Two Men On Monopoly

Anthony van Dyck ‘Studies of a Man's Head’ (17th century)

The analytical complementarity between Schumpeter and Weber is the focus of this week’s essay on competition with temporary monopoly, i.e. imperfect competition. I find that wherever one of these two men lacks something, the other one 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 subject called ‘economic sociology’. The effect of Weber on Schumpeter was especially deep. Schumpeter acknowledged his admiration for Weber’s intellectual and moral 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”. Interestingly, Schumpeter described Weber in the terms that Weber used to depict charisma, and that Schumpeter used to depict entrepreneurship. 

I say this only to hint at why the two figures are in some senses almost one, in my mind. I am sorry for those economists who approach Schumpeter on his own, without appreciating the synergies between Schumpeter and Weber. I am sure they miss much of the subtlety, or are unable to appreciate the importance of what is understated or left unsaid because it is bleeding obvious and couched in politeness or subtle sarcasm. 

Market freedom, not free market...

“Free” has the classical meaning in the economics of Weber and Schumpeter because it is joined to “competition”. A monopolistic shelter created 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 the law prevails, the market never can, will, or should be perfectly free like in the jungle. There is a caveat, however. Only the state can keep a monopoly alive. 

Inevitably 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 the critics of market freedom and free competition. It should be noted that no competition is ever ‘perfectly’ free. That is a fact of life.

The reason for the imperfection is the monopolistic tendency present in every form of economic and political community. The desire to monopolise cannot be wished away. And it should not be wished away. Monopoly profit is the carrot, a shiny lure that attracts ingenuity in market enterprise. The stick of the law cannot kill the monopoly drive, and it should not even try. 

But the instruments of state regulation can be waved and where necessary wielded to administer the conditions of temporary monopoly in an almost 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 some monopoly in some form for some time reflects their realism. On the other hand both men assumed that well informed readers would understand, in Schumpeter’s words, “the necessary qualifications” to the tolerance of temporary monopoly. 

It can be useful to draw the 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. The political entrepreneur enjoys a policy shelter between changes of government. The shelter of an economic entrepreneur holds 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...

All that is by way of introduction. I will attempt -- before returning to the Weber complementarity -- to summarise Schumpeter’s revolutionary theory of innovation in three parts: leadership, profit motive, imperfect competition. 

The point should be made that Schumpeter starts with a positive analysis of crisis and 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. Materials and forces of production are combined in new ways. New ideas change the way something is produced, sold or consumed, and transform economies by creating new industries, firms, ideas, goods, methods, and organisations. 

Schumpeter even proposed a similar theory for deliberately adaptive institutional change that occurs with 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 competency for understanding and modifying 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 by "sailing against the wind". Every innovation perturbs the status quo of markets or organisations and unleashes a process of disequilibrium learning.

Innovation is the work of motivated leaders...

Innovation leaders are more important as agents of change than the owners of capital and property, because innovators build the roads that capitalists will walk along. As William J. Baumol has shown, today large firms often lead in technology development and routinely attempt to cultivate entrepreneurial aptitudes among teams within the firm. 

Schumpeter was sceptical about the long-run value of attempts to automatise or routinise innovation in this way. When Schumpeter studied the innovation process, its leaders still were typically individual entrepreneurs, daring and intuitive “new men” in young firms who took bold initiatives and stepped “outside the routine” with their flashes of genius. 

Innovators swim against the stream and defy constraints on change. They persuade investors who take a commercial view of the viability of an enterprise and the profitability of innovations to bear the risks of a new idea and to provide the finance for entrepreneurial plans. Schumpeter might have been satisfied knowing that now small firms led by daring, intuitive people undertake catalytic experimental innovation and are subsequently 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.

Then 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 the 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”. 

But in the final analysis, it is clear that profit is the central motivator and signalling device in successful economic innovation. Without profit the entrepreneur would not exist. But look out! In capitalism the 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 an unhealthy business, a leading 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 neoclassical theory, was how Schumpeter conceptualised the specific phase of competition during innovation. When responding to his critics in the Preface of the 2nd edition of Capitalism, Socialism, and Democracy, he said:

“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 described the relevant context in Capitalism, Socialism, and Democracy and 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. Schumpeter insisted that 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 for itself. He mentions, for example, patents, insurance, hedging, secrecy, the use of corporate seed capital, price or investment strategies that give the firm time to build its customer base, mutual agreements to avoid cutthroat competition, and even (heaven forbid) cartels. 

Schumpeter clearly believed that the process of creative destruction forced monopolies to face competitive pressures notwithstanding their efforts to acquire 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. The restrictive practises which the business employs in disequilibrium conditions of innovation can be “effective remedies under conditions of depression”, legitimate means to weather the storm. 

In capitalism’s “perennial gale”, the 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 and the monopoly cannot endure…

My aim is only to trace 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 may be useful to recall that Schumpeter made these suggestions at least two decades after Weber had established the original position. 

Let us be clear that 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 competition can produce real entrepreneurship and maintain the climate of innovation and change. 

Tactful and reserved state regulation is required. The state should not limit the investment opportunities of entrepreneurs, and it should not try to stabilise capitalism by reducing the risk taking on which innovation thrives. State economic action should be confined only to “matters that can be successfully handled by a government”. This means a 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, almost always took the trouble to systematically distinguish between the not-so-bad monopoly that is inevitable, persistent, but exposed to competition and compatible with capitalism, and, in the opposite corner, the bad monopoly protected from competition and incompatible with capitalism.

