Fritz Machlup, Capitalism and Its Future Appraised by Two Liberal Economists (June 1943)

Fritz Machlup’s review essay compares Graham’s Social Goals and Economic Institutions with Joseph A. Schumpeter’s Capitalism, Socialism and Democracy. Their shared liberalism means commitment to individualism, rationalism, and political and economic freedom, not progressive regimentation. Yet admiration for capitalism does not entail defending its existing institutions. Graham proposes extensive reforms to preserve free enterprise; Schumpeter predicts that capitalism’s own development will prepare its replacement by socialism. Machlup organizes the essay into a comparative discussion of common problems, followed by separate accounts of each book. The governing contrast is between Graham’s social ethics and Schumpeter’s sociology: deliberate institutional reconstruction versus an evolutionary process that transforms people’s preferences as well as their circumstances.

Graham wants to reform capitalism and he develops a program which would drastically change many institutions of the capitalist order.

The comparison tests how far common liberal premises yield common conclusions. Both authors value entrepreneurial initiative, distrust comprehensive state planning, and recognize the importance of differential rewards. Neither equates freedom with equal incomes. Schumpeter’s socialist alternatives themselves expose the tension: equal distribution requires compulsory allocation of labor, whereas occupational choice requires differentiated remuneration. Both also regard heavily progressive taxation as potentially destructive of enterprise when profits are taxed away but losses remain private. Their apparent agreement that socialism and individualism can coexist is less secure: Machlup observes that Graham never adequately defines the socialism he regards as compatible with individuality.

Competition produces the sharpest disagreement. Graham sees monopoly as a barrier to entry, innovation, and rewards corresponding to genuine economic contribution. Schumpeter sees temporary protection, restrictive strategies, and large enterprises as possible conditions of long-term investment and technological advance. Machlup makes this dispute central rather than treating monopoly simply as a departure from textbook efficiency. Schumpeter’s standard is dynamic performance: present restrictions might enable future expansion. Graham’s is the preservation of opportunities for independent enterprise. Machlup nevertheless calls Schumpeter’s conviction of big business’s superiority one of his strongest and strangest claims.

Large corporations also connect economic performance with capitalism’s political survival. For Graham, corporate size concentrates coercive power and inhibits adventurous owner-management. For Schumpeter, corporations may excel economically while weakening the personal attachment to property that sustains the capitalist order.

With the disappearance of the owner-entrepreneur the defender of the capitalist order disappears.

This distinction explains why Schumpeter can disparage small firms’ efficiency while valuing their political importance. Ownership embodied in a business generates loyalties that dispersed securities do not. The family motive similarly supports accumulation beyond an individual lifetime. Graham acknowledges that motive but sharply restricts inheritance to preserve equality of opportunity; Schumpeter treats its erosion as another source of capitalism’s decline.

Machlup’s account of Graham follows the movement from declared social values to institutional prescriptions. Freedom, opportunity, responsibility, and rewards for socially useful ability supply the criteria for reform. He admires this explicit normative foundation but questions the elasticity of “power,” which shifts among ability, productivity, wealth, and other meanings. Graham’s practical centerpiece is commodity-reserve money: dollars would be issued against stored baskets of raw commodities and withdrawn as those commodities were released. The aggregate basket price would be stabilized while individual prices remained flexible. Storage would counter shifts into monetary liquidity, sustaining production and employment without continuous deficit spending.

The accompanying reforms include full cash reserves in banking, restrictions on corporate concentration, public ownership of unavoidable monopolies, stringent inheritance limits, and relatively modest taxation of current income. Machlup’s sympathy does not prevent criticism. Graham fails to explain how necessary wage reductions would actually occur, and his treatment of interest contains misunderstandings of Keynesian theory. The resulting appraisal is respectful but discriminating: a substantial liberal reform program whose analytical components deserve separate examination.

Schumpeter’s argument proceeds from an assessment of Marx to capitalism’s prospects, socialism’s feasibility, democracy, and the history of socialist parties. Its decisive move separates economic success from institutional survival. Capitalism need not collapse through impoverishment or exhausted investment opportunities. Instead, innovation becomes routinized, entrepreneurial functions diminish, ownership becomes impersonal, protective social strata disappear, and intellectual criticism strengthens hostility to the system. Success undermines capitalism’s defenders and motivations. Machlup finds this sociological explanation illuminating without accepting inevitability as demonstrated; Schumpeter’s allowance for reversals and another successful capitalist run also leaves the timing indefinite.

Schumpeter's Socialist Blueprint does not provide a planned but rather an automatic economy, which allocates productive resources not through planning boards, rationing schemes and priorities, but instead through prices resulting from competitive bidding on the part of the independent managements of firms and industries.

Machlup thus distinguishes collective ownership from detailed administrative allocation. He also emphasizes Schumpeter’s attention to transition, bureaucratic capacity, and retaining experienced managers. Yet logical compatibility with democracy cannot establish its probable survival.

This Schumpeter does not believe himself; personally he thinks that socialism will more likely mean dictatorship.

That gap between possibility and probability concentrates Machlup’s methodological objection: Schumpeter uses sociology to explain capitalism’s dissolution but formal definitions to establish democratic socialism’s compatibility. The essay’s lasting significance lies in keeping distinct economic efficiency, political allegiance, personal preference, and historical prediction. Its praise for both books remains inseparable from scrutiny of the conceptual moves by which each claims to understand capitalism’s future.