Schumpeter's - Market Processes

Schumpeter's Perspective on Market Processes

Arguments about the intertemporal optimality of regulation and its related problems of risk and uncertainty in long-term contracting can be found in eco­nomic literature much earlier than the contemporary writings of Goldberg and others. Earlier in this century, Joseph Schumpeter character­ized the market function as an intertemporal competitive process which im­plies certain things about the role of government regulation. According to Schumpeter, risk is an unavoidable and natural element of market activity. Schumpeter discussed the critical nature of risk and'uncertainty and the prob­lems they pose for entrepreneurs in a capitalist society.

Practically any investment entails... certain safeguarding activities such as insuring or hedging. Long-range investing under rapidly changing conditions, especially under.. .the impact of new commodities and technologies, is like shooting at a target that is not only indistinct but moving—and moving jerkily at that. Hence it becomes necessary to resort to such protecting devices as patents or temporary secrecy of processes or, in some cases, long-period contracts secured in advance. But these protecting devices which most economists accept as normal elements of rational management are only special cases of a larger class__If for instance a war risk is insurable, nobody objects to a firm's collecting the cost of this insurance from the buyers of its products. But that risk is no less an element in long-run costs, if there are no facilities for insuring against it, in which case a price strategy aiming at the same end will seem to involve unnecessary re­strictions and to be productive of excess profits. Similarly, if a patent cannot be se­cured or would not, if secured, effectively protect, other means may have to be used in order to justify the investment. Among them are a price policy that will make it possible to write off more quickly than would otherwise be rational, or additional investment in order to provide excess capacity to be used only for aggression or de­fense. Again, if long-period contracts cannot be entered into in advance, other means may have to be devised in order to tie prospective customers to the investing firm (Capitalism, Socialism, and Democracy, p. 88).

The point that Schumpeter stresses in this passage is that elements of com­petition that may appear to be anti-competitive from a purely static perspec­tive (patents, etc.) may be elements of progress in a more dynamic competitive setting. Expressing a few reservations about the adverse effects of cartels, Schumpeter characterized a number of static "monopolistic" practices as "natural" tools of dynamic (long-run) competition. But he was also alert to the possibilities of utilizing regulatory procedures to subvert the welfare effects of the marketplace. Since government is the only permanent source of monopoly privilege, its regulatory actions should be scrutinized intensively:
The power to exploit at pleasure a given pattern of demand... 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___Even railroads and power and light concerns had first to create the demand for their services and, when they had done so, to defend their market against competition (Capitalism, Social­ism, and Democracy, p. 99).

Schumpeter's perspective on market processes provides a forceful case for a clear delineation between "static" competition and "dynamic" competition. Nongovernmental restrictions on competition, when viewed in a static sense, are usually considered suboptimal, when in fact they may help regulate the in­troduction of new technology that improves economic welfare. Government regulation, on the other hand, is the major source of long-term economic rents associated with output reductions and welfare losses.

Ultimately, the debate over natural market processes versus regulation is a debate over economic efficiency. Schumpeter and other economists have ar­gued that precontracting may be a natural response to the uncertainty and risk involved in intertemporal sales policies. Market contracting to avoid risk may take the form of warranties, guarantees, futures contracts, etc. Other econo­mists are more inclined to reduce risk and uncertainty through government regulation. Does the market provide a necessary bridge between present and future supplies at a lower cost to society than government measures aimed at the same objective? This is an issue that remains hotly debated. Only a well-executed, case-by-case, empirical study seems capable of providing convinc­ing support for one view or the other. In the absence of such complete docu­mentation, Schumpeter's insights, combined with the modern theory of regulation, remind us that the mere existence of regulation and of intertemporal problems of production and consumption does not constitute proof that the market has failed to work properly.