Joseph Schumpeter
gigatos | June 22, 2022
Summary
Joseph Alois Schumpeter (Trest, Moravia, February 8, 1883-Taconic, Salisbury, January 8, 1950) was a prominent Austro-American economist, Minister of Finance in Austria (1919-1920). He studied at the University of Vienna and was a disciple of Eugen Böhm von Bawerk and Friedrich von Wieser. He taught economics for years at the universities of Vienna, Czernowitz (now Chernovtsi, Ukraine), Graz and Bonn from 1909. He settled in the United States in 1932 and was a professor at Harvard University until his death in 1950.
He was noted for his research on the business cycle and for his theories on the vital importance of the entrepreneur, emphasizing his role in the innovation that determines the rise and fall of prosperity. He popularized the concept of creative destruction as a way of describing the process of transformation that accompanies innovations. He predicted the socio-political disintegration of capitalism, which, according to him, would destroy itself due to its own success.
Schumpeter was born in 1883 in Trest (Moravia, now belonging to the Czech Republic) was the only son of the Catholic, German-Moravian cloth manufacturer Joseph Alois Karl Schumpeter († January 14, 1887 there) and his wife Johanna, née Grüner († June 22, 1926 in Vienna). Trest (Moravia), which at that time belonged to the western half of the Austro-Hungarian monarchy. After the early death of his father, the 5-year-old moved to Graz with his 27-year-old mother in 1888 so that he could attend a quality public school. Here his future stepfather Sigismund von Kélersden was a lieutenant field marshal in the army.
So that Joseph could continue his studies at the monarchy”s best educational institution, the family moved to Vienna in 1893 and Schumpeter was accepted at the Theresianum. In 1901 he left the Theresianum with a very good degree and immediately began to study economics at the University of Vienna, which at that time was only possible as part of a law degree. Schumpeter studied with Friedrich von Wieser and Eugen von Philippovich and from 1904 with Eugen Böhm von Bawerk. Among his fellow students were Ludwig von Mises, Emil Lederer, Felix Somary, Otto Bauer and Rudolf Hilferding. In this way he became familiar not only with the methodological dispute between Carl Menger and Gustav von Schmoller, but also with the Böhm-Bawerk controversy.
In the summer of 1905, Schumpeter began the Rigorosum in legal history and political science until early 1906 and received his Ph.D. in February 1906 as a doctor of law. He then attended Schmoller”s seminar in Berlin and spent a year as a research student at the London School of Economics and the universities of Oxford and Cambridge. At the end of 1907 he married Gladys Ricarde Seaver, daughter of a high dignitary of the Anglican Church.
In 1907, Schumpeter practiced at the International Court of Justice in Cairo, where he wrote his methodological work The Essence and Main Content of Theoretical Economics, published in 1908. In October he submitted it to the Faculty of Political Science of the University of Vienna as a qualifying thesis to become a professor in 1909.
The following autumn he became an associate professor at the University of Chernivtsi, at that time the capital of Bukovina, and wrote there the Theory of Economic Development.
In 1911 he returned to Graz as full professor of political economy at Karl-Franzens University; he became the youngest university professor in the monarchy. The appointment in Graz came against the bitter resistance of Richard Hildebrand (son of the better known Bruno Hildebrand), who, as a representative of historicism, was against any economic theory. Only two years after his appointment, Schumpeter went to Columbia University in New York as an exchange professor for a year. There he personally met Irving Fisher, Frank W. Taussig and Wesley Clair Mitchell. His wife refused to return to Graz with him, so Schumpeter considered the marriage over. In the academic year 1916
From 1916 onwards, Schumpeter launched several political initiatives to end the World War, including rapprochement with Emperor Karl I. He warned against a customs union with Germany and instead campaigned for the maintenance of multinational monarchy, directed against the rise of individual nationalisms. In the winter of 1918
On March 15, 1919, although politically independent, he became Austrian State Secretary for Finance in the government of Renner II. He quickly came into dispute with the two coalition parties, the Social Democrats and the Social Christians, but also with his former fellow student Otto Bauer, now State Secretary for Foreign Affairs, especially over the connection to Germany or the sale of the steel company Alpine Montan AG to Fiat. On October 17, 1919, by decision of the National Assembly, the government was replaced by the cabinet of Renner III, in which Schumpeter was no longer a member.
