4. Karl Marx, Joseph Schumpeter, and an Economic System Incapable of Coming to Rest

4. Karl Marx, Joseph Schumpeter, and an Economic System Incapable of Coming to Rest


Prof: Okay,
let’s go to work. Violating the syllabus,
I’ve re-titled today’s discussion “From Marxist
Historicism to Howard Head’s Tennis Racquet,”
and let’s begin with Howard Head’s tennis racquet.
Howard Head was an alum of
Harvard College, a bright guy,
and a not very good airframe engineer.
He was a second-class designer
of the details of airplanes for McDonnell Douglas Corporation,
and he was an avid skier, and an avid,
but very untalented, tennis player.
As he tells the story,
there was a night on a bus, a motor coach to use his words,
bringing him back to New York from Vermont,
from Stowe, and he’d had a rough weekend of skiing and he
said, “What would happen if we
took the aluminum wafer with which we’re building airplanes,
and made a ski from it?” Sure enough he did that,
and the skiing industry, not just the sale of skis but
the total size of the skiing market,
was transformed forever because skiing now became more fun and
vastly easier. Five years later he had the
same–he applied the same thought process to tennis
racquets. At the time the world market in
tennis racquets had converged on the Bancroft wooden racquet,
named for Jack Kramer, who died–his obit is in The
Times this morning– and everybody was competing on
price and details of quality with the wooden racquet.
There were no rules about how
big a racquet could be. It occurred to Head that,
if he substituted in the bow of the racquet,
substituted aluminum for wood, the structural properties of
aluminum would allow the head of the racquet to be much bigger.
Do any of you play with giant
tennis racquets? I know it’s a point of pride
among really good players not to do that.
Mine–I retired from tennis
three or four years–mine at my retirement was about like that.
It makes tennis easy,
and it created a mass market and it redefined the whole
business. Now the idea of creative
destruction, which is usually about things more complicated
than skiing and tennis; the whole idea of creative
destruction is that the process of competing to sell the best
product at the lowest price within the given market
framework often does, indeed, lead to something like
monopoly, or at least oligopoly,
and a point made at length by Marxist critics of capitalism.
As that happens,
it occurs over and over and over again,
that somebody like Howard Head finds an alternative technology
invariably aimed not at luxury markets,
aimed at regular people, and very seldom aimed at
corporate or governmental buyers,
but again at private sector buyers,
and generates with that product an entirely new market,
shatters the equilibrium, hits it with a hammer.
And this thought is,
on the one hand, antagonistic to Marx.
That is, it is a way of
refuting Marx’s idea about monopoly capitalism.
On the other hand,
it is exactly in the spirit of young Marx,
the young Marx we hear in The Communist Manifesto
read for today’s assignment, who saw capitalism as an
enormously productive system which was incapable of standing
still, which was always leaning
forward into the wind, which was, to use Schumpeter’s
term, nothing more than a mechanism
for economic change. According to Schumpeter the
very essence of capitalism is that it is a system always in
the process of revising itself. It is never capable of standing
still, and young Marx certainly
believed just about that same thing,
and believed that the productive forces–
now remember he’s writing in 1847,1848–
that the productive forces associated with capitalism were
unprecedented in world history. May I call on one of your
classmates to read the pivotal paragraph from that work?
Student: “The
bourgeoisie cannot exist without constantly revolutionizing the
instruments of production, and thereby the relations of
production, and with them the whole
relations of society. Conservation of the old modes
of production in unaltered form was,
on the contrary, the first condition of
existence for all earlier industrial classes.
Constant revolutionizing of
production, uninterrupted disturbance of
all social conditions, everlasting uncertainty and
agitation, distinguishes the bourgeois
epoch from all earlier ones. All fixed, fast-frozen
relations, with their train of ancient and venerable prejudices
and opinions, are swept away.
All new-formed ones become
antiquated before they can ossify.
All that is solid melts into
air; all that is holy, is profaned;
and man is at last compelled to face, in sober sense,
the real conditions of life, and his relations with his
kind.” Prof: Thank you very
much. Marx is there talking about
the–at the time he’s writing, railroads are just beginning to
transform the European world around him.
Steamships are a generation and
a half into transforming world commerce.