Weber’s ‘closure’ innovation was measured 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 (e.g. of status groups) 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 greater than market-based power, if profit seekers swarm around the honeypot of state agencies rather than around 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 similarly noted -- when actors perceive a self-interest in monopolistic tactics, and the opportunity presents, they will form closed relationships.

Contemporary ‘industrial policy’ strategy sometimes simulates competitive dynamics inside a sheltered sector. Even within a monopolistic group, such as a business network in receipt of state subsidies, public agencies create conditions that Weber called “competitive struggle within the group” at the same time as they protect “the group” against outsiders. Then there is “free competition for all the advantages which the group as a whole monopolises for itself”. 

Plainly, he goes on to say, “capitalism is retarded if monopolies are protected by the state and stabilised with state subsidies”. It would seem that the size, scale, scope and situation of a monopolisation drive are irrelevant. Only this matters - is it politically shaped or is it real?

How Weber laid foundations for Schumpeter’s innovation...

The relative power of state and business is raised indirectly in one of Weber’s comments on the tendency of 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. We shall designate those interest groups which are enabled by formal market freedom to achieve power, as market-interest groups.”

Weber found that temporary monopolies can perform valuable functions for capitalist economies if 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.” 

At the same time, however, since control over economic goods is one of the most important instruments of power, we should explain the consequences of private monopolies with respect to the balance of power between state and business. Weber discusses two relevant types of domination. Modern public bureaucracy is “domination by virtue of authority, i.e. the power to command and duty to obey”. The other type is “domination by virtue of a constellation of interests”. The prime example of the latter is “monopolistic domination in the market”. 

What is the message? Through skill, exclusive possession of goods, or other concrete material advantage, a monopolistic enterprise influences the conduct of other market actors who nevertheless remain formally free of any obligations of duty to the dominant enterprise.

Typical examples of such domination include market closure through price fixing or the 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.” 

In other words, if legal-regulatory constraint on the exercise of state power is insufficient, a relationship of domination in the market that is protected and sustained by the state can be converted into a relationship of domination by virtue of an authority that is felt not to be legitimate because its origins lie in “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.”

Two men with a duopoly of common sense about monopoly…

I hope to have indicated why Schumpeter’s alleged ‘defence’ of monopoly was 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. 

My opinion is that these foundational ideas of market freedom, free competition, and creative destruction are being forgotten. Persistent clamour in mainstream economics for revivals of industrial policy is just one reminder of the forgetfulness (see, for example, the June 2014 essay by Joseph Stiglitz at Project Syndicate). 

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 or lest it 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.”

As well as suggesting how economic sociology can account for a somewhat subtle and possibly inescapable relationship between innovation and temporary monopoly, I have intimated at least one reason why Schumpeter opposed what today is called ‘industrial policy’. When government is discretionary toward a business or sector it is on the road to creating conditions that produce state-buttressed monopolisation, i.e., 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. A slippery slope. 

*****************************************************

MY COMMENT IN REPLY TO JOSEPH STIGLITZ

[reference below @ Project Syndicate]

Creating a Learning Society

Jun 5, 2014

On Stiglitz vs Schumpeter:

In his introduction to the most recent edition of Schumpeter’s ‘Capitalism, Socialism, and Democracy’ (2010) Joseph Stiglitz attempted a demolition job on Schumpeter’s explanation of capitalist crises. It is telling that in that introduction Stiglitz wrote about the difficulties of “translating” Schumpeter. Yet Schumpeter wrote in excellent plain English. So what is the problem?

Stiglitz supplies misleading hatchet ‘translations’ of Schumpeter’s central message because Stiglitz apparently requires great names like ‘Schumpeter’ to give pseudo-credibility to the specious socialist interpretation of the financial crisis of 2008/9. Yet Schumpeter was consistent and unrelenting in exposing the many silly guises of socialism. Schumpeter spotted pranksters like Stiglitz a mile off.

The Stiglitz edition of Schumpeter’s ‘Capitalism, Socialism, and Democracy’ conveniently omits several of Schumpeter’s own ‘Prefaces’ in which he responds with self-confessed “amusement” to various misinterpretations of his monopoly argument by the less competent economists. They “thunder on”, he said, but they leave out the qualifications, and “to leave out the necessary qualifications is not to present the whole truth”. There is much much more to Schumpeter’s arguments about competition and monopoly than Stiglitz is willing to let on.

The real content of Schumpeter’s “long-run” innovation perspective, which Stiglitz pretends to praise, is fundamentally the opposite of the one Stiglitz advances here. It is a complicated theory of long-run capitalist cycles with their indispensable evolutionary ups and downs. No one except Stiglitz would have the temerity to infer and foist upon the unsuspecting public the erroneous idea Schumpeter supported industrial policy. Schumpeter thought industrial policy a terrible idea !! Schumpeter did have a theory of ‘learning’, but it was closer to the Washington Consensus than to the Beijing Consensus. 

Anyone familiar with the true evolutionary Schumpeterian view of dynamic economic learning could offer countless counter-blasts to the hot air in this article. A pithy paragraph from Schumpeter’s introduction to his own ‘Business Cycles’ (the book which outlines his theory of long-run innovation in ways apparently unrecognisable or untranslatable to Stiglitz) will suffice.

“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.”

That’s the real Schumpeter speaking. Too subtle for some? 

http://michaelgheller.blogspot.com

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.

Joseph Stiglitz, 2014, ‘Creating a Learning Society’, Project Syndicate.

Max Weber, [1922] 1978, Economy and Society, 2 vols, G. Roth and C. Wittich (eds), Berkeley: University of California Press.

Michael G. Heller ©2014