Anti-trust or pro-monopoly?
A 'creative destruction' debate may divide the Trump administration which should learn from Schumpeter but not from Stiglitz..
This essay is dedicated to Google, a sometimes somewhat ‘woke’ private organisation that is nevertheless thoroughly and admirably capitalistic and which, in a practical way, ‘enables’ daily life and work for millions of people worldwide far more effectively than does any public organisation. An excellent WSJ discussion brought me up to date with the matter as it concerns recent anti-trust actions against Google and other anti-capitalist regulatory moves reported on this year — here, here, here, and here. It made me think it was time to revisit the old masters on monopoly — Schumpeter & Weber.
Studies of a Man's Head, by Anthony van Dyck, 1619 Antwerp
The complementarity between the ideas of Joseph Schumpeter and Max Weber is the focus of the following essay on competition with temporary monopoly, i.e. imperfect competition. Wherever one of these two men lacks something, the other provides it.
I came to study Joseph Schumpeter’s work through an immersion in the writings of Max Weber. Young Schumpeter also developed his distinctive economics ‘through’ the elder Max Weber. They influenced each other and their paths converged in creating the social science of ‘economic sociology’. The impact of Weber on Schumpeter was deep. Schumpeter acknowledged his admiration for Weber’s intellectual strength, leadership, courage, sense of duty, and charisma — “He was an imposing figure. You submitted to him, whether or not you wanted to. Energy resounded from his every word, flowed from every pore of his being”. Schumpeter described Weber rather as Weber depicted ‘charisma’ and rather as Schumpeter depicted ‘entrepreneurship’. I say this only to hint at why the two figures are in some senses almost one (in my mind at least). I feel sorry for economists who approach Schumpeter on his terms alone without being able to appreciate the synergies between Schumpeter and Weber. They must miss much of the subtlety, sarcasm and all that is left understated or unsaid.
Market freedom, not the free market
“Free” has the classical meaning in the economics of Weber and Schumpeter because it is joined to “competition”. A monopolistic shelter generated by entrepreneurial innovation will have an appropriately short shelf life if competition is free. Weber’s preferred phrase was “market freedom” which gives legal right to usurp monopolies. Assuming rule of law prevails, the market never can, will, or should be perfectly free like in the jungle. There is a caveat, however. Only a state can keep a monopoly alive.
There is another way in which the market is not ‘free’ even when competition is ‘free’. The phrase ‘free market’ is misleading and for that reason is the preferred pejorative term among socialists and critics of market freedom and free competition. It should be noted that no competition is ever ‘perfectly’ free. The reason for the imperfectly free is the monopolistic tendency that is necessarily present in all economic and political communities. The desire to monopolise cannot be wished away, and no attempt should be made to stifle it. Monopoly profit is the carrot, the lure that attracts ingenuity in market enterprise. The stick of the law cannot kill the monopoly drive, and it should not even try. Rather, the instruments of state regulation can be waved and wielded to administer the conditions of temporary monopoly in a limitless zone of competition that endeavours to the best of its ability to be full of failure and free of fraud.
In similar ways Weber and Schumpeter abhorred monopoly. That both of them should tolerate or welcome some monopoly in some form for some time reflects realism. On the other hand they assumed informed readers would understand, in Schumpeter’s words, “the necessary qualifications” to the tolerance of temporary monopoly.
It can be useful to draw an analogy between the successful political entrepreneur and the successful economic entrepreneur. Both are incessantly exposed to forces of free competition either in real or surrogate form. For limited periods during hard-won interludes, they acquire victorious shelter from vicious competition until the rewards of their innovation are harvested. A triumphant political entrepreneur enjoys policy shelter while in government. The shelter of an economic entrepreneur may be held through a limited ‘patent’ if available, or with clever strategy to ward off competitors, but only until the imitators and adaptors can no longer be held off. Before long rivals and upstarts swarm in to seize and spread the new growth and profit opportunity.
Schumpeter’s innovation was bold and daring
Before returning to Weber I will try to summarise Schumpeter’s revolutionary theory of innovation in three parts: leadership, profit motive, imperfect competition.
Schumpeter starts with a positive analysis of crisis and its shifting neighbourhoods of equilibrium and disequilibrium. A balanced economic or institutional system “that at every given point of time fully utilises its possibilities to the best advantage” will not be as good for development as a system that experiences disturbances and struggles to improve performance. “Real” development, it must be understood, always occurs in disequilibrium when disturbances force the system to depart from the circular flow.