The use of newly efficient
steam engines in manufacturing is creating ever cheaper goods.
The market in world textiles
has driven the price of ordinary cotton cloth nearly to zero,
so that nearly everyone in the market–
advanced market societies, can afford to dress,
more or less, the way all of you are dressed.
That is to say,
whatever, look around. But the point is that the
revolutionary transformation of the means of production,
and of what is produced and at what cost it sells,
is very much on Marx’s mind. Additionally,
Europe is politically unstable in the 1840s.
And there are five or six nodes
of apparent revolutionary activity stretching from Austria
through Germany, into tsarist Russia.
And Marx imagines that his
relatively abstract analysis of capitalism is scientific.
By scientific he means that it
has predictive force. That his science of economy and
society is so powerful that it allows him to foresee the
future. Not to foresee the exact dates
and details of future history, but that the broad outlines are
beyond human control. There are actually two
assertions here. One is that the world’s history
is determinate, that it is like the machinery
of the heavens, it is like the planets
revolving around the sun. A good astronomer can readily
predict the phases of the moon, the occurrence of eclipses,
all those things, and that’s science which was in
the past by Marx’s time, and which he aspired to that
level of confidence. We’re going to look at his
historicism, that is, the double belief that
the world is deterministic and that he and his associates can
actually unlock the keys to the future,
under six headings. The first of which is monopoly
capitalism, and we’ll take that up momentarily.
Second is the proposition that,
in the long run, the rate of profit for
capitalist enterprises has to fall.
Third the immiseration of the
working class, that as profits fall,
so does the wage stream available to the working class.
So both the capitalists and
their adversaries in the proletariat face a squeezing
vice which takes their discretionary power out of the
system. As the vice squeezes,
revolution becomes inevitable. That’s the fourth point on
the–or the third point on the chart.
The fourth point is Marx’s–I’m
a great respecter of Marx’s brilliance, but the theory of
the universal class is almost childlike.
The idea is that if you search
out the bottom of the bottom of the bottom classes than that
class will have the unique property that it has no one else
to exploit. If it has no one else to
exploit then there won’t be exploitation,
and since the purpose of the state is to defend the interest
of an exploiting class, then the state will become
unnecessary and will, as the bottom line says here,
wither away. Now the many decades of
experience we have lead us to be friendly critics toward the top
of this story and unfriendly critics toward the bottom
because the story told at the bottom is not only false,
but dangerous. Monopoly capitalism–you’ll
remember that when I was sitting with Jim Alexander last class
talking about Adam Smith and the conditions under which the
invisible hand remains invisible,
I used the Porter Forces commonly used in MBA instruction
to define the opposite of each of the conditions put forward by
Smith, and so I’m using them again
here. In a monopoly capitalist
situation, the monopolistic firm has eliminated direct
competition or rendered it trivial.
It has caused the erection of
high barriers to entry so that as its profits increase and
others say, “What a good idea let’s
get into that business,” it has ways of keeping them
out. Or, once they come in,
of punishing them to the point of bankruptcy.
Third, these are products that
are not discretionary; they’re hard to substitute for.
You can’t have a serious
monopoly in children’s games. You can’t have a serious
monopoly in a given fragrance of aftershave lotion or of perfume.
Serious monopolies are always
in things which people need and for which they don’t readily
find substitutes. The firm is vertically
integrated, and by vertical integration I mean,
think about starting–well, let’s take the laptop in front
of you. Starting with the aluminum,
the silica, the metal wires, all that stuff;
starting with raw materials that are in the earth,
extracting those, designing them,
fabricating them, marketing the machine,
distributing the machine, that whole long trail of
production from raw materials at the one end to finished product
in the hands of a buyer at the other.
Vertical integration,
in the extreme, means that the corporation
controls that whole sweep. The part that reaches from
manufacturing toward the buyer is called “forward
integration.” The part that reaches from the
manufacturer back to raw materials is called
“backward integration.”
This pattern of integration
gives the company great power because there are no suppliers
who can hold up the firm for a part of its profits.
Buyers don’t have leverage to
control prices. Competitors can’t manufacture a
very similar machine 20% cheaper and drive down profits.
And people in substitute
industries don’t have any way of drawing away customers.
