the established order of things.

In his signature book Capitalism, Socialism, and Democracy,[1] Schumpeter included a chapter titled "Can Capitalism Survive?". In this chapter he notes that capitalism has the capacity to produce enormous quantities of goods and services. But he also talked about the fundamental weakness of capitalism. He talks about what is commonly referred to as the "business cycle" where capitalist economies tend to alternate between periods of expansion and periods of contraction. He states emphatically that a rise in unemployment is a natural (and even predictable) consequence of the “prosperity phase” of economic expansion. This rise in unemployment is part of the “mechanism of capitalism itself”. Removing these “supernormal” periods of unemployment is in his opinion one of the virtues of socialism.

So when we look for those who predicted the current economic crisis, we would have to include Joseph Schumpeter as one of the most articulate writers in predicting not only the circumstances of our current crisis, but he also explained the very mechanisms of how it would take place. Furthermore, he predicted that our current crisis would occur over and over again because it is an inherent characteristic of capitalism.

His prediction that should give us all pause under the current circumstance is that the public policy response to a sharp rise in unemployment during the contraction phase of the cycle is always to insist on “economically irrational methods of financing relief and on lax and wasteful methods of administering it”. This is what I call the “Schumpeter curse”. It is the presumed inevitability that in trying to address the pain of heightened unemployment, government will almost always take actions that make the situation worse.

No one can argue that both the Bush and the Obama administrations have used unconventional methods to finance “relief” for the financial services industry, (including residential mortgage industry), the banking industry, and now the auto industry. Some voices are already charging that these methods are riddled with waste and fraud. Is it possible that the current administration can avoid the “Schumpeter curse” and actually find a way to address the current situation without making matters worse? If they do succeed, it would surprise Schumpeter as much as the invention of a time machine would surprise Einstein.


[1] Joseph A Schumpeter, Capitalism, Socialism, and Democracy(Harper Torchbooks, 1942), 68-71.