The cause of development is innovation. Continual product and process innovation is the “outstanding fact” in the economic history of capitalism. Capitalism is a machine generating ‘newness’. Materials and forces of production are combined in new ways. New ideas change how things are produced, sold or consumed. New ideas transform economies with new industries, firms, ideas, goods, methods, and organisations.
Schumpeter even proposed the kernels of a similar theory for deliberately adaptive institutional change that occurs through political leadership alongside or in response to the economic changes. Sadly, for obvious reasons, institutional innovation hardly ever occurs in anticipation of (ahead of) economic change. The economy in conditions of free competition moves along with its own momentum. The best that can be done is to design simple institutions that will adapt efficiently to all circumstances.
Development economist Albert Hirschman proposed an idea that echoes Schumpeter. He described decision makers developing their competencies for understanding and modifying the means and ends of policy to best effect when working in a hothouse economic environment that forces them to learn by coping with recurrent tensions, bottlenecks, shortages, and instability. Society, said Hirschman, moves forward only by “sailing against the wind”. Every innovation perturbs the status quo of markets or organisations and unleashes the developmental process of disequilibrium learning.
Innovation is the work of motivated leaders
Innovation leaders are more important as agents of change than owners of capital and property. Innovators build the roads that the capitalists then drive along. Economist William J. Baumol showed that large firms often lead in technology development and routinely attempt to cultivate entrepreneurial aptitudes among teams within the firm. But Schumpeter was sceptical about the value of attempts to automatise or routinise innovation. When Schumpeter studied the innovation process its leaders were still typically individual entrepreneurs, daring and intuitive “new men” in young firms who took bold initiatives and stepped “outside the routine” with flashes of genius.
Innovators swim against the stream and defy constraints on change. They persuade investors to take commercial views of the viability of an enterprise and profitability of innovations, bearing the risks of a new idea and providing the finance for the plans of entrepreneurs. Schumpeter might have been pleased to know that now small firms led by daring, intuitive people undertake catalytic experimental innovation and are amply rewarded (becoming multi-millionaires) when their companies are purchased and absorbed by giant talent-spotting firms operating on the frontiers of new technology.
Innovation is a behavioural characteristic of capitalism. The psychology of innovators differs from managers who maintain an established business. Schumpeter said: “Everyone knows that to do something new is very much more difficult than to do something that belongs to the realm of routine”. Innovators move production into new channels where the means and ends of economic activity are not calculable. They break conventions, conquer social resistance, and usurp older firms. They win new customers. The neoclassical equilibrium routine does not need this kind of leadership.
There is the question of what motivates the leaders. The usual motive of economic action is satisfaction of wants. Related motives include status rivalry or power gained as a result of successful entrepreneurship. Schumpeter believed that noble ambitions and work ethics also influence innovation — “the will to conquer, the impulse to fight, to prove oneself superior to others, to succeed for the sake, not of the fruits of success, but of success itself”, and “the joy of creating, of getting things done, or simply exercising one’s energy and ingenuity”. In the final analysis, however, it is clear that profit is the motivator and signalling device in successful economic innovation. Without profit the entrepreneur would not exist. But watch out! In capitalism profit motive must coincide with institutional incentives that channel economic action away from politically shaped profits and toward pure market competition and innovation. Politically shaped profit is unhealthy business, a cause of economic depression.
Imperfect competition is a fact of life
What type of competition encourages innovation? Schumpeter said, “the new does not grow out of the old but appears alongside of it and eliminates it competitively”. Competition spreads the benefits of an innovation by improving products, creating mass markets, lowering costs. What was unusual, at least compared with conventional neoclassical theory, was how Schumpeter conceptualised the most intense phase of competition during innovation. When responding to his critics in the Preface of the 2nd edition of Capitalism, Socialism, and Democracy, he wrote:
Current economic theory is almost wholly a theory of the administration of a given industrial apparatus. But much more important than the manner in which capitalism administers given industrial structures is the manner in which it creates them. And into this process of creation the monopoly element enters necessarily.
Schumpeter had described the relevant context in his earlier books like Business Cycles. The driving force of economic evolution is not price competition but rather “competition from the new commodity, the new technology, the new source of supply, the new type of organisation”. An often misunderstood point follows from this. He insisted successful innovation usually happens in conditions of imperfect competition.
