Pablo
Paniagua
May 28, 2012
Professor
Schumpeter was an Austrian-Hungarian Economist and Political Scientist, born February
8th, 1883 in what is now known as the Czech Republic. He came into
this world at the very beginning of the most exciting entrepreneurial-based
society: the capitalist and innovative society of the XX century.
Schumpeter started
his academic life studying law at the University of Vienna, where he also
obtained his PhD in 1906. The Law School of Vienna University was under the
Austrian-Hungarian Empire control. At the time, this was considered one of the
most important studying centers in the world, alongside Stockholm University
(where Knut Wicksell studied) and Cambridge (Keynes). Since Economics was not yet a widespread
degree, the Law School of Vienna was the closest thing in Central Europe
offering a comprehensive and profound study of Economics.
It was actually at
the University of Vienna where the Austrian School of Economics was started. By
Schumpeter’s time, it was on its second generation of Austrian School of
Economics already active, with professors Eugen von Böhm-Bawerk and the founder of the Austrian School,
Professor Carl Menger (already retired at the time). They were among the most
influential scholars and important economic thinkers of Central Europe. This
was the effervescent environment in which Schumpeter was first introduced to
Economics, forever changing his mindset. Although we cannot consider
Schumpeter’s work as actual orthodox Austrian Economics, his early writings and
market economy view with its adaption mechanisms have deep Austrian and
Mengerian roots. Therefore he is sometimes considered part of the third
generation of Austrian Economists, along with Professor Ludwig Von Mises.
Before WWII,
Schumpeter moved to the United States after being invited by Harvard University
in 1939, where he lectured for several years. His lectures where not very
popular or easy to follow since his views clashed with the fashionable economic
thinking at the time: Keynesianism. But this did give Schumpeter a small
prestige among Harvard colleagues during those years.
Professor
Schumpeter, as Hayek defined: “had the biggest intellectual adaptability, which
helped him always to quickly accommodate current intellectual fashions.” This
assisted him throughout his life in the U.S. to adapt to current economic
thinking and it was there which he decided that economic studies should take a mathematical approach. That decision was considerably
influenced during his early student life by the hard mathematics of Leon
Walras; this guided Schumpeter to be one of the founders of the Econometric
Society, serving as its president 1940-1941.
However, Schumpeter
was not a mathematician and had no profound mathematical background. He
therefore adopted a more eclectic approach towards economic analysis,
introducing a sociological understanding of economic theories (much more in
line with his mentors from the Austrian School). This novel approach of seeing economic models
led Professor Schumpeter to be a pioneer in several economic theories and ideas
that were beyond any practical mathematical representation. He is considered
relevant for founding and dispersing many theories in the United States, such
as: the business cycle theory (originally Austrian and Russian) and Economic
Development through innovation and growth. He concentrated his ideas mainly on
entrepreneurship and risk-taking business. Schumpeter’s groundbreaking works
and theoretical foundation were very well received in the U.S., largely because
he truly captured the entrepreneurship and innovation-driven growth of American
society. This is why Professor Schumpeter is considered one of the greatest
economists of our times.
Throughout his
professional life, Schumpeter defined innovation
in several ways: the creation of a new good or new quality of a good, the
creation of novel methods of production, the opening or discovery of new
markets to sell your goods, the capture and restructure of new sources of
supply, and a new organization of the chain of production and a reorganization
of the factors of production. Innovation therefore is an essential activity for
entrepreneurs.
He established that
innovation did not need any new or special kind of knowledge; he believed that
innovation may appear when existing knowledge has not yet been utilized in
different industries. According to Schumpeter,
“There never has been anytime when the store of
scientific knowledge has yielded all it could in the way of industrial
improvement, and, on the other hand, it is not the knowledge that matters, but
the successful solution of the task sui generis of putting and untried method
into practice….there may be, and often is, no scientific novelty involved at
all, and even if it be involved, this does not make any difference to the
nature of the process.”
Therefore innovation
is an act of will and not intellect; it deeply depends on leadership and
risk-taking activities and much less on intelligence.
Schumpeter’s
Most Relevant Works
History of
Economic Analysis
In
addition to all the economic theories that Schumpeter developed throughout his
life, he was also considered one of the most knowledgeable scholars on economic
history and the development of economic thought; therefore he wrote the History of Economic Analysis, which was
posthumously published. Professor Hayek called this book one of the finest ever
made in the field of history of economic thought. The book is an extensive
review of the history of Economics through a Schumpeterian point of view (very
personally biased). In the book, Professor Schumpeter established that the
greatest 18th century economist was Turgot and not Adam Smith.
Schumpeter was also very critical about Keynes, whom he said relied too much on
reasoning through abstract models.
The Business
Cycle Theory
The
Schumpeterian idea of the business cycle is rooted and primarily based in the
static view of the economy defined by Leon Walras. He was the 19th
century French economist who created the basic and well known “Walrasian
Equilibrium,” which elegantly explained a mathematical formula of the
theoretical and ideal equilibrium set in markets. Schumpeter built off of this
equilibrium but believed it was overly simplistic, therefore he added
theoretical complexity: he applied a dynamic approach and the introduction of
disequilibrium through entrepreneurship and innovation. He introduced the
Austrian notion of constant disequilibrium in his model on a real market-based
economy; disequilibrium and constant adjustment of spontaneous coordination are
the constant in the market, not equilibrium.