That’s the–I’m
caricaturing–but things which more or less fit that
description historically would be, for example,
Standard Oil. John D. Rockefeller who
controlled–who came into control of oil all the way from
exploration and the wellhead. Through refining and
distribution, he came to control the
railroads, which his rivals would need to
use to distribute their product, and managed to use the
railroads to impose artificially high freight prices on his
competitors so that he was able, in effect, to monopolize the
whole industry. The–U.S. Steel,
a similar story. This would be Andrew Carnegie.
Microsoft.
There has been a long debate
about antitrust for Microsoft, and it’s pretty close to a
monopoly. I look around the room and I
see little white Apples illuminated everywhere,
and I have one myself. My eldest daughter is a
partner-level executive at Microsoft and in her house are
Apple computers, which I have given her family.
Another story of the same
instance is the regulated airlines.
The regulated airlines,
this is before the late 1970s when the airlines were
deregulated, would own a route and monopolize it.
And they would compete not on
the basis of price, because they would charge
monopoly prices. They would compete on the basis
of food and attractive flight attendants–and I’m not going
near that. The big pharmaceuticals,
or pharmas, are sometimes in monopolistic
or near monopolistic positions about drugs and many other
cases, though fewer than the
ideological critics of capitalism would make you
believe, and fewer partly because of
creative destruction. As monopolies ossify people
find ways to blow them up. Let’s talk about that.
On the left side of this little
diagram we have ways to build a monopoly, and on the right side,
ways to burn a monopoly. And on the vertical we have
market forces and on the horizontal, the top horizontal,
we have market forces. The bottom horizontal we have
governmental forces, and let’s just get ourselves
familiar with the four resulting cells.
Scale and scope, mostly scale;
if there are returns to scale so that each widget gets cheaper
to produce as you produce many of them,
the firm which is producing the largest quantities enjoys an
enormous strategic advantage. Illustrated here,
if number of widgets produced is on the horizontal dimension
and the marginal cost of the last widget is vertical,
being positioned where this little green company is
positioned is an enormous advantage in comparison with the
little orange firms at the left. These are boutique firms doing
very little, and the giant producer,
which in the American economy for a very long time was General
Motors, for example.
It’s General Motors and its
immediate competitors in Ford and Chrysler.
Let’s–I’ll illustrate the
point. At the time of–the decade
before World War I there were 1,200 automobile manufacturing
companies in the United States, and almost all of them got
winkled out by the end of the 1920s.
There were about a dozen at the
end of the 1920s. We’re now approaching–what
number are we going to end up with?
Student: Zero.
Prof: Zero is one real
possibility. More likely,
I think one, one and a half,
two, something like that. But the scale economies in that
kind of business are enormously important.
Creative destruction,
and here we have Schumpeter again,
and one way of using Schumpeter is to take a very long view of
dominant technologies for energy and production,
and look at how they have shifted over time.
In this chart–is that legible
for any of you or not? Not really?
Okay.
The chart begins with
production based on water power; on mills based on falling water.
It turns out historically that
these were very important. The first great advances in the
manufacture of textiles occurred in plants located along the
fault line of rivers, where it was possible to
extract a great deal of energy from falling water and drive
mass manufacturing. Then you have creative
destruction with the emergence of steam and rail as
alternatives. Then electricity,
and I won’t pause long but the great battle of the 1890s was
between alternating current electricity,
controlled by George Westinghouse,
and direct current electricity controlled by Thomas Edison,
both of them as corporate leaders.
Yale didn’t fully give up on
direct current technology until about 1985.
There were dorm rooms were the
lights were actually run on direct current generated in a
plant over near where the swing dorms are now.
I’ll leave it to sections for
you to parse this out because it’s actually a very interesting
story. The advantage of direct current
electricity is it can’t kill you.
It doesn’t matter how much,
it’s not going to kill you. The disadvantage of direct
current electricity is that as you put it through a long
transmission wire, you lose most of it after the
first five miles. So Edison controlled direct
current electricity, and wanted to make the
government regulate it in. So what did he do?
He stressed safety.
And so if Edison had won,
there would have been a generating plant about every
five miles all over the country, in every urban neighborhood its
own generating plant. How did he dramatize that?