Perfectly free entry into a new field may make it impossible to enter it at all … As a matter of fact, perfect competition is and always has been temporarily suspended whenever anything new is being introduced — automatically or by measures devised for the purpose — even in otherwise perfectly competitive conditions.
The explanation for the diminishment of competition during an innovation cycle obviously lies with how innovators understand their future profit. Entrepreneurs know the special premium from the innovation cannot last. Monopolistic profits are “prizes offered by capitalist society to the successful innovator”. The lure of monopoly, even if only temporary or partial, is a tangible incentive to compete.
By imperfect competition Schumpeter did not mean a long-run condition in which large monopolies dominate transactions in products and sectors. Rather he referred to acceptable or at least lawful strategies by which business can create “temporary shelter” from competition. Patents, insurance, hedging, secrecy, corporate seed capital, price and investment strategies all give the firm the time needed to build a customer base, mutual agreements to avoid cutthroat competition, and even (heaven forbid) cartels.
Schumpeter clearly believed the process of creative destruction forced monopolies to face competitive pressures notwithstanding their efforts to gain dominance in some sector or product. The prospect of extinction is pressure enough, and the mere threat of competition can elicit behaviour that corresponds to ideal competition. Restrictive practises which business employs in disequilibrium conditions of innovation can be “effective remedies under conditions of depression”, legitimate for weathering storms.
In capitalism’s “perennial gale”, a Schumpeterian self-constructed shelter of imperfect competition is not as damaging to real development as it would be in the stationary equilibrium, or as it would be when the shelter has been politically-constructed.
Withdraw state support so monopoly cannot endure
I will trace just one example of the congruence between the perspectives of Schumpeter and Weber. Self-protections by firms of the kind described above are preferable to state interventions. It is useful to recall that Schumpeter made these suggestions at least two decades after Weber had established the original position.
Let us be clear — Schumpeter was critical of state-administered protections, such as import tariffs, subsidised credit, and other political supports that lead to weakness and “industries of doubtful value”. Only unhampered competition can produce real entrepreneurship and maintain the desired climate of innovation and change.
For this tactful and reserved state regulation is required. The state should not limit the investment opportunities of entrepreneurs. The state should not try to stabilise capitalism by reducing the risk taking on which innovation thrives. State economic action should confine itself only to “matters that can be successfully handled by a government”. This requires a severe limitation on the ‘activism’ of the state.
A monopolist has to be aware that he is “surrounded by a sufficiently broad zone of competition”. Both Schumpeter and Weber were convinced that a monopoly cannot be sustained without government intervention. Here is Schumpeter’s main statement:
Pure cases of long-run monopoly must be of the rarest occurrence and... still rarer than … perfect competition. The power to exploit at pleasure a given pattern of demand - or one that changes independently of the monopolist’s action and of the reactions it provokes - can under the conditions of intact capitalism hardly persist for a period long enough to matter for the analysis of total output, unless buttressed by public authority.
Schumpeter and Weber, when discussing monopolistic tendencies, took the trouble to systematically distinguish between not-so-bad monopoly that is inevitable, persistent, but exposed to competition and compatible with capitalism, and, in the other corner, the bad monopoly protected from competition and incompatible with capitalism.
Weber’s ‘closure’ innovation was beyond reproach
In Economy and Society Weber explains that organisations and social or economic relationships of all types exhibit monopolisation tendencies, which he refers to as “closure”. His focus was state-centred political monopolies (status groups within the state) rather than market-based economic monopolisation. The difference here is that monopolisation strategies in the market are necessarily temporary if they are not sustained by the state. In contrast, the monopolisation of economic privileges that become rights granted by the state may indefinitely suppress free competition.
Because the power wielded by state agencies is ultimately far greater than market-based power, if profit seekers swarm around the honeypot of state agencies rather than around their market opportunities, the consequences are damaging to society. Opportunity will not be “levelled”. The entrepreneurial skills required for market competition are quite unlike the political skills required for regulatory closure.
When forming closed (monopolistic) relationships, individuals and organisations look for their own survival even though their long-run advantage lies in a regulatory order that equally guarantees the rights of their competitors. If regulatory regimes are open rather than closed, all participants “expect that the admission of others will lead to an improvement of their situation”. Openness to outsiders and newcomers is the essence of market freedom. But, as Adam Smith also noted, when actors perceive self-interest in monopolistic tactics, and the opportunities, they will form closed relationships.
