On Schumpeter as an economist, sociologist and prophet

I guess we are on a history of thought week. I wrote about Adam Smith being misinterpreted. Now it is about Schumpeter, who is often celebrated as the great theorist of innovation, the dynamic force behind capitalism according to him, being overrated. In this longer post (link to substack below), I argue that this reputation is largely overstated. While Schumpeter offered an influential narrative centered on entrepreneurs and technological change, his economics remained firmly within the marginalist tradition and added little analytically beyond earlier authors like his teacher Böhm-Bawerk. His real insights lay elsewhere, particularly in fiscal sociology in his famous essay on the tax state, but not much of a sociologist of technology. I discuss Schumpeter as economist, sociologist, and prophet (his approach to Marx in Capitalism, Socialism and Democracy), showing that he was a conventional theorist of growth, an interesting but limited sociologist, and ultimately a failed prophet about the fate of capitalism, especially when contrasted with Keynes, whose more modest proposals for managing capitalism proved far closer to historical reality. Read the whole thing here.

Development by invitation: a short digression on the concept

 

Development? Be my guest 

The concept of development by invitation, as far as I know, and most of my knowledge comes from Esteban Pérez's paper in a book we co-edited long ago,  originates with Arthur Lewis and refers to a development strategy in which small developing economies attract foreign capital to initiate industrialization. For Lewis, the problem of many small developing economies, particularly in the Caribbean, was that they lacked several key elements required for industrialization, namely: domestic capital, entrepreneurial skills and large domestic markets. Because of these constraints, industrialization could not easily emerge through domestic investment alone. Lewis therefore proposed industrialization by invitation, meaning that governments should invite foreign firms to establish manufacturing activities in the country.

Immanuel Wallerstein refers to a path of development in which a peripheral country advances economically because the multinational corporations from central countries actively expand into the world economy. This development occurred not through autonomous national transformation, but through external investment resulting from political and economic cooperation with central countries. For Wallerstein, the concept referred to a structural process within the capitalist world-system. In his framework, central countries allowed limited industrialization in some peripheral areas as multinational firms relocated production. That was, in fact, to some extent the phenomenon in a good part of the Latin American periphery, In other words, development by invitation was not a development policy, but a mechanism of global capitalism that reorganized production.

In the work of Carlos Medeiros (published with Franklin Serrano; he is pictured above), the notion of development by invitation refers to a historical process in which peripheral or late-industrializing countries accelerate their development because the leading powers of the international system actively support or tolerate their industrialization for geopolitical reasons. The concept is embedded in their analysis of international monetary regimes and growth dynamics. Growth is demand-led, and based on the supermultiplier, if that wasn't clear.

For Medeiros, the starting point is that capitalism naturally generates divergence between countries due to structural asymmetries in military power, technological capabilities, and monetary hegemony. All three are interrelated. Because of these asymmetries, most peripheral countries face a balance-of-payments constraint that limits growth. However, in certain historical periods, some countries can overcome these constraints when the dominant power facilitates their development.

For Medeiros,  development is not simply the relocation of production associated to multinational or transnational firms, be that as a policy strategy or an endogenous process of integration within the capitalist system. It involves state-led industrialization and strategic geopolitical support from the hegemonic power. Hence, development by invitation can produce successful industrial catch-up, not merely integration into the world economy.

Note that Esteban's discussion implicitly highlights a critique of the early concept from a structuralist perspective. Even though Lewis viewed the strategy as a path to development, in practice it often led to enclave industrialization and persistent dependence on multinational firms. The outcome sometimes resembled the type of dependent integration emphasized by Wallerstein. In a sense, Medeiros version is a further critique, suggesting that the interaction of political coalitions, behind the developmental state, and the geopolitical context matter.

Note that one might be correctly skeptical  of the notion that a country develops simply because the hegemonic power invites it to do so. Even acknowledging that favorable geopolitical contexts existed, such as those of Japan, South Korea, or several European countries in the postwar period, one might argue that development was ultimately the result of internal strategies, that is, strong states pursuing active industrial policies of technological catch up. In this view, the invitation may have constituted a favorable external framework, but it was never the decisive factor.