Yes.
Student: The electric
chair. Prof: The electric
chair, exactly. He put forward the view that,
well Westinghouse has a great technology if you want to kill
people, and actually did demonstrations
on animals and all that sort of thing,
it was just awful. Ultimately it was a case where
the unregulated market won. The government stayed out of
it, and alternating current, from the point of view of
illuminating our classroom, is pretty efficient.
Then you get petrochemicals and
digital networks– this is all very stylized in
this diagram– but the point is that
monopolies, one after another, after another,
after another get winkled out by these changes in the
underlying technology. New Haven at one time was
arguably the leading manufacturing city for horse
drawn carriages. Well, it was over,
and over pretty suddenly. Regulatory capture.
Regulatory capture means what
it says, and there’s a basic political
science kind of a thesis about this,
which is that regulatory agencies get captured by the
companies they regulate. If I’m a bank or a brokerage,
I’m intensely interested in the SEC and I develop friendly
relations with it. I feed information to its
staff, its staff comes to rely on me.
After spending a cycle of four
or eight years in a politically appointed position in the
regulatory agency, it occurs to people that they
might pursue a career in the industry they’ve been
regulating. There gets to be a reciprocal
relationship there, which allows a dominant firm to
enjoy some advantage from its relationship with the regulator.
The current crisis in banking
is a little different from this and it’s not really
monopolistic, but it is not unfair to suppose
that Goldman Sachs has enjoyed a fruitful relationship to the
Federal government in the last four or five decades,
and that there have been very few times when there wasn’t a
Goldman Sachs partner in a position to influence key
decisions. The more classic story would be
the airlines, the one I told you where TWA,
Pan Am, and all the others of that era
had this monopolistic relationship created by airline
regulation. What killed them was that
enjoying a monopoly relationship to the airline regulators
allowed them to be pretty soft. They didn’t have to control
costs; they could waste $.15 of every
dollar in profits and still look great to their investors.
When deregulation came the
“legacy” costs were lethal to many of
these firms because they were up against,
now, they were up against airlines like Southwest which
had no legacy costs and ran very efficiently.
Finally, antitrust.
Antitrust emerges in the states
with the Sherman Antitrust Act of 1890 and is–
there is a continuous oscillation in government policy
here and in most other market economies,
between strict and not so strict interpretation of what
counts as a monopoly, and what counts as predatory
monopolistic behavior. When we get to cases we will
see several specific instances of this.
Falling rate of profit.
Remember those of you who were
here the first class, the slides that contrasted
labor intensive production, and for example,
I had two yaks pulling a plow in Tibet juxtaposed to a
twenty-ton John Deere tractor tilling earth in Minnesota,
Iowa or some such place. On the one side you had
relatively low production per labor hour and on the other an
enormously high rate of production per labor hour,
but based on capital outlays for the equipment like the John
Deere tractor, well into six figures.
The Marxist idea of how capital
makes money from labor is that capital–
that labor is a commodity and the labor theory of value more
or less applies to that commodity.
How much do you have to pay for
the commodity which he calls labor power or laboring
powering? Well you have to pay what it
costs to feed the worker, to clothe the worker,
to rear his or her children, you have–the analogy is
imagine you have a plow horse, what does it cost you to
maintain the plow horse? Well that same reasoning Marx
applies to the workforce. You pay wages that are broadly
consistent with that. In my diagram the laboring
power is represented by the blue and capital pays labor that much
for its activity. The total pie represents how
much value is produced by labor and what’s left over is called
surplus value. The capitalist firm keeps the
surplus value, by that means exploits labor,
and by that means increases its wealth to create wealth.
Now that leaves out a lot.
One thing it leaves out is the
fundamentals of supply and demand for labor.
It doesn’t take into account
the idea that labor would be extremely cheap in this
phase–how many people here haven’t seen the demographic
transition? Good, because we did it a
couple days ago, but I never know about
turnover. Marx is oblivious to that
except how would he answer if I said that?
He would say,
well no labor is cheaper in these conditions because the
socially shared expectations for how well they have to be fed,
clothed, and their children reared are low in those
conditions. Village India,
the cost of labor power is vastly less then it is in
Midtown Manhattan; that’s one issue.