Contemporary ‘industrial policy’ strategy sometimes simulates competitive dynamics inside a sheltered sector. Even within a monopolistic group of businesses in receipt of state subsidies, public agencies create what Weber called “competitive struggle within the group” which effectively protects the group against outsiders. There is then “free competition for all the advantages which the group as a whole monopolises for itself”. Plainly, however, “capitalism is retarded if monopolies are protected by the state and stabilised with state subsidies”. The size, scale, scope or context of a monopolisation effort become irrelevant. Only this matters — is it politically shaped or is it real?
Weber laid foundations for Schumpeter’s innovation
The relative power of state and business is raised in one of Weber’s comments on the tendency of state-backed status groups to resist the spread of market competition:
The beneficiary of a monopoly by a status group restricts and maintains his power against the market, while the rational-economic monopolist rules through the market. [Those] interest groups which are enabled by formal market freedom to achieve power [are] market-interest groups.
Weber found that temporary monopolies can perform valuable functions for capitalist economies as long as they are monopolies,
based solely upon the power of property [and] upon an entirely rationally calculated mastery of market conditions which may, however, remain formally as free as ever [without] restrictions on the formation of rational market prices.
However, since control over economic goods is one of the most important instruments of power, there are consequences of private monopolies with respect to the balance of power between state and business. Weber discusses two relevant types of domination. Public bureaucracy is “domination by virtue of authority, i.e. the power to command and duty to obey”. The alternative type is “domination by virtue of a constellation of interests”. The prime example of the latter is “monopolistic domination in the market”. Through skill, exclusive possession of goods, and material advantage the monopolistic enterprise can thereby influence the conduct of all market actors who nevertheless remain formally free of obligations of duty to the dominant enterprise. Examples of such domination include market closure by price fixing or appropriation of technologies. The danger is that a constellation of interests in the market can,
easily be transformed into formally regulated relationships of authority [which are] more oppressive than an authority in which the duties of obedience are set out clearly.
If there is insufficient legal-regulatory constraint on the exercise of state power, a relationship of domination in the market that is protected and sustained by the state can be converted to a relationship of domination by virtue of an authority founded, in effect, on “the very absence of rules”. Three forms of profit making depend, according to Weber, on a state’s willingness to supply monopolistic privileges to groups:
Orientation to opportunities for predatory profit from political organisations or persons connected with politics.
Orientation to the profit opportunities in continuous business activity which arise by virtue of domination by force or a position of power guaranteed by the political authority.
Orientation to profit opportunities in unusual transactions with political bodies.
A monopolistic tendency exists, it cannot be wished away, it is a inbuilt feature of the social system, it facilitates innovation only within a zone of competition and only in the context of ongoing creative destruction. We must not let it be shaped by politics lest it become permanent and bring creative destruction to a halt. In Weber’s words:
It is quite possible that a private individual by skilfully taking advantage of the given circumstances and of personal relations, obtains a privileged position which offers him nearly unlimited acquisitive opportunities. But a capitalist economic system is obviously greatly handicapped by these factors.
I hope to have suggested why Schumpeter’s alleged ‘defence’ of monopoly was in practice nuanced and qualified through a Weberian lens, which, to be fair, is not among the optics habitually used by economists. If Schumpeter didn't spell out the sociological or political economy aspects of his view of monopoly sufficiently, it might simply be because the founding ideas were well-established and too obvious to repeat.
Sense and nonsense
These foundational ideas of beneficial monopoly with market freedom, free competition, and creative destruction are being forgotten. Even today there is a persistent clamour in mainstream economics for revivals of industrial policy. It does not help that Joseph Stiglitz — recipient of the Nobel Memorial Prize in Economic Sciences 2001 — has somewhat distorted Schumpeter’s legacy in economics.
In a 2014 opinion piece Stiglitz wrote:
A century ago, the economist and political scientist Joseph Schumpeter argued that the central virtue of a market economy was its capacity to innovate. He contended that economists’ traditional focus on competitive markets was misplaced; what mattered was competition for the market, not competition in the market. Competition for the market drove innovation. A succession of monopolists would lead, in this view, to higher standards of living in the long run.
Schumpeter’s conclusions have not gone unchallenged. Monopolists and dominant firms, like Microsoft, can actually suppress innovation. Unless checked by anti-trust authorities, they can engage in anti-competitive behavior that reinforces their monopoly power.