However, this critique appears to address a somewhat simplified interpretation of Medeiros’ concept. In his framework, development by invitation was never presented as a purely external process or as a microeconomic explanation based on private decisions. The concept was formulated in macroeconomic and geopolitical terms, placing emphasis precisely on the role of the state. The question was not whether Japan or Korea developed simply because the United States invited them, but rather why certain developmental states were able to industrialize so rapidly through manufactured exports. The answer highlights that these states benefited from exceptional external conditions. First, the unilateral opening of the US market, financial transfers,  very often facilitated technological transfers, beyond tolerance toward aggressive industrial policies, and strategic support within the context of the Cold War. This was not diplomatic magic, but rather a combination of an internal developmental state and a relaxation of the external constraint facilitated by American hegemony.

In other words, Medeiros’ concept does not attempt to explain development exclusively through external factors, but rather to illuminate why certain developmental states faced fewer external constraints, had greater access to financing, and enjoyed broader access to strategic markets than others. This allowed for a particular mix of export promotion and import substitution and helps explain why several Asian countries not only avoided the lost decade that followed the debt crisis of the 1980s, but also managed to accelerate their process of industrialization as a good part of the center, and other peripheral regions deindustrialized.

If the discussion is brought to the current Argentine case (I wrote a short note on this in Spanish), the most important point may not be to deny the relevance of the concept but to recognize that Argentina today lacks a developmental state capable of taking advantage of any potential invitation. If the government dismantles industrial, technological, and financial policy instruments, then whether a country is invited or not becomes almost irrelevant. The issue is not whether Washington extends a diplomatic invitation, but whether there exists a national strategy capable of transforming a favorable geopolitical context into productive accumulation.

Ultimately, the debate should not revolve around whether development arrives mechanically by invitation, but rather around the interaction between internal state strategy and external conditions. Development has never been automatic or purely external, but neither has it been independent of the geopolitical order and the decisions of the hegemonic power.

The Wealth of Nations at 250! Misunderstood icon of free markets

Today, March 9th, marks the 250th anniversary of the publication of The Wealth of Nations (WN) in 1776. Adam Smith may also be one of the most misunderstood thinkers in the history of economics. Smith is not the father of modern economics, neither of capitalism, a term he never used.

In modern discussions Smith is often portrayed as a precursor of contemporary economics, something like an early version of the Arrow-Debreu model of competitive equilibrium. I remember Sam Bowles suggesting that (he actually said something to the effect that Smith, Marx and Arrow, all said the same thing) at a talk at the University of Utah. In that interpretation, Smith supposedly discovered that self-interested individuals interacting through markets generate optimal outcomes, the infamous “invisible hand.”

Many books, including most classics on the topic suggest that interpretation. For example, yesterday WAPO had an op-ed (actually two; the other was much less problematic) by Jesse Norman, who will be publishing a book titled, you guessed, Adam Smith: Father of Economics. He correctly notes that the: "250th anniversary is not a moment for hagiography. It is an opportunity to recover a way of thinking that is directly relevant, indeed urgent, to the economic, social and political challenges we face today." He goes on to analyze essentially the question of tariffs with modern economic notions. Note that back in the 1790s, just after Smith passed, Alexander Hamilton, using Smithian ideas and method achieved very different policy conclusions.*

These readings of Smith as a father of modern economics and a champion of free market capitalism tells us far more about modern neoclassical economics than about Smith himself. The conceptual universe of modern economics is fundamentally different from that of classical political economy, the tradition to which Smith belonged.

Smith should be understood as part of a broader intellectual tradition that begins not with him but with William Petty, and continues through Cantillon, the Physiocrats, Ricardo, and ultimately Marx, what later came to be called the surplus approach. This tradition was concerned with the material conditions for the reproduction of society, the generation of surplus, and the process of accumulation.