Another issue,
this is the age curve, and it’s just an embellishment
of the demography. Another is how hard people work;
this is a Breugel sixteenth century picture of agricultural
labor, which by the evidence there is not very intense.
The idea that you pay for what
you get in labor is a powerful one,
and the so-called scientific management movement of a century
ago, which grew up around large
manufacturing companies in the U.S.
and Europe, was that you
develop incentives to make people work really hard.
The simplest case was Henry
Ford’s $5 a day salary, which was way above market
prices, but allowed him to be very choosy about his workers,
to demand very intense labor, and to demand that they allow
him to inspect their lives. He had what he called
sociologists who went around to people’s houses looking for
alcohol or devices for gambling and so on but intensity of labor
is another variable that needs to be thought of.
Now I just made that story
sound really sensible, I think, but the logic of it
has always escaped me. The notion that labor is
different from any other standard for measuring value and
that you can– you attribute to labor the
whole pie, but actually you’ve got to
attribute much of the pie to capital.
Beyond capital you’ve got to
attribute much of it to ownership and to management,
and intellectual property. Knowhow, the ability to
actually made widgets well and effectively at low costs,
all that is left out of Marx’s story.
He assumes, he just says,
“necessary labor time” and draws attention
away from what capitalism is best at,
which is again and again revising the way we produce
something, the way we distribute it,
the way we design it, the way we design the machinery
that creates it, even the way we design the
machinery that designs the product,
all of that is marginalized in a Marxist analysis.
And for that reason Marxism
does not function well in analyzing real companies in real
markets. Now the surplus value that can
be extracted depends on how much labor is used in production.
As total labor used in
production goes towards zero, the opportunity to exploit
workers goes away, and with it profits have to
fall, and from that follows the evisceration of the working
class. Look at this bottling plant
where the work is to sit at this control panel and adjust the
process, plus a little maintenance.
Have any of you been in a plant
where there were virtually no workers present?
Can you hand him the microphone?
Student: It was the
Celestial Seasonings tea factory in Boulder, Colorado.
It’s just machines
putting–sorting leaves, putting them into bags.
And there are like three or
four workers in this huge room sitting at this screen adjusting
(inaudible). Prof: Right, exactly.
Other examples?
In the back,
can we get a mic back to the very last row?
Student: I took a tour
of the Tsing Dao Beer Factory in China.
I mean, it’s fairly old,
I mean, the only people working there were tour guides and
inspectors that were within the>
Prof: So a very high
degree of automation? Student: Yes.
Prof: I was some years
ago in a textile factory in Turkey, which covered six acres
of interior manufacturing space. Every square foot of it was
either an aisle between machinery or machinery,
and virtually all the machinery was working,
and the cloth was coming out in bolts like this at ten or twelve
different points, and automata were throwing it
on conveyer belts, and conveyer belts were taking
it where it needed to be for shipping,
and labeling it and having it ready to go.
When I was there,
there were about six people in the plant,
all of them technicians and the story about the plant was that
it could operate that way for as much as 60 hours and then there
would be a shutdown for a few hours of maintenance and
adjustment, and then another 60 hours and
so on. Another historical example is
the Bonsack Cigarette Machine; cigarettes were not popular
before the Bonsack Cigarette Machine.
The Bonsack Cigarette Machine
could make 6,000 cigarettes per hour,
which–they’re now much better than that,
they’re 100,000 an hour–but at 6,000 per hour with zero labor
cost, it occurred to the people who
formed American Tobacco that they could make an awful lot of
money if they created a marketing end,
that would allow them to pump all those thousands of
cigarettes out into the market. And they did it,
and did a very good job of it. At the core of it was this
little piece of technology, continuous production,
and paper and tobacco leaf go in one end of the machine,
and cigarettes neatly stacked in consecutive order come out
the other. So capital intensivity takes
labor out of the picture. In effect, the dead who created
the machinery are the producers. Inevitable revolution in
advanced capitalist societies. The idea here is that with
falling rates of capital and the immiseration of the working
class, this system ceases to be stable.
This is a guy named Georgi
Plekhanov, and Plekhanov was a Marxist who
was a follower of Lenin’s, and he’s famous for having
asked the question, “If the revolution is
inevitable, why must we fight and die to
make it happen?” That’s an interesting question,
and it gets the name Plekhanov’s paradox.
