Book 1: Capitalism at Work: Business, Government, and Energy

Chapter 5 Internet Appendix

5.1 Kolko and Schumpeter on Capitalist Stagnation and Instability
5.2 The “Remarkable” Influence of Perfect-Competition Theory
5.3 The Realism of Arthur Bentley
Bibliography: Chapter 5 Appendices

5.1 Kolko and Schumpeter on Capitalist Stagnation and Instability

Underlying Kolko’s historical analysis was the Marxian notion of the inherent inability of capitalism to create adequate profits for business, thus leading business leaders to lobby government for relief. To Kolko, capitalism and political capitalism were one and the same because of the inherent instability of laissez-faire. So political capitalism, as it were, saved capitalism (Kolko: 1963, 288–90).

This dynamic embraced by Kolko was stated by two Marxist economists, Paul Sweezy and Paul Baran:

It therefore becomes a state responsibility under monopoly capitalism to insure, as far as possible, that prices and profit margins in the deviant industries are brought within the range prevailing among the general run of giant corporations. This is the background and explanation of the innumerable regulatory schemes and mechanisms which characterize the American economy today (65).

Kolko uncritically adopted Marxian economics as his theoretical framework, fallaciously positing a unified ruling class that used political might to dominate the market through oligopolies, prevent competition within industries, and stamp out populist uprisings. This Marxist dynamic explains, in part, why Kolko’s new interpretation became popular in the 1960s.

Joseph Schumpeter rejected Marxist ruling-class economics, but he shared some kinship with a Marxist view of the world. Like Erich Zimmermann (whose sound functional theory of mineral resources did not prevent him from falling into the depletionist trap, discussed in Capitalism at Work (chapter 8, pp. 213–14), Schumpeter drew fallacious inferences from an otherwise sound theory of competition and entrepreneurship.

Schumpeter believed that the process of creative destruction would stamp out smaller firms to leave capitalism stagnant. In his words (1942: 134): “Since capitalist enterprise, by its very achievements, tends to automatize progress, we conclude that it tends to make itself superfluous—to break to pieces under the pressure of its own success.” The result, Schumpeter believed, would be a post-capitalist socialism, since “the perfectly bureaucratized giant industrial unit not only ousts the small- or medium-sized firm and ‘expropriates’ its owners, but in the end it also ousts the entrepreneur and expropriates the bourgeoisie as a class which in the process stands to lose not only its income but also what is infinitely more important, its function.”

Schumpeter’s thesis is inconsistent with market rivalry, in which small firms can and do upstage large ones, and vice versa. In the marketplace, as in nature, change is the only constant, and survival goes not to the strongest but to the most adaptable. The most adaptable company is not always the largest.

Statistically, industrial concentration has not appreciably changed in the last half-century (L. J. White: 2002). Research into organizational boundaries has concluded:

Large and centralized firms are only one of several forms of organization that may speed innovation and growth. Depending on the nature of the problem under consideration, the stage of the product life cycle, the availability of external information channels and many other factors, small, independent firms . . . may be the most efficient ways of generating innovation and growth (Langlois and Robertson: 150).

John Kenneth Galbraith’s hypothesis of the “socialization of the mature corporation” (1967: 394) has fared little better. There has not been a marked tendency toward industrial giants—or just one giant firm. Yet Schumpeter’s faulty inference misled New Left historians who otherwise, as discussed in chapter 6, corrected the mainstream with a historiography of American political capitalism.

Schumpeter (1939, vol. 1: 138) advanced a theory of the business cycle predicated on “external factors plus innovation.” Good fortune and a burst of entrepreneurial innovation caused the boom; bad events (natural disaster, etc.) coupled with a low ebb of innovation caused the bust.

But why would such discontinuity in the entrepreneurial function create anything more than localized, non-congruent business fluctuations (Rothbard: 1970, 749–50)? It is not evident how the wheels of individual fortune could drive macroeconomic activity in a large, interconnected economy. Business cycles, a macroeconomic phenomenon where broad industries simultaneously go through boom and bust, result from other causes, such as government intervention into money and banking that artificially determines interest rates governing the structure of production (Callahan: chapter 13).

Further, as technology has advanced, people have become less and less vulnerable to the vagaries of natural disaster.