In that framework, economics was not primarily about individual choice or utility maximization. It was about the reproduction of society. Seen in this light, Smith’s analysis was fundamentally about social conflict and the distribution of income, not about harmonious equilibrium among optimizing individuals. The core problem of political economy was explaining how societies generated and distributed the surplus that allowed accumulation and growth.

Another common myth is that Adam Smith founded economics. In reality, Smith was the great systematizer of a body of ideas of the surplus approach. Political economy emerged gradually during the Scientific Revolution and the early modern period. Petty, Cantillon, and the Physiocrats had already developed crucial insights about value, production, and economic reproduction before Smith wrote the WN. Smith’s real contribution was to organize these insights into a coherent framework and to place them at the center of his critique of the mercantilist system he saw as dominant. His book certainly helped establish political economy as a distinct intellectual discipline.

Nor was Smith the theorist of capitalism in the modern sense. The term itself was not part of his vocabulary. Smith spoke instead of commercial society, a stage in historical development characterized by the expansion of markets, manufacturing, and exchange.** He was certainly against the mercantile system, and believed that Physiocracy had incorrectly limited the creation of wealth to agriculture. But his defense of the system of natural liberty was not a defense of free markets in the modern sense.

Modern defenders of free markets often claim Smith as their intellectual ancestor. But the relationship between the liberalism of classical authors (not classical liberalism, which brings another series of confusions) and neoliberalism is far more complicated. Smith’s defense of laissez-faire was largely a reaction against the mercantilist system and the remnants of feudal regulation that constrained economic activity in the eighteenth century. The liberalism of Smith and Ricardo was historically progressive; it aimed to dismantle the privileges of the Ancien Régime and promote economic development.

Neoliberalism, by contrast, emerged in the twentieth century as a reaction against the Keynesian and welfare-state reforms of the New Deal era. Its central objective has been to limit the ability of democratic governments to regulate markets or redistribute income. In that sense, neoliberalism is better understood as a revival of what Marx called “vulgar economics”, rather than a continuation of the classical tradition.

Perhaps no concept has been more abused than Smith’s invisible hand. In modern economics it is often interpreted as a general theorem about markets producing optimal outcomes. But in Smith’s text the metaphor appears in a very specific context: merchants preferring domestic investment for reasons of security, which incidentally supports domestic employment. That is a far cry from the sweeping claim that all self-interested behavior leads to socially optimal results.***

Smith was also deeply skeptical of concentrated economic power. His famous warning that “people of the same trade seldom meet together… but the conversation ends in a conspiracy against the public” reflects a profound concern with monopoly and collusion. Competition, not the invisible hand, was the mechanism that restrained self-interest. He was anti-monopoly, not anti-state. In fact, he was for taxes to fund public education, a radical proposition back then (and now if you believe libertarian views that education is not a public good).

If you want to understand more about Smith ideas I recommend Tony Aspromourgos' The Science of Wealth: Adam Smith and the framing of political economy. For a book that puts in perspective how the legacy of Smith evolved in the 19th century read  After Adam Smith: A Century of Transformation in Politics and Political Economy by Murray Milgate and Shannon Stimson.

* On the distortions on Smith's views within the American context see my comments on  Glory M. Liu's book Adam Smith's America: How a Scottish Philosopher Became An Icon of American Capitalism. 

** On Smith's views on history and the four stages of development see the classic paper by Ronald Meek.

*** On that see the revised entry on the Invisible Hand by Tony Aspromourgos for the New Palgrave Dictionary of Economics.

PS: He also did not build up on the ideas of Ibn Khaldun, who, in turn, cannot be seen as a precursor of classical political economy or of Smith. On that see this post.

 

The macroeconomic perspectives: The GDP and employment numbers and the war in Iran

The new GDP and employment numbers are out, and they confirm something I have been arguing for a while, namely: the US economy is slowing down, but it is not in a recession, and the tariffs did not cause the stagflation that so many commentators confidently predicted.