And of course the answer to it
is that the revolution wasn’t inevitable.
Where it did happen,
it didn’t happen for the reasons Marx described.
Where were the most advanced
systems where you would expect the capital intensive
production, falling rate of profit,
and low wages to labor, where were those systems?
Let’s name a few countries.
Yes.
Student: UK,
Germany and the U.S. Prof: UK,
Germany and the U.S. Those are not the places where
the revolution happened. It happened most dramatically
in Russia, and then by conquest in the rest of the Soviet Union,
and Cuba. This is Fidel on the right and
Che Guevara on the left. There was–I have a photograph
in my collection at home of Fidel Castro at the New Haven
train station and a New Haven policeman looking at him like
he’s from Mars. And it was just after the
revolution when they hadn’t–when the break with the
U.S. hadn’t really hardened,
and he was on a university tour speaking on college campuses
trying to raise money for the revolution.
Cuba was not an advanced
capitalist economy and still isn’t.
The best thing you can say
about–I’ve been twice and have been a guest of the government
once, and the best thing you can say
for them is that they actually have done a splendid job with
rudimentary public health, so that on the longevity
dimension of the data automation we looked at,
if you’ll screen it up tonight you’ll discover a little green
moon way, way high side outlier on
longevity, and that’s Cuba.
On the other hand they are dirt
poor. China, not an advanced
industrial economy when the revolution occurred;
Venezuela, an oil state, and whether the revolution has
occurred or not is open to question.
And this at the height of the
Cold War was the way the chess board looked,
where red meant Marxist and pink meant sort of Marxist,
and the game of controlling emerging market countries was at
the core of Cold War strategy or very near it.
The theory of the universal
class. If the aristocracy exploits
serfs in medieval European society,
and capitalists exploit proletarians in capitalist
society, and proletarians come to power,
who are they going to exploit? There’s no one below them.
Since there’s no one below them
they are the universal class and exploitation is over.
Now please.
So the reasoning is like the
eastern division of the American League, and Baltimore is the
universal class because there’s no one they can beat.
What’s at the core of this last
thing, and it is truly dangerous
reasoning, is that the universal class,
being in a position superior to no other class,
brings an end to exploitation, and since that’s true the state
can wither away. Now it doesn’t happen in a
hurry, and behind this is a really fundamental issue of
principal agency. Did we talk about principle
agency a few days ago? Maybe not, well let’s just for
simplicity, let’s suppose the people own
the country and the Communist government is the agent that
they have elected to choose, or which has chosen itself to
manage the country on behalf of the people.
The principal agency problem
which occurs in things as small as a grocery store is that the
employee’s agents choose, instead of serving the purposes
of the owners or the country, choose to serve purposes of
their own. The invariable fact about state
socialism was that the people at the top of the state apparatus
privileged themselves and their children,
and a new class struggle developed.
Now, more generally and here
I’m using the work of a sociologist named Ralf
Dahrendorf, economist sociologist who died
just a few weeks ago, and Dahrendorf’s point,
which I’m sure is true, is that you can generate
classes around any process of production and distribution.
There is nothing final about
the proletariat coming to power, and there is never a time in
human history when we’ll be done with the possibility that those
who control the direct levers control them not to the benefit
of others, but to the benefit of
themselves. Francis Fukayama,
who famously wrote a book called–
that had the punch line: The end of history–
after the Cold War ended–his view was that capitalist
democracy became, “the end of history,”
the unchangeable endpoint, and of course that’s not true.
The course of history is not,
contrary to Marx, determinate.
Marx was not only wrong about
his own ability to understand the course of future history,
he was wrong about the very concept that there could be a
deterministic theory which told us what was going to happen in
the future. This guy, Schumpeter,
who, I know you hate the way he writes, but he understood that
point profoundly. I’m out of time so I’m not
going to elaborate him, I’ll do it at the beginning of
class next time. The guy who comes to center
stage next time is F.A. Hayek, whose most famous book
was called, The Constitution of
Liberty, and who believed that a market
society had within it the capacity for enormous creativity
and growth, and we’ll examine that in class
on Wednesday.

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