His main contribution is the cyclical and irregular conception of capitalist development, elaborated in 1911 in his Theorie der wirtschaftlichen Entwicklung (”Theory of Economic Development”) while he was teaching in Czernowitz (present-day Chernivtsi, Ukraine). In it, he presents his theory of the “entrepreneurial spirit” (Unternehmergeist), typical of entrepreneurs, who create technical and financial innovations in a competitive environment in which they must assume continuous risks and receive benefits that are not always sustained over time. All these elements are involved in irregular economic growth.
After serving as Austrian Minister of Economics after World War I, after which he was dismissed, and after heading the Biederman Bank, he held several university professorships, including Harvard. In this last period of teaching he completed three more books: Business Cycles (1939), Capitalism, Socialism and Democracy (1942) and his History of Economic Analysis (published posthumously in 1954). In the first two he focused on his theory of “entrepreneurship”, developing it in a more global scope and integrating it into a cyclical theory of business, and on the socio-economic evolution of contemporary capitalism.
In 1921 Schumpeter applied in Graz for his leave of absence from his professorship and became president of “Biedermann & Co. Bankaktiengesellschaft”. He took out loans, invested the money and lived an elaborate and sophisticated lifestyle in Vienna. However, the economic crisis of 1924 brought this to an abrupt end; he lost his fortune and his position. In this disastrous situation, Arthur Spiethoff, a professor at the University of Bonn, managed to win Schumpeter for the local chair of economic and political science in October 1925. Students of the Bonn period include Hans Wolfgang Singer, Cläre Tisch, Wolfgang F. Stolper, Herbert Zassenhaus and August Lösch. In 1925 he married Anna Josefina Reisinger, twenty years his junior and the daughter of the concierge of his mother”s house. On August 3, 1926 she died giving birth to their first child; the boy also did not survive the birth. His mother had already died in June. Schumpeter should no longer fully recover from these blows of fate. He devoted himself to scientific work and in 1926 presented a second, revised version of the theory. He also made his position clear, partly emphasized in the article The Instability of Capitalism (The Economic Journal, 1928). Competitive capitalism in the form of entrepreneurship is increasingly being replaced by a defensive capitalism in which the personality and initiative of the entrepreneur are less important. In the presidential address to the American Economic Association in 1949, he speaks of a “march toward socialism.” However, in contrast to the well-known Marxist prognosis, he understands this to be a progressive process which he by no means welcomes politically.
He did not complete the work he had planned on monetary theory after Keynes published the Treatise on Money in 1930. From the fall of 1927 to the spring of 1928 and toward the end of 1930 he was a visiting professor in the Department of Economics at Harvard University. Together with Ragnar Frisch, he co-founded the Econometric Society; for several years he was a member of its board of directors and was its president in 1940.
He accepted the call to Harvard University in 1932 and moved to the United States in September, where he lived in the Taussig house until he married Elizabeth Boody Firuski in the summer of 1937. In 1933, Schumpeter was elected a member of the American Academy of Arts and Sciences. His success as a teacher was based on students such as Paul A. Samuelson, James Tobin, Richard Musgrave, Abram Bergson, Richard M. Goodwin, Erich Schneider, Paul Sweezy, Eduard März, and John Kenneth Galbraith. At his suggestion, a course on “Mathematical Economic Theory” was introduced, which he himself maintained until it was taken over by his friend Wassily Leontief. The renewed fame, which Keynes gained at Harvard after the publication of The General Theory of Employment, Interest and Money in 1936, was not at all shared by Schumpeter, who openly expressed in his disapproving criticism.
In 1939 he presented the two-volume analysis of business cycles, in which Schumpeter re-presented his conception of the capitalist economic process, in particular the interaction of overlapping cycles. The latter view was strongly criticized by Simon Kuznets in 1940. He then considered going to Yale, because of his refusal to hire Samuelson as a professor, but was finally persuaded to stay at Harvard. The core of his work Capitalism, Socialism and Democracy, published in 1942, is a theory of democracy that uses patterns of economic thought in the analysis of the political process. This idea is later carried forward in the “New Political Economy” or “Economic Theory of Politics” (Anthony Downs) and is considered one of the foundations of democratic socialism.
