Capitalism, Socialism and Democracy
Essential analysis on where the world economy is headed
By Joseph Schumpeter
Category: History | Reading Duration: 23 min | Rating: 4.1/5 (676 ratings)
About the Book
Capitalism, Socialism and Democracy (1942) is a seminal work of economics. Its ideas have proven prophetic, and remain relevant to this day. It claims that capitalism will ultimately be eroded by the very processes that define it. It also explains the differences between capitalism and socialism and their relationship to democracy, and helps readers understand the role of entrepreneurship and creative destruction in modern capitalism.
Who Should Read This?
- Students of the social sciences
- Those interested in politics, economy, and their histories
- Critical thinkers curious about the future of capitalism
What’s in it for me? A short sketch of one of the most important theories of modern economics.
Until recently, it seemed as if the battle of ideologies was over, and capitalism had won. But in the last few years, we have once again started asking ourselves questions about how else to organize our societies. Could socialism be an alternative? Should capitalism last forever?
And is that even possible? Back in the 1930s, economist Joseph Schumpeter asked himself exactly those questions – and he came to a startling conclusion: by its very nature, capitalism is bound to destroy itself. this summary will help you understand his groundbreaking argument. You’ll learn more about Schumpeter’s definition of democracy, his theory of creative destruction, and his emphasis on entrepreneurship – ideas that defined much of the economic theory of the twentieth century.
You’ll also learn - what Marx got wrong;
- why economic rationality helped civilization transcend magic and mysticism; and
- how capitalism will ultimately abolish itself.
Chapter 1: Karl Marx’s economic theories were prophetic – but they’re too stationary to account for modern capitalism.
In the social sciences, no figure looms larger than the German economist and philosopher Karl Marx. With his famous argument for an inevitable revolution, spearheaded by the working class, Marx became the great prophet of socialism. Indeed, for its proponents, Marxism is something like a religion. For better or for worse, they view absolutely everything through its lens.
Why is that? Well, it’s in part because Marx’s ideas were indeed prophetic, or at least very much ahead of their time. For example, Marx was one of the first thinkers to suggest that what shapes our societies, actions, and attitudes is the economy. He was also among the first to recognize the cyclical nature of economic processes. He recognized that economic crises were inevitable and occurred at regular intervals. The key message here is: Karl Marx’s economic theories were prophetic – but they’re too stationary to account for modern capitalism.
The author, Joseph Schumpeter, recognized the prophetic qualities of Marx’s work – and he agreed that the great German thinker contributed greatly to the field of economics. But he maintained that there were quite a few problems with Marx’s conception of capitalism. Marx argued that history is essentially all about a struggle between two – and only two – classes. On the one hand, there’s the working class, or proletariat. Its members sell their labor to the capitalists, or the bourgeoisie. These are the people who own the means of production.
According to Marx, the capitalist system encourages business owners to make laborers work longer and longer hours, without necessarily paying them for it. Business owners therefore extract “surplus value” from the work of the proletariat. This is the foundation of profit – and over time, the proletariat loses out; the poor become even poorer. Enterprises, meanwhile, tend to become less and less profitable. Schumpeter pointed to a few problems with Marx’s theory. First, it leaves no room for a third class of people essential to capitalism: entrepreneurs.
Capitalism is driven by smart and energetic people who don’t necessarily belong to the bourgeoisie, but wish to ascend to it. With their ideas and innovations, entrepreneurs are constantly revolutionizing the system from within. For Schumpeter, another issue is that Marxism is too stationary. It cannot explain the constantly evolving phenomenon that is modern capitalism. Finally, Schumpeter sees no evidence that capitalism fuels oppression and poverty, as Marx held. In fact, capitalism has actually improved the lives of most people living under it – as we'll see in the next blink.
Chapter 2: Capitalism is responsible for great social and intellectual progress.
It would be foolish to diminish the progress that societies have made under capitalism. Indeed, in The Communist Manifesto, Marx himself praised capitalism’s many achievements. He argued that capitalism was a necessary historical stage, unavoidable before the triumph of socialism. The most obvious form of progress that capitalism enables is, of course, economic.