Real GDP growth slowed again in the most recent quarter, but it still expanded at about 1.4 percent. Real GDP growth is slower than in 2024, but it was still above 2 percent (see below). That is clearly below the pace we saw in the immediate aftermath of the pandemic, when fiscal expansion and the reopening of the economy generated unusually strong growth. But it is still positive growth. As in previous quarters, consumption remains the central driver of the economy, which should not be surprising in a country where household spending accounts for roughly seventy percent of GDP.

The more worrisome component in the GDP report is actually government spending, which fell significantly. This decline reflects the wave of layoffs of federal workers and the broader push toward fiscal restraint that has accompanied the current administration, including falling nondefense spending. In other words, a certain degree of austerity has been quietly introduced into the federal budget, with a negative bias with respect to social spending. That matters because the rapid recovery of the US economy after the pandemic owed a great deal to fiscal expansion. As that support fades, or is actively reversed (although I doubt that) the economy naturally settles into slower growth.

On the labor market side, the most recent BLS employment report shows a decrease of about 92,000 jobs. That is certainly weak by the standards of the last few years, but it is not yet consistent with a recession. A lot of this was caused by a major, four-week, strike involving over 30,000 nurses and health care workers. Unemployment remains relatively low, and the labor market appears to be softening rather than collapsing. In other words, what we are seeing is broadly consistent with what macroeconomic theory would predict: when growth slows, job creation also slows. Okun’s law still works.
 
The decline in federal employment is part of that story. But here again there is an interesting political twist. While civilian federal jobs have been cut, the administration has promised a significant increase in military spending, which is likely to offset some of the contractionary effects of austerity elsewhere. This is not exactly a new strategy. Economists used to call it military Keynesianism, using defense spending to sustain demand when other forms of public spending are politically difficult.
 
All of this confirms something that was widely disputed last year. The tariffs did not trigger the recession that so many analysts predicted. Nor did they produce a surge in inflation. They also did not bring back manufacturing jobs, but that isn't a surprise either (on that see this post). As I argued repeatedly, tariffs might produce a one-time increase in the level of prices, but that is very different from generating persistent inflation. And the effect was small, with CPI increasing by less than it did in 2024 (see figure above). The data have borne this out. Inflation has remained relatively subdued, and the economy, while slowing, continues to grow.
 
That does not mean the risks have disappeared. In fact, the risks may now be higher than they were earlier in the year, but for reasons that have little to do with tariffs. The most important new development is the war with Iran and the sharp increase in oil prices. Since the beginning of the conflict, oil prices have risen by more than 25 percent (see below). Energy shocks have historically played an important role in US inflationary crises, including the Pandemic. Higher oil prices increase production costs,  push inflation and squeeze household budgets. The affordability issue (like the Epstein files) might not go away.

But the key channel here is not simply inflation. The real issue is the Federal Reserve’s reaction to these cost pressures. Throughout last year I have argued that the main recession risk comes from monetary policy, not trade policy (and to a lesser extent fiscal policy). The Fed kept interest rates relatively high for a prolonged period in order to combat inflation after the pandemic. Those high rates have already slowed residential investment and put pressure on consumption through higher mortgage rates and credit costs. If oil prices push inflation slightly higher again, the Fed may become even more reluctant to reduce interest rates further. Kevin Warsh was a hawk before he wasn't. 
 
In other words, the oil shock could reinforce the Fed’s cautious stance and delay the easing of monetary policy. That would prolong the period of tight credit conditions and increase the risk that the slowdown eventually turns into a recession. Ironically, this means that the biggest macroeconomic danger today comes not from tariffs, not from supply chains, and not from the uncertainty that commentators love to invoke. It comes from the interaction between energy prices and monetary policy.
 
PS: My view has been more or less in line with the results of the Fair model forecasts. He sees a slowdown of growth and a small increase in inflation (last one was before the Iran war).