He married three times, his first wife being Gladys Ricarde Seaver, an Englishwoman almost 12 years his senior (married 1907, separated 1913, divorced 1925). The best man at his wedding was his friend and Austrian jurist Hans Kelsen. His second was Anna Reisinger, twenty years his junior and the daughter of the concierge of the tenement in which he grew up. They married in 1925, but a year after their marriage, she died in childbirth. The loss of his wife and newborn son came only weeks after Schumpeter”s mother had died. In 1937, Schumpeter married American economic historian Elizabeth Boody, who helped him popularize his work and edited what became his magnum opus, the posthumously published History of Economic Analysis.
He died at his home in Taconic, Connecticut, at the age of 66, on the evening of January 7, 1950.
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General theory of capitalism
Schumpeter”s work, from his Theory of Economic Development (1911) onwards, makes sense from a dynamic way of conceiving the capitalist system that contrasts with the models of traditional neoclassical economics. For Schumpeter, capitalism is by nature a form or method of economic change, and can never remain stationary. His aspiration was to create a theory that could explain the functioning of this economic change, which in such a short period of time has profoundly revolutionized human existence. He used to call the process by which capitalism constantly revolutionizes its own conditions of existence the “gale of creative destruction.
Schumpeter starts from a fundamental distinction between different types of economic change. On the one hand, there are exogenous changes, caused by social or political factors. On the other hand, there are those of an endogenous nature, which arise from the economic dynamics of the capitalist system itself. It is only the latter that constitute economic development as such, and which are the subject of his theory.
Another important distinction is that between growth and economic development: “Nor will the mere growth of the economy be called a development process here, for it does not represent qualitatively different phenomena”. For it does not represent qualitatively different phenomena”. His attention is therefore directed towards growth processes that are related to the introduction of qualitative novelties, which alter the very functioning of the system:
Development, in our sense, is a characteristic phenomenon totally different from what can be observed in the circular current or in the tendency to equilibrium. It is a spontaneous and discontinuous change in the channels of the current, alterations of the equilibrium that displace forever the previously existing state of equilibrium. Our theory of development is but the study of this phenomenon and its accompanying processes.
According to Schumpeter, simple incremental or cumulative growth may well be explained within the framework of traditional neoclassical theory. However, it is not sustained and regular growth of an additive character that constitutes the true nature of capitalism. By its essence, capitalism is discontinuity, alteration, novelty, constant reduction of all parameters to variables. For this reason, our author considers the neoclassical theoretical construction as insufficient or even, in certain cases, disorienting.
Real capitalism is characterized by processes that constantly make perfect competition impossible, based, among other things, on the transparency of the system, i.e., on free and immediate information, and on free entry to all productive spheres. These facts are certainly recognized in neoclassical theory, but they are treated as imperfections that negatively affect the efficiency of the price system and, thus, the efficiency of the distribution of productive resources. For Schumpeter, on the contrary, it is not a question of imperfections that will lead to a non-optimal use of resources, but of the very engine that drives the exceptional technological-productive progress that distinguishes the capitalist system:
The introduction of new methods of production and new commodities could hardly be conceived in a situation of perfect – and perfectly immediate – competition from the outset. And this means that most of what we call economic progress is incompatible with it. In this respect, perfect competition is not only impossible but inferior and has no right to be held up as a model of ideal efficiency.
According to Schumpeter, economic development or progress is totally dependent on the possibility of establishing temporary monopoly positions and receiving, for a time, what he calls “quasi-rents” or “quasi-monopoly rents”. The monopoly position is only temporary and will be lost as a result of the diffusion of knowledge, the disappearance of eventual legal protection of inventions, and so on. These rents or “profits of the entrepreneur” are the only ones that Schumpeter defines as “profit” and must be clearly differentiated from the normal remunerations of the factors of production. In a system in equilibrium, which Schumpeter calls kreislauf (“circular flow”), there is no profit. It arises only thanks to the “destabilizing” activities of entrepreneurs, by means of which they manage to decisively lower their production costs or introduce new goods. These activities are defined by the concept