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Wednesday 20 October 2010

Time for Shiva and Schumpeter

Destroy Who You'd Make Good

There comes a time in every desperate recapitalisation of the creaking financial system when governments need to bite the bullet and then use it to put broken-down institutions out of their misery. Capitalism is, at its heart, a recapitulation of the basic Hindu principle of regeneration. Until there’s destruction there can be no creation.

In their desperation to shore up the world’s banks politicians can lose sight of this basic principle. It’s one thing to protect deposit holders – although allowing them to make reckless gambles without the promise of commensurate pain opens up a world of moral hazard – it’s entirely another to offer shareholders and managers a free hand with bottomless pits of taxpayer’s cash. Vishnu the Preserver’s had his day, it’s time to let Shiva the Destroyer out of his cage.

Nietzschian Annihilation

The ideas of creative destructionism are usually bracketed with the work of the Austrian economist Joseph Schumpeter but actually go back far further, to Werner Sombart and before him the philosopher Friedrich Nietzsche. Nietzsche’s generally got a bad name these days having been expropriated by the Nazis in their quest for intellectual justification. Quite how they squared his Hindu mythology with the Arian master race isn’t entirely clear, but frankly, that’s pretty much par for that particular course.

Anyway it seems to have been the influence of Hindu thought on Nietzsche which to have led to the central ideas of Thus Spoke Zarathustra: “whoever must be a creator always annihilates”. For Nietzsche the opposite of the idea of creation-destruction was preservation – the forces of inertia, attempting to ensure that the status quo is preserved at the expense of change and development.

Although Nietzsche was primarily concerned about moral order and overthrowing traditional ideas of religion through what we might loosely describe as a form of social evolution it’s fairly easy to see how a philosophy like this can be translated into an economic theory. This is situation normal for economics, of course: having no original ideas of its own it cleaves to the thoughts of others as a thirsty alcoholic hangs on a pitcher of iced tea: grimly, but without enthusiasm.

Creative Destructionism

It was Schumpeter who unleashed the ideas of Nietzsche’s creative destructionism on the economic world. He believed that the key to capitalism was innovation:
“Schumpeter’s claim was that the new process or product that results from a dynamic leapfrogging innovative competition, is more important in understanding capitalism, than the static standard model of price competition that emphasizes unconcentrated markets as the means to lowering prices, where the goods and technologies are assumed constant”.
The hero of this process was the entrepreneur, creating waves of “industrial mutation”. The whole theory is evolutionary in nature, with the innovator cast as the source of change. It’s also a theory of punctuated equilibrium, as the economy lurches between booms caused by new ideas and busts caused by the erosion of the innovator’s profit margins.

If Schumpeter’s ideas are right then the success of the capitalist approach rests on these great waves of change. There can be no progress without its opposite – so forests need to be replaced by coal and coal by oil, while horses are replaced by steam engines and cars and slide rules and log tables by mainframes and computers and smart phones. And in the wake of these innovations come new types of business unimaginable before: who’d have thought the PC could offer so many business opportunities, if only for hackers and writers of viruses?

Free Markets, Right or Wrong

In many ways the Schumpterian approach to capitalism is the classical one beloved of the most radical and dogmatic of free marketeers. Let the market take care of itself, they argue, let the duff banks fail and the market will sort the wheat from the chaff. Only by allowing the weak to die can the strong grow and fulfil their potential. If only those pesky politicians and central bankers would stop meddling everything would sort itself out, they reckon. At the extreme this view was referred to as liquidationism, and its role in the Great Depression was bitterly remembered by President Hoover, years later:
“The ‘leave-it-alone liquidationists’ headed by Secretary of the Treasury Mellon…felt that government must keep its hands off and let the slump liquidate itself. Mr. Mellon had only one formula: ‘Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate’.…He held that even panic was not altogether a bad thing. He said: ‘It will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people’.”
Yeah, that worked then …

Liquidating the Liquidationists

Unsurprisingly liquidationists got a bad name and Schumpeter’s greatest rival, Keynes, won the plaudits. Schumpeter ended up believing that the inevitable end of these sickening rollercoaster lurches between boom and bust was the failure of capitalism. The inevitable end of a Schumpeter cycle is the ultimate destruction of liberal democracy as we know it.

Only, as we know, he was wrong. Admittedly against quite a lot of odds and in a rather battered condition capitalism is still with us and is still, more or less, the main driver of global economic growth. And, whenever this looks like grinding to a halt the central bankers conspire to throw some more government cash around to prevent this. The lessons of history suggest that, in the main, they’re right to do so because allowing the free market to indiscriminately destroy businesses when it goes into one of its periodic funks is more about psychology than any real process of innovation driven change.

Destroying the Regualtory Status Quo

Yet there’s a limit to this and that limit has been breached often enough in the past for us to know where a perpetual bailing out of woefully managed financial institutions leads. As Japan has shown, badly run banks don’t get any better by being permanently propped up. There come a time when the weak must be led to the knackers yard and disposed of as humanely as possible.

Oddly enough this process of creative destruction seems to apply to the regulators as much as the regulated. As Barry Eichengreen notes in The Crisis in Financial Innovation:
“Looking back, one cannot help but be impressed by the role of degegulationist ideology, especially in the U.S. and the UK in the wake of Reagan and Thatcher, in setting the stage for the subsequent crisis. The idea that markets, left to their own devices, get it right and that governments, when they intervene, can only get it wrong, became deeply ingrained in intellectual and policy discourse. The idea that we should move in the direction of light-touch regulation, where banks are relied upon to manage their risks using their own internal models (along with the ratings they purchase on the securities they issue) reflected this ideology”.
Of course, one could also argue that the deregulation sparked off a twenty year boom in innovation that has left the world immeasurably better off, even with the commensurate problems we’ve suffered in the last decade. Unleashing innovation in Schumpeter’s world simply guarantees a future failure. It’s just better to have the boom before the bust than the bust without the boom.

