Sunday, May 9, 2010

Schumpeter Vs. Keynes

Here is a great paper by Peter Drucker on why Schumpeter PWNS Keynesian Economics.

Here is also a link to the same Peter Drucker article hosted on Forbes.

For those of you not familiar with Schumpeter here is his wiki page.
He is the inventor of the term Creative Destruction which was later used by Theordore Levitt in his epic HBS paper Marketing Myopia.

Excerpts from the Peter Drucker paper:

Keynes asked the same questions that Ricardo, Mill, Marx, the "Austrians," and Marshall
had asked but, with unprecedented audacity, turned every one of the answers upside
down. In the Keynesian system, the "symbol economy" of money and credit are "real,"
and goods and services dependent on it and its shadows. The macroeconomy - the
economy of the nation-state - is everything, with individuals and firms having neither
power to influence, let alone to direct, the economy nor the ability to make effective
decisions counter to the forces of the macroeconomy. And economic phenomena, capital
formation, productivity, and employment are functions of demand.
By now we know, as Schumpeter knew fifty years ago, that every one of these Keynesian
answers is the wrong answer. At least they are valid only for special cases and within
fairly narrow ranges. Take, for instance, Keynes's key theorem: that monetary events -
government deficits, interest rates, credit volume, and volume of money in circulation -
determine demand and with it economic conditions. This assumes, as Keynes himself
stressed, that the turnover velocity of money is constant and not capable of being
changed over the short term by individuals or firms. Schumpeter pointed out fifty years
ago that all evidence negates this assumption. And indeed, whenever tried, Keynesian
economic policies, whether in the original Keynesian or in the modified Friedman version,
have been defeated by the microeconomy of business and individuals, unpredictably and
without warning, changing the turnover velocity of money almost overnight.
...
But Schumpeter's real contribution during the thirty-two years between the end of World
War I and his death in 1950 was as a political economist. In 1942, when everyone was
scared of a worldwide deflationary depression, Schumpeter published his best-known
book, Capitalism, Socialism and Democracy, still, and deservedly, read widely. In this
book he argued that capitalism would be destroyed by its own success. This would breed
what we would now call the new class: bureaucrats, intellectuals, professors, lawyers,
journalists, all of them beneficiaries of capitalism's economic fruits and, in fact,
parasitical on them, and yet all of them opposed to the ethos of wealth production, of
saving, and of allocating resources to economic productivity. The forty years since this
book appeared have surely proved Schumpeter to be major prophet.
And then he proceeded to argue that capitalism would be destroyed by the very
democracy it had helped to create and made possible. For in a democracy, to be popular,
government would increasingly shift income from producer to nonproducer, would
increasingly move income from where it would be saved and become capital for
tomorrow to where it would be consumed. Government in a democracy would thus be
under increasing inflationary pressure. Eventually, he prophesied, inflation would destroy
both democracy and capitalism.
When he wrote this in 1942, almost everybody laughed. Nothing seemed less likely than
an inflation based on economic success. Now, forty years later, this has emerged as the
central problem of democracy and of a free-market economy alike, just as Schumpeter
had prophesied.

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