Modern Prophets: Schumpeter or Keynes? - Page 7

And then, during World War I, Schumpeter realized, long before anyone else - and a good ten years before Keynes did - that economic reality was changing. He realized that World War I had brought about the miniaturization of the economies of all belligerents. Country after country, including his own still fairly backward Austria-Hungary, had succeeded during the war in mobilizing the entire liquid wealth of the community, partly through taxation but mainly through borrowing. Money and credit, rather than goods and services, had become the "real economy." In a brilliant essay published in a German economic journal in July 1918 - when the world Schumpeter had grown up in and had known was crashing down around his ears - he argued that, from now on, money and credit would be the lever of control. What he argued was that neither supply of goods, as the classicists had argued, nor demand for goods, as some of the earlier dissenters had maintained, was going to be controlling anymore. Monetary factors - deficits, money, credit, taxes - were going to be the determinants of economic activity and of the allocation of resources.

This is, of course, the same insight on which Keynes later built his General Theory. But Schumpeter's conclusions were radically different from those Keynes reached. Keynes came to the conclusion that the emergence of the symbol economy of money and credit made possible the "economist-king," the scientific economist, who by playing on a few simple monetary keys - government spending, the interest rate, the volume of credit, or the amount of money in circulation - would maintain permanent equilibrium with full employment, prosperity, and stability. But Schumpeter's conclusion was that the emergence of the symbol economy as the dominant economy opened the door to tyranny, and, in fact, invited tyranny. That the economist now proclaimed himself infallible, he considered pure hubris. But, above all, he saw that it was not going to be economists who would exercise the power, but politicians and generals.

And then, in the same year, just before World War I ended, Schumpeter published The Tax State ("The Fiscal State" would be a better translation). Again, the insight is the same Keynes reached fifteen years later (and, as he often acknowledged, thanks to Schumpeter): the modern state, through the mechanisms of taxation and borrowing, has acquired the power to shift income and, through "transfer payments," to control the distribution of the national product. To Keynes this power was a magic wand to achieve both social justice and economic progress, and both economic stability and fiscal responsibility. To Schumpeter - perhaps because he, unlike Keynes, was a student of both Marx and history - this power was an invitation to political irresponsibility, because it eliminated al economic safeguards against inflation. In the past the inability of the state to tax more than a very small proportion of the gross national product, or to borrow more than a very small part of the country's wealth, had made inflation self-limiting. Now the only safeguard against inflation would be political, that is, self-discipline. And Schumpeter was not very sanguine about the politician's capacity for self-discipline.
Schumpeter's work as an economist after World War I is of great importance to economic theory. He became one of the fathers of business cycle theory.

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.