Destroying the Capital Junkies

Enough, though, is enough. The recent farce of bank stress testing in Europe is simply the fag-end of the problems. It’s time to stop throwing cash at the capital junkies that are our at bust banks and to manage their death thralls as gracefully as possible. It’s time to put the world’s investors on notice that governments will no longer continue to bail out insolvent financial institutions, while ensuring that existing and new prudent corporations will be supported when madness strikes.

The global economy will only really rise again when the corporate zombies that stalk the world are finally nailed to the stake. The world’s financial system no longer teeters on the brink of absolute failure. It’s time to round up the failures and put them out of their misery, before they inflict it on the rest of us because until we do we’re left to live with the inept and the incompetent and the undeserving. As Nietzsche might have pointed out, while these are allowed to control the world we can’t move on. Time for Shiva.

Related articles: Investing by Jerks, Basel, Faulty?, Panic!


  1. great article. although there are several points on which I strongly disagree.

    nevertheless, the basic point that we must destroy to prosper is THE point

    by that, I mean that sacred cows and the established order must be overthrown as they become decrepit and senile.

    to make room for the new ideas and new ways.

    sadly, those in power will ride it to the bitter end of gotterdamerung.

    but, inevitably, it will happen.

    and not because we will it or engage it. but because that is just the way it is.

    and on the pedestal these words appear:
    `My name is Ozymandias, King of Kings:
    Look on my works, ye mighty, and despair!'
    Nothing beside remains. Round the decay
    Of that colossal wreck, boundless and bare,
    The lone and level sands stretch far away".

  2. Hi, I have recently unsubscribed from this blog (in Google Reader) but saw the link on AR. I do not think this article is very good. It's nice to be reminded about Keynes, Schumpeter and Nietzsche, but your argument for the right approach today comes in one sentence: "Enough, though, is enough." This is not a good argument.

    Why do people go to finance blogs? A lot of people go to them to hear another daft rant, so I am sure you can get readers that way. I go to a blog because it is intelligent and distinctive. I liked your carefully-thought-through pieces about pschology, economics, behavioural finance, and so on, where you seem to have a good level of knowledge. Commentary that passes judgement on the disagreements of great minds with arguments like "enough is enough" I tend to avoid.

  3. Hi JB

    The great thing about the web is that none of us need to read anything we don’t want to, it’s a joyous form of democracy in action.

    Perhaps a better way of considering the idea here, which is a development of previous articles, is that there is no single model of the world that works all the time. If economists and other thinkers could get out of the habit of thinking that their own little bubble of time is representative of all times and that ideas proven to work in one era will work in all eras then we might move in the direction of theories that promote a genuine understanding, as opposed to localised sets of rules that fail as soon as we change the environment a bit. This isn't a problem just of economics but it is one that anthropologists face and deal with habitually, so it's not something so original that it can't be comprehended.

    Of course, the idea that Keynesian expansionist policies might have been right a couple of years ago when the alternative looked like a Depression-era black hole while Schumpterian destructionism might now be appropriate to lay waste to the excesses of financial institutions that seem to be incapable of reforming themselves requires us to take a view across the differences between these great thinkers: and, of course, it’s an idea that could be completely wrong in its timing, but that doesn't mean it isn't worth airing.

    One thing I will guarantee, though, is if I want to attract more readers I ain’t going to do it by writing about Nietzsche :)

    All the best

  4. timarr,

    Thank you for your reply. I have gone too far here. The idea that you write daft rants is completely absurd.

    As I read the article, the main point is that you judge that the moment to switch from Keynes to Schumpeter has arrived. That point is not interesting -- I do not think anybody is likely to be able to consistenly pick such moments, and I have no reason to think you have any special skill in so doing. Your comment puts the article in a much more interesting light: it raises the problem that bank rescues and fiscal deficits hold back creative destruction. That raises another question: how can we substitute for it? Immediately a load of half-formed answers to this interesting question swim in my mind; perhaps you have some fully-formed ones.

    Best wishes,


  5. Hi JB

    I am, I’m afraid, as capable of a good rant as the next mad blogger down the street, although I do try and restrain myself. For what it’s worth I don’t believe I have any capability to predict any economic trend and any suggestions that I do should be blamed on my fingers running ahead of my brain.

    There are a couple of more interesting ideas underlying this article, though. Firstly there’s the idea that there’s no single model of economics that can explain everything all the time. Monetarism or Keynesianism or whatever, they all have their place, but they’re all partial models and they all fail at times. This is akin to the recent developments in physics where the attempts to create a single unified model of everything have given way to a set of consistent, overlapping models. Somewhere in such a development would be an explanation of how we trend from one model to another and possibly a way of avoiding the excesses of boom and bust. Alternatively we need to re-engineer the financial system to prevent these happening: but that’s an argument for another day.

    Secondly there’s the idea that mainstream economics is nothing more than an extended justification of the underlying political structures. This suggests that economists from Adam Smith onwards aren’t describing something “out there” but something “in here” and in doing so are aiming to provide an intellectual justification for the established power structures of the world. In this case worrying over the arguments of Schumpeter versus Keynes is to miss the main point, which is that they’re both debating something which is entirely a construction of human minds. Had history taken a different course we wouldn’t have economics at all: unlike psychology or physics or anthropology it doesn’t really exist.

    Trying to develop articles around these ideas, taking them from first principles to a developed argument in 1250 words in a way that a non-technical reader can understand and even enjoy is proving a bit of a challenge. But I welcome feedback, even when it’s to point out one of my manifold faults: how else does one ever improve?