One way to measure this is to look at a country’s total production of all goods and services in a year. Let’s take the US, for instance. From the Industrial Revolution through to the 1940s – Schumpeter’s time – this total kept increasing, at an average of about 2 percent per year. With it, people’s average income also increased. And what’s more, contrary to Marx’s predictions, the income gap between the rich and the poor didn’t really widen – at least not until well into the twentieth century. Here’s the key message: Capitalism is responsible for great social and intellectual progress.
Capitalism’s economic progress made life better for many in myriad ways. As disposable incomes grew, for example, people began to spend more on personal goods and services that enriched their lives. And it wasn’t just that people started to earn more; their money actually went farther and farther. A car, for example, cost considerably less in proportional terms in the 1940s than it did in the 1900s. On top of this, products just kept getting better. That’s because companies weren’t just competing with each other on price – they also focused on quality and general standards.
Think about something as simple as white stockings, for instance. In the nineteenth century, they were largely the preserve of royalty. By the 1940s, they were ubiquitous – even factory girls could afford them. Alongside all this progress, something else happened: capitalism, as such, became less costly. For example, practices like child labor and sixteen-hour workdays that defined the Industrial Revolution are now long gone. All in all, then, big business and even monopolistic practices have largely improved our lives.
And capitalism didn’t just accelerate material progress. It also encouraged us to develop a certain economic rationality. The basic cost-profit calculation, which lies at the heart of capitalism, is now applied in such diverse fields as space exploration, medicine, beauty, and even justice. This “rationalization” of society gradually replaced the magic and mysticism of the old days. Finally, capitalism encourages hard work, innovation, and invention. This means that we have capitalism to thank for our high standard of living, our rational mindset, and our greatest inventions, such as refrigerators, airplanes, and even radio and television.
Chapter 3: Capitalism feeds on a process of creative destruction.
As we’ve seen in the last blink, capitalism is responsible for all kinds of progress. Indeed, capitalism itself is constantly progressing. Since it first developed, it has been expanding, accelerating, and transforming. And this is no accident.
Indeed, this constant change is in the very nature of the capitalist system. For one, businesses and entrepreneurs are in constant competition with each other – or at least in constant fear of competition. This encourages them to restructure, invent, and innovate at an accelerating pace. You’re never safe at the top for long. Your business strategy may have worked yesterday, but it could easily fail tomorrow. And so every year we see the rise of new markets, new consumer goods, new methods of production.
None of this innovation comes from nowhere: the novelty always destroys the old structures and grows right through them. The key message is this: Capitalism feeds on a process of creative destruction. The author popularized a new term, which he used to describe capitalism’s constant transformation from within. He called it the process of “creative destruction” – and, in his view, many economic theories, including Marxism, failed to take it into account. For example, many economists seem to think that capitalism functions best in a state of “perfect competition. ” This view is, of course, idealized, and it simply assumes that all companies in a market produce exactly the same product and compete only on price.
Some economists say that big business practices have derailed the structure of perfect competition. But that view presupposes that such a state can exist in the first place. Schumpeter thought that such analyses were facile. He didn’t believe that the state of perfect competition ever existed. To him, competition was not based only on price – it also took into account product quality and advertising. And, above all, he viewed capitalism as a process.
To him, the system was subject to constant innovation and destruction. So, then, you can’t really understand capitalism if you don’t take into account the process of creative destruction. And that means that capitalism has never really been static. We’ll come back to capitalism later. But first, let’s look at the system that has opposed it throughout history: socialism.
Chapter 4: There’s nothing to prevent socialism from working.
For most of history, socialism has been considered the only viable alternative to capitalism. In a socialist society, the means of production are controlled by just one central authority, rather than by many private actors. Can this system work in the real world? Many economists have had their doubts.
Here’s the key message: There’s nothing to prevent socialism from working. In a commercial system like capitalism, the economy is controlled through constant competition. Companies, entrepreneurs, and bankers set prices, decide what to buy and sell, and hire and fire people. This means that, in theory at least, a capitalist market regulates itself. A socialist market is different. Instead of self-regulation, it relies on an external force – such as, for example, a political authority.