The stationary state
of the economy in a Walrasian world is also known as the “circular flow.” Under this set of thought, we exclude innovation
and risk-taking entrepreneurship in the economy. This system has a reciprocal
circulation of income between producers and consumers. Producers provide goods
and services in exchange of the consumer’s “factors of production” (their labor
hours). This creates a very stable and never ending monotonous flow, but it
lacks innovation and is missing sudden creations of goods and services, which
both positively disrupt the economy. This interruption, according to Schumpeter’s
insight, is the leading path to an exponential and sustainable growth for
societies. In Schumpeter’s perspective, the Walrasian Equilibrium is therefore
not the way to societal growth and wealth creation. Something was missing in
the big picture, therefore Professor Schumpeter added the hero of our story: the entrepreneur.
It is the
entrepreneur, and no other, who disrupts the monotonous equilibrium of the
economy and who is the prime cause of economic development and increases
societal wellness. Therefore innovation and development are disturbances in the
Walrasian circular flow. However, this disruption of the formerly established
equilibrium leads to both a highly unstable growth phase and a volatile market
for competitive industries. This led Professor Schumpeter to believe in the
market system’s inherent instability and the problems of these disruptions. He
also understood the risk of massive entrepreneurial failure as a threat anda
potential flaw of Capitalism itself; this pushed him to conclude that economic
cycles are endogenous in our economic system.
He suggested that in
a capitalist system, these problems are the very core of the money flow, which
is the credit to entrepreneurs; Professor Minsky later enriched this view in
the XXI century. With the incorporation of several entrepreneurs in the
economy, along with the growing extension of credit, the system develops a
rapid economic boom or expansion. At the same time, this massive incorporation
of entrepreneurs to a single industry will create excessive competition and
eventually some will fail. This creates a negative economic shock, severely
dampening the system. Schumpeter also suggested that a system which relies on
spontaneous innovation will have periods in which entrepreneurial success is
less likely, leading to stagnation or recessions (when massive entrepreneurial
miscalculations happen). This is the cycle’s dual face and the twin entity of
entrepreneurial disruption and innovation. The name is not quite accurate since
‘cycles’ give the idea of time dependence and a pattern of sorts; a more
accurate term may be ‘economic fluctuations.’
Capitalism,
Socialism and Democracy
This work
was Professor Schumpeter’s most popular one in English. In this book, he is
sympathetic to Marx’s view that Capitalism will eventually fail, leading to a
form of Socialism. However Schumpeter believed that this change in the economic
system will not happen in the way that Marx predicted; Schumpeter envisioned
the fall of Capitalism could be described with one of his more famous terms, “creative destruction.”
Creative
destruction means that the economic organization’s old ways will be
endogenously destroyed and replaced with new ways of order from within.
According to his view, this will happen with Capitalism. Schumpeter’s idea of
Capitalism’s evolution is that it endogenously will transform itself into a
form of large, programmed Corporatism
that will slowly erode small entrepreneurship’s values. Therefore in an
advanced capitalist stage, we will see mainly big companies with little space
for small entrepreneurs to convey their business ideas. Consequently there will
be no space for entrepreneurial values in the common society and the system
will then be replaced by some form of Socialism. He argued that Capitalism's
collapse from within will come about as democratic majorities vote for
restrictions upon entrepreneurship, burdening and destroying the capitalist
structure and values.
In this book,
Schumpeter also enlightens us with a very novel perspective of Democracy.
Following Max Weber’s view, he establishes that democratic systems are no more
than mere mechanisms of competition among leaders, very similar to a
competitive capitalist market structure.
It is true that the public democratic vote legitimizes governments but
the policy programs of different parties are, in the end, their own programs
and not the plan of the entire spontaneous society. So in this way, individual
participation and liberties are severely reduced.
Schumpeter in
Today’s World
Considering all the
incredible contributions that Professor Schumpeter brought to Economics and
Social Politics, he is nowadays mostly associated with the expression ‘creative
destruction’ and the relevance of innovation and entrepreneurship in keeping companies
and economies competitive. His ideas are currently thriving more in Management
rather than in Economics. He was one of the pioneers who believed that most
technological changes and sustainable growth must come from Unternehmergeist, the German expression for entrepreneur-spirit. He also believed that this incredible
source of innovation should come from large companies that should encourage
innovation from within in order to survive in a competitive global environment.
Schumpeter simultaneously
argued that technological innovation often creates temporary monopolies and
allows uncharacteristic profits. He realized that these temporary monopolies
were unfortunately necessary in order to provide the incentive required for
large firms to continue developing new products and production processes in the
long-term.
Overall Schumpeter
is still obviously influential and very much indeed fashionable. He was the
economist that profoundly understood the fundamental spirit of innovation and
risk-taking business, which is at the very core of American values. It is what
keeps granting U.S. supremacy in business success; just think about Apple as a
XXI century living example of Schumpeter’s ideas.
This spirit was further carried on in 2009 when The Economist inaugurated a column on business, management
and innovation named "Schumpeter."
The publication has a history of naming columns after significant figures or
symbols in the field. The initial Schumpeter column praised him as a
"champion of innovation and entrepreneurship whose writing showed an
understanding of the benefits and dangers of business that proved far ahead of
its time.”
* Edited by Victoria Finn
Selected Works:
1912. The Theory of
Economic Development. Leipzig: Duncker and Humblot. Translated by R. Opie. Cambridge: Harvard
University Press, 1934. Reprint. New York: Oxford University Press, 1961.
1939. Business Cycles.
2 vols. New York: McGraw-Hill.
1942. Capitalism, Socialism and Democracy. New York: Harper and
Brothers. 5th ed. London: George Allen
and Unwin, 1976.
1951. Ten Great Economists. New York: Oxford University Press.
1954. History of Economic Analysis. Edited by E. Boody. New York:
Oxford University Press.
Professor Schumpeter’s photograph, Harvard University, 1940.