Schumpeter’s capitalist reality, a superior framework for judging competition and progress as compared to perfect-competition theory, can be separated from his twin non sequiturs of capitalistic stagnation and the capitalistic trade cycle. As with Erich Zimmermann, the best of Schumpeter can be retained, while the more speculative and unfounded discarded.

5.2 The “Remarkable” Influence of Perfect-Competition Theory

Schumpeter did not stand alone in opposition to mainstream competition theory. In the 1920s and 1930s, such luminaries in the economics profession as J. M. Clark, Abba Lerner, Francis Edgeworth, and Alfred Marshall warned against interpreting real-world rivalry and market adjustment through the lens of models that presumed perfect knowledge, perfect-competition, or both (Machovec: 287–93; DiLorenzo and High: 425–29). Frank Knight wanted to substitute the termatomistic competition for perfect competition since there was “presumption of psychological competition, emulation, or rivalry” (Knight: 1946, 102) among the innumerable tiny price-taking firms. It was Knight who earlier brought attention to “the impossible conditions of ideally perfect competition, where time and space were annihilated and universal omniscience prevailed” (1916: 283).

F. A. Hayek also censured perfect-competition theory and, more generally, equilibrium analysis, to advance the perspective of Schumpeter. (Both were trained in Austrian School economics, but Hayek would be the more “Austrian” of the two.) To Hayek, perfect-competition “has little justification to be called ‘competition’ at all” since the model described an end state in which competition was over (Hayek: 1948, 92). The theory assumed what had to be explained. The very action of competition—improving, differentiating, informing, price discounting, quantity dealing, and substituting—were postulated away and, worse, noted Hayek, assigned to the bin of “imperfect-competition” (96–97). Institutions, reputation, and goodwill were similarly discounted and ignored (95, 97).

Hayek (105) noted how equilibrium-centered economists became “intolerant” of market imperfections and “silent” about barriers to rivalry that had their source in government. He debated socialist economists who thought perfect-competition could instruct a central planning board how to set prices and quantities (Bradley: 1981). So-called market socialism never graduated from the blackboard and journals to the real world. As Schumpeter and Hayek knew, its perfect-competition base was fictional to begin with. (The economic calculation debate between free-market and socialist economists is described in Internet appendix 4.4, “Economic Calculation Revisited,” at https://live-political-capitalism.pantheonsite.io/Book1/Chapter4/Appendix4.html).

An important point in chapter 6 of Capitalism at Work is how misplaced economic theory led to errant historical interpretation. Specifically, perfect-competition theory caused historians to lower their guard when it came to recognizing political capitalism in action, for if capitalism is monopolistic, then capitalists should be fat and happy. Thus the depth of the perfect- versus imperfect-competition debate—and the victory of the inferior theory—should be appreciated.

John Roberts wrote in the Palgrave dictionary of economics (837):

In the competition between economic models, the theory of perfect-competition holds a dominant market share: no set of ideas is so widely and successfully used by economists as is the logic of perfectly competitive markets. Correspondingly, all other market models … are little more than fringe competition.

Its dominate influence is “remarkable,” Roberts continued (838), since “no important market fully satisfies the conditions of perfect-competition and … most would not appear even to come close.” Moreover (ibid), it is “striking” that “perfect-competition is a theory of price competition that contains no coherent explanation of price formation.”

What, then, explains the attraction and staying power of such a limiting, problematic theory? Roberts explained (ibid) that “there is in fact no powerful theory of imperfect-competition,” just “a myriad of competing partial equilibrium models of imperfectly competitive markets” based on their own questionable assumptions.

Schumpeter’s fundamental criticism is not mentioned by Roberts. Nor does Roberts consider the work of Ludwig von Mises, F.A. Hayek, and, more recently, Israel Kirzner, who, like Schumpeter, were expositors of dynamic competition theory, better known as market-process theory. For Roberts, as for mainstream economics, the only theory is a formal model—graphically depicted, mathematically described, and empirically falsifiable. Economists raced to measure competition via concentration ratios of the number of competing firms in an industry. “Indeed,” stated one historian of competition measurement “from 1939 to about 1970 the abundant availability of the ratios reinforced the tendency to regard (perhaps over-regard) oligopoly as a central issue” (Shepherd: 563).

