In his 1942 book, Capitalism, Socialism and Democracy, Joseph Schumpeter asked the essential question: “Can capitalism survive?” His unsettling answer was, “No. I do not think it can.” Schumpeter’s words were in no way meant to denigrate capitalism, instead he felt “its very success undermines the social institutions which protect it.”

History in many ways proved his views prophetic. The success of capitalism means that many are allowed to do things that have nothing to do with productivity. And from government and academic elites that frequently seek to undermine the very system that enabled their cushy jobs, to foundations created by capitalist profits that often dismiss same, the commercial success wrought by the pursuit of profit has created an unproductive elite that lives off the very business profits that it regularly casts a skeptical eye on.

Schumpeter was of course talking about a United States that he envisioned post World War II, but his fears then don’t stray too far from the concerns of many today. Indeed, he worried that as wars usually accrue to the power of the state, that heavy government spending “would likely evolve into total government control over investment.” So far we’ve got the stratospheric spending to the tune of a $3.6 trillion budget, and from planned investment in everything from green energy to mortgage securities to autos, it seems that the alleged good that comes with government largesse will morph into the bad of government-directed investment.

On the business front, Schumpeter envisioned what would essentially be a two-tier system in which the government would largely stay out of the doings of retailers, laborers and clerks, all the while nationalizing what some call the “big business” parts of the economy. So while the hapless Fed Chairman Bernanke not long ago suggested that bank nationalization would not materialize, a few days later the federal government took an 80 percent ownership stake in Citigroup, the largest bank in the United States.

Federal investment in Citi and other supposed beneficiaries of TARP money was supposed to be passive, but as the New York Times reported last week, the financial institutions that took TARP funds are now being told by their federal minders to among other things “put off evictions and modify mortgages for distressed homeowners”, slash dividends, and cancel job offers made to individuals lacking a U.S. birth certificate.

Before Citigroup’s nationalization the U.S. economy had already been whacked by the nationalization of AIG, once the largest insurer in the world. And as is well known now, the federal government’s supposed compassion toward AIG had little to do with saving it, and a lot to do with aiding the banks whose risk was insured by AIG. So while Goldman Sachs protested that it didn’t need TARP funds, it’s increasingly apparent that GS and others were the beneficiaries of an AIG bailout that insures greater control from the Commanding Heights over bank and investment bank activities.

Schumpeter saw the investment banker as “the capitalist par excellence” for providing capital to entrepreneurs, but in our new economy the investment banker will have to please the political class first, and in ways that likely mean the disruptive entrepreneur will find it difficult to access capital. If war is the health of the state, then economic crises are its oxygen, and Washington has used what should have been a minor financial hiccup and turned it into an opportunity to greatly expand its footprint.

Schumpeter correctly saw Washington as usually the place for lesser minds. Along those lines, the previous administration “blessed” us with our current Fed Chairman, which means that the man who blinked with regard to Bear Stearns, and as such, helped author our financial problems, will now oversee “tougher capital requirements for big banks, limits on investments by money-market funds, and the introduction of some mechanism that would allow the U.S. to wind down big financial institutions” and “possibly run them temporarily.”

The irony of a government that fostered our financial destruction overseeing its resuscitation has seemingly never troubled Bernanke, so now the very regulations that failed so impressively when it came to rooting out previous financial mistakes will be expanded. What’s rarely asked is how the very people who achieve stature through something called “pay grades” could ever successfully regulate those who make millions by gaming those same regulations and regulators.

Once this is considered, it has to be remembered that a bigger regulatory state simply insures that there will be more big failures, and more Bernie Madoffs to contend with. Regulations, rather than a deterrent when it comes to nefarious activity, actually encourage it for the existence of rules that sharper minds in the private sector will always work around. Regulations merely tell those eager to cheat or take excessive risks what they’ll have to comply with while cheating and taking excessive risks.

Better it would be if Bernanke et al were to acknowledge how tragically unequal they are to the task of outsmarting private sector minds. If so, if the regulatory state shows an appealing modesty with regard to its shortcomings, it can be assured that private individuals, with money on the line, will do for themselves what Washington has never been able to do. Future Madoffs will be caught long before they can grow big enough to cause international scandals.

And while he was talking about the New Deal, Schumpeter was very troubled by a widespread prejudice against business, one in which private wealth was under a “moral ban” alongside public antagonism that would “make it impossible to accumulate venture capital.” Today we have politicians scrutinizing bonuses up and down Wall Street, all the while talking up increased taxes on work and investment engaged in by the “rich.” Simplified, politicians will seek to redistribute wealth away from the vital few, and into the hands of what some deem the “working classes.” Marx and Engels observed in the Communist Manifesto that “A heavy progressive or graduated income tax” was a certain way for the proletariat to seize power, and its apparent Washington will try to make taxes even more progressive.

All of the above should be remembered the next time overly sanguine economists talk about economic recovery that’s either here, or just around the corner. Indeed, unless the laws of economics have significantly changed, any supposed recovery will be a certain shadow of previous ones seared in our memory. The federal government has greatly expanded its role in the economy, and as such, future activity will have a flaccid quality if history is any kind of indicator.

Schumpeter may have been early in his suggestion that socialism would win out over capitalism, but this in no way detracts from his visionary predictions. In much the way that he foresaw, we’re on a slow march toward socialism; one that insures a more austere future for rich and poor alike.