Moreover, markets may not be efficient in either the level or direction of investments in research and learning. Private incentives are not well aligned with social returns: firms can gain from innovations that increase their market power, enable them to circumvent regulations, or channel rents that would otherwise accrue to others.
But one of Schumpeter’s fundamental insights has held up well: Conventional policies focusing on short-run efficiency may not be desirable, once one takes a long-run innovation/learning perspective. This is especially true for developing countries and emerging markets. Industrial policies — in which governments intervene in the allocation of resources among sectors or favor some technologies over others — can help “infant economies” learn.
Stiglitz carries intellectual weight in this discussion because he wrote the inevitably influential ‘Introduction’ to the most recent 2010 edition of Schumpeter’s Capitalism, Socialism, and Democracy. It is telling that in that introduction Stiglitz wrote about the difficulties of “translating” Schumpeter. Yet Schumpeter wrote in excellent English. So what is the problem? One problem is Stiglitz’s ‘mistranslation’ of Schumpeter’s central message. Schumpeter thought industrial policy a terrible idea!!! A paragraph from Schumpeter’s introduction to his Business Cycles will suffice. The book outlined a theory of long-run innovation in ways unrecognisable (or untranslatable) to Stiglitz.
It is important to keep in mind that what we know from experience is not the working of capitalism as such, but of a distorted capitalism which is covered with the scars of past injuries inflicted on its organism. The very fundamentals of the industrial organisms of all nations have been politically shaped. Everywhere we find industries which would not exist at all but for protection, subsidies, and other political stimuli, and others which are overgrown or otherwise in an unhealthy state because of them. Such industries are assets of doubtful value, in any case a source of weakness and often the immediate cause of breakdowns or depressive symptoms. This type of economic waste and maladjustment may well be more important than any other [Joseph Schumpeter, [1939] 1964, Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process.]
The Stiglitz edition of Schumpeter’s Capitalism, Socialism, and Democracy conveniently omits Schumpeter’s ‘Prefaces’ where he responds with self-confessed “amusement” to misinterpretations of his monopoly argument by the less competent economists. They “thunder on”, Schumpeter wrote, but leave out the qualifications, and “to leave out the necessary qualifications is not to present the whole truth”. Stiglitz does not tell truth when he suggests Schumpeter favoured industrial policy. Schumpeter’s real long-run innovation perspective is quite the opposite of the one Stiglitz advanced. Schumpeter offered a subtle theory of long-run capitalist cycles with indispensable evolutionary ups and downs. No one should try to foist upon the unsuspecting public the erroneous idea that Schumpeter favoured industrial policy. Yet it seems Stiglitz required great names like Schumpeter to give pseudo-credibility to his misinterpretation of the 2008-2009 financial crisis. Thus Stiglitz’s claim that Schumpeter favoured industrial policy:
Such policies, when adopted, have been frequent targets of criticism. Government, it is often said, should not be engaged in picking winners. The market is far better in making such judgments. But the evidence on that is not as compelling as free-market advocates claim. America’s private sector was notoriously bad in allocating capital and managing risk in the years before the global financial crisis.
Schumpeter was consistent and unrelenting in exposing the many silly guises of socialism. As well as suggesting how ‘economic sociology’ accounts for a somewhat subtle and probably inescapable relationship between innovation and temporary monopoly, I have intimated at least one reason why Schumpeter opposed industrial policy and misplaced anti-trust regulation. When government is discretionary toward a business or sector it is on the road to creating conditions that cause state-buttressed monopolisation, which is the harmful sort. Not only is this bad for the economy in general terms. It also sends a political message that protection from competition can be supplied. Business will lobby for it as an entitlement. That is a slippery slope.
Hopefully, America’s great companies will find more freedom from anti-trust regulators under Trump/Vance than they currently have under Biden/Harris.
.. written by Michael Heller
Main sources:
William J. Baumol, 2002, The Free-Market Innovation Machine: Analyzing the Growth Miracle of Capitalism, Princeton: Princeton University Press.
Joseph Schumpeter, [1939] 1964, Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process, Philadelphia: Porcupine Press.
Joseph Schumpeter, 1947, Capitalism, Socialism, and Democracy, London: George Allen & Unwin.
Max Weber, [1922] 1978, Economy and Society, 2 vols, G. Roth and C. Wittich (eds), Berkeley: University of California Press.