What is Schumpeter’s theory of capitalistic development through innovations?

Schumpeter’s theory of capitalistic development through innovations

Theory of Economic Development first published in 1912 and translated into English in 1934.

A brilliant conception, it has laid almost dormant because it is so broad-based that it does not lend itself to the economic model building that has been the vogue in mainstream economics for some fifty years. In the foreword to Eduard Murz’s recent study of Schumpeter, Nobel Prize winner and model builder

James Tobin comments that Schumpeter’s “theories of development and business cycles were difficult to incorporate into the style and method that came to dominate economics, especially American economics, over the past fifty years.”

Ironically, Schumpeter was a strong proponent of the greater use of mathematics in economics and econometric testing of hypotheses, the areas in which he was at a comparative disadvantage.

Schumpeter’s explanation of the process of economic growth does not fit into the orthodox mold, because he stressed the noneconomic causes of growth. Though he examined some strictly economic factors, he insisted that the principal elements in the past growth of the system and the elements that will reduce growth in the future are noneconomic.

At first it is very essential to look at his novel analysis of economic factors. He essentially accepted Say’s Law, although he recognised and analysed the fluctuations in economic activity under capitalism. To him depressions were self-correcting, and there could be no equilibrium at less than full employment.

Where Marx had seen depressions as a manifestation of the contradictions in the system that lead to its ultimate collapse, Schumpeter considered depressions beneficial to the system; they were an integral part of the entire process of economic growth.

Growth was tied to the prosperity stage of the cycle, because this phase represented the ultimate outcome of the introduction of new products and technology into the economy. But excesses develop as credit is over expanded and businesses overextend themselves.

The resulting depression is beneficial in that it shakes out the economy, removing the less efficient firms, and thereby prepares the way for a growing economy of healthy, well-managed, efficient firms.

But the principal agents of economic growth are noneconomic, according to Schumpeter, and are to be found in the institutional structure of the society.

Schumpeter attributed to the activities of what he called entrepreneurs the tremendous growth that took place in the industrialised world.

An entrepreneur to Schumpeter is not just a businessperson or manager; this person is a unique individual who is by nature a taker of risks and who introduces innovative products and new technology into the economy.

Schumpeter clearly distinguished between the process of invention and that of innovation. Only a few far- sighted innovative business persons are able to grasp the potential of a new invention and exploit it for personal gain. But their gain is the economy’s gain.

After the introduction of a successful innovation by the entrepreneur, other business persons will follow suit and the new product or technology will spread throughout the economy.

The real source of growth in the economy, therefore, is found in the activities of the innovative entrepreneur, not in the activities of the mass of the business community, who are risk- averting followers.

Therefore, economic growth is fostered by an institutional environment that rewards and encourages the activities of entrepreneurs; early capitalism, with its private property and laissez-faire government, was ideally suited to economic growth.

Insofar as it stresses the importance of incentive and laissez-faire government, this part of Schumpeter’s analysis is in theoretical and ideological accord with the classical theory of growth; but where classical theory stressed the economic factor of the size of capital accumulation, Schumpeter emphasised a noneconomic, cultural, sociological factor in his analysis of the role of the entrepreneur.

The contrast between this view of growth and that of mainstream neoclassical economics was stated succinctly by Schumpeter: Schumpeter believed that once the giant firm has eliminated many of the small, owner-operated firms, a large part of the political support for capitalism will have been removed.

The success of capitalism will destroy, moreover, the old conception of private property and the willingness to fight for it, Schumpeter contended. Once the entrepreneur is gone, the paid manager and the stockholders will no longer defend the concept of private property. Their attitude will also prevail among the working class and public at large.

“Eventually there will be nobody left who really cares to stand for it-nobody within and nobody without the precincts of the big concerns.” Again, the success of capitalism will speed this process, for the increases in income and wealth produced by capitalism will permit the growth of an intellectual group in the society who “wield the power of the spoken word” and who have “no direct responsibility for practical affairs.

“The success of capitalism will permit these intellectuals to live off the fruits of the system but, at the same time, to criticise it. They will radicalise the labour movement; although they will not usually run for public office, they will work for and advise the politician.

Occasionally they will become part of the government bureaucracy; but most important, with the ever-increasing growth of mass communication, they will be able to disseminate throughout the society a discontent with and resentment of the institutions of capitalism.