One of its jobs could be to provide people with vouchers, each representing a citizen’s share of all goods produced in a country’s economy. In theory, this value is easy to set: you simply divide the total of all goods by the overall number of claimants. Some economists, though, think that there’s a flaw in that plan. Here’s their question: Without price competition, how would you gauge the demand for a certain product? In capitalism, after all, prices have a really important role to play: they regulate supply and demand. But Schumpeter saw no problem with implementing a similar system under socialism.
For example, the government could set up a pricing authority for each industry whose decisions would be based on customer demand. And as for consumers themselves, they could even receive different “incomes,” depending on how much they worked. Some of that may sound a lot like capitalism. But there’s a key difference here, and that’s the lack of competition. A socialist economy is not shaped by internal market forces. Instead, the way it works is all down to its central authority.
Logically, then, there’s no reason why socialism cannot work. Some economists acknowledge this, but they claim that there’s a difference between theory and reality. In practice, they say, socialism is simply inoperable. For one, a government could never have sufficient information to run a whole economy smoothly.
But here’s Schumpeter’s counterargument: government’s decisions are no harder than those that businesses have to make under capitalism. Whatever the system, running it will always involve guesswork. For Schumpeter, the case is clear: of course socialism can work. Whether it’s compatible with democracy is a question we’ll address in the coming chapters.
Chapter 5: We need to update our definition of democracy to account for the realities of elections.
How well do socialism and democracy go together? Before we explore this, let’s ask ourselves what democracy is. Is it some sort of ultimate good, as many people believe? Can it be an end, in and of itself, rather than a political method?
Well, let’s imagine a society that makes a democratic decision to reinstate witch hunts. Clearly, that would be appalling. So should we really consider democratic processes inherently good or bad? Often, democracy is simply defined as “rule by the people. ” But as soon as we probe this formula, it begins to fall apart. First of all, most democracies don't involve all people – children and convicts, for example, are often barred from voting.
As well, in a democracy, people don't "rule" directly. Instead, they delegate their power to leaders who supposedly represent their interests. But here’s what often happens: as soon as these delegates get into office, they begin putting their own ambitions first. The key message here is: We need to update our definition of democracy to account for the realities of elections. The classical definition of democracy is a bit more complex. It says that democracy is a method of arriving at political decisions for the common good, by letting people elect their own leaders.
But that presupposes that a common good is something that people can agree on rationally. And it also suggests that people can work out among themselves how to put decisions into practice. In our complex societies, that is clearly not the case. Even if we agreed that everyone deserves to be healthy, for example, people would still debate the benefits of vaccination. In reality, we all have interests and values that are varied, irrational, and impulsive. Some of these values aren’t even our own – instead, they’ve been sold to us by advertisers or politicians.
So, clearly, we need a new definition of democracy. How about this one? Democracy is a way of making political decisions by letting individuals compete for people’s votes, in order to gain the power to implement those decisions. This definition works far better than the classical doctrine.
For one thing, it makes room for the crucial element of democratic leadership – the fact that it’s politicians who rule countries, not voters themselves. Second, it makes clear that the role of the people isn’t to be the government, but to choose the government. And last, it leaves room for the fact that no democratic government can represent all people – just a majority of them. Now that we’ve defined democracy, let’s look at whether it works under socialism.
Chapter 6: Socialism may be as compatible with democracy as capitalism – under certain conditions.
Throughout history, many socialists have said that theirs is the only path to “true democracy. ” But some believe that it’s OK to use undemocratic methods – such as violence and terror – to create a socialist society. There’s no direct relationship between socialism and democracy. They are neither mutually exclusive nor necessarily entwined.
In Russia, for example, socialism was enforced by very undemocratic methods. But in Belgium, the Netherlands, and even England, socialist parties readily embraced democracy. So what are the conditions under which a democracy can thrive? And is there anything that precludes socialism from creating them – especially after capitalism has laid the economic groundwork? Let’s explore this further. The key message is this: Socialism may be as compatible with democracy as capitalism – under certain conditions.