Entrepreneurship, as purposeful human action, cannot be portrayed in rigid, mathematical terms. Business competitors do not act robotically, and neither do consumers. Assuming that economic action unfolds in a “perfectly competitive” way compounds the error. As D.T. Armentano (31) has stated: “Businessmen and consumers would hardly describe selling markets with no direct price competition, no product differentiation, no brand names, no selling costs, no location advantages, no advertising, no economies of scale, and no innovation as ‘purely competitive’!” But which should be discarded: intuitive, descriptive theory or model formalism?

Mainstream economics now pays lip service to entrepreneurship, models imperfect-competition, and acknowledges the limitations of perfect-competition as a real-world or policy tool. But this is not enough for reasons that are as true today as they were when Schumpeter first penned the theory of creative destruction in 1942. Formalized “competition” is not only Hamlet without the Danish Prince; it is Hamlet without any real action.

5.3 The Realism of Arthur Bentley

Arthur Bentley’s laser focus on realism and truth was his weapon and ultimate vindication against academic error, fashion, and inertia. Sidney Ratner concluded (1969: xi): “[Bentley] insisted on portraying the ‘whole truth’ about political behavior.” Mancur Olson (119) saw a major contribution of Bentley’s The Process of Government in its “attack [on] … certain methodological errors that had troubled the study of politics.” (Ratner described the book as “probably one of the most influential in American social science.”) Bentley himself stated, “We must find the only reality and only truth in the proper functioning of the felt facts and the thought facts in the system to which they belong” (1908: 172).

Why did Bentley succeed where so many did not? Ratner posited (1969: xi) that “Bentley’s unusual combination of tough-mindedness and open-mindedness enabled him to be the most devastating political realist of his time.” Bentley also chose methodological realism, the same technique that Schumpeter and Erich Zimmermann employed in comprehending the nature of competition and mineral-resource theory, respectively. This methodology centers on subjectivism (mind-centered causality), individualism (disaggregation), and process analysis (versus statics). It is quite possible that the influence of Carl Menger steered Bentley in these directions (Ratner: 1957, 28), given that Menger was an explicit proponent of all three methodological canons (L. H. White: 7–9).

Realism/Subjectivism: Bentley was attuned to the acts of human beings (Taylor: 1957, 5) behind political decision-making, not outside “objective” factors that do not drive individuals to drive groups to drive politics. Taylor added (1952: 218): “Bentley was not concerned with the crude causal interconnections of the behaviorists; his concern was always with the systematic description of activity of men.”

Bentley himself stated: “When an investigator starts out with dead external factors in his interpretation … he will be compelled to set up something more ‘human,’ something ‘subjective’ to carry his interpretation farther forward” (1908: 135). He added: “If we should substitute for the actual interest of the activity some ‘objective utility,’ to use the economist’s term, we should be going far astray, for no such ‘objective utility’ appears in politics at all” (213). Mental states—or, in the words of one Bentley interpreter—“the group in its meaningful, purposive activity” (Lavine: xv)—is primary.

Individualism: Bentley attacked such holistic notions as “the social will” (1908: 154): “Emphasis on personified society” is “putting a spook behind the scenes” (ibid). He added: “If we believe that it carries us to the explanation of social happenings, we are simply lulling ourselves to sleep with a huge draught of the ‘psychic’ opiate” (155).

The parts of the whole, not “social psychic entities,” are causal to Bentley. What were the parts? Bentley explained: “The raw material [of politics] can be found only in the actually performed legislating-administrating-adjudicating activities of the nation and in the streams and current of activity that gather among the people and rush into these spheres” (1908: 180).

Process Analysis: “We have one great moving process to study, and of this great moving process it is impossible to state any part except as valued in terms of the other parts” (Bentley: 1908, 178). His methodology was stated thus: “The political groups are following definite courses…. The business of the student is to plot the courses” (213–14).

Process requires recognizing change. “When we succeed in isolating an interest group the only way to find out what it is going to do, indeed the only way to be sure we have isolated an interest group, is to watch its progress” (214). The “practical reality,” he adds, requires social dissection (153) via “observation” (216) and “clear, cold reasoning” (447).

Bentley’s recipe for realism—subjectivism, individualism, and process—applies across the social sciences, as Book 1’s review of the ideas of other top social scientists attest.

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