The first condition for the success of democracy is the availability of high-quality leaders. This means that the political sphere of a country should be accessible and appealing enough to attract the right kind of people – individuals who are smart, conscientious, and capable. The second condition is that political decisions made democratically should stay within an appropriate range. The government should decide some things about public life, but not all of them. In fact, there’s no need to make all decisions democratically. For example, most countries appoint supreme courts outside the democratic process.
The third thing necessary for democracy is a well-functioning bureaucracy. It needs to be efficient enough to take care of all the mundane but important work that goes into democratic decision-making. And finally, a democracy only works smoothly if all people accept the way decisions are made, and are able to tolerate differences in opinion. Schumpeter believed that democracy emerged as a by-product of capitalism’s rationalist ideology. But the four conditions for it can exist in either system – socialist or capitalist. No system is perfect, of course.
For example, democratic decision-making can be inefficient in large and complex societies. In a socialist country, this may be an even bigger problem. After all, if you can’t make efficient decisions, how can a central body run an efficient economy? But these are niggles. Socialism and democracy can coexist – and that’s good news, because, as we'll see in the next blink, socialism may eventually replace capitalism altogether.
Chapter 7: The key features of capitalism will ultimately lead to its self-destruction.
Finally, let’s turn to the central question of this summary: Can capitalism survive? Schumpeter answers this question with a resounding No. He thinks that the very success of capitalism will be its undoing. It will create conditions for its own destruction and a socialist takeover.
But how? As we’ve already seen, capitalism uses the mechanism of creative destruction to push social and technological progress. But progress can only go so far. What happens if one day we find all human needs completely satisfied? What if we lose the motivation to keep pushing? The key message here is: The main features of capitalism will ultimately lead to its self-destruction.
Under capitalism, progress is becoming increasingly automated and predictable. For example, capitalist progress diminishes the figure of the business owner. Instead, it hands over control to an impersonal structure of managers, executives, and stockholders. In such a world, where running a business becomes an abstraction, why even try? As the cost of living increases, and as businesses focus on small niches, not revolutionary innovation, there’s less and less incentive for true entrepreneurial leadership. Instead, there is growing demand simply for administration of already-existing processes.
But this is something that socialism does just as well as capitalism! Capitalist progress also erodes the mechanisms that used to protect the bourgeoisie. For example, it encourages a taste for anti-bourgeois ideas. The rationalist ideology of capitalism creates a critical frame of mind – and, in the end, it inevitably turns against itself. For evidence, just think of the many bourgeois intellectuals who now align themselves with the working class and are growing more and more hostile toward capitalism. And there’s another way in which capitalism destroys the very ground that nurtures it.
The trend to rationalize everything has contributed to the decline of the traditional family unit. As this trend grows, more and more people will feel inclined to conduct a cost-benefit analysis of having children. As a result, they may well decide to remain child-free. If you don’t have children, you don’t really need long-term investments like property. And that gives you the incentive to earn, and save, less. That's no good for the constant economic growth that capitalism requires.
And so, just as capitalism raises our standard of living, gives us more leisure time, and makes us better educated, it also weakens our motivation. This is self-defeating and can destroy the very structures that underpin the capitalist system. Schumpeter believed that capitalism would, eventually, destroy itself and pave the way for socialism. But maybe that’s nothing to worry about – especially if we can figure out how to consolidate socialism with democratic values. Capitalism is constantly evolving.
Final summary
It’s driven by a process of creative destruction, and that means that products, production methods, technologies, and markets restructure themselves incessantly. As capitalism progresses, these transformations increasingly threaten its very foundations, such as entrepreneurship and competition.
At the same time, these changes can open up society and culture to socialist ideas. Capitalism will ultimately self-destruct and pave the way for socialism. Such socialism, given certain conditions, is in principle entirely operable – although running a democratic socialist society may present a challenge.
About the Author
Joseph Schumpeter was one of the most influential political economists of the twentieth century. After briefly serving as the Finance Minister of German-Austria, he emigrated to the US in 1932 and became an economics professor at Harvard. Capitalism, Socialism and Democracy is regarded as his most important and most profound work. It’s the third-most-cited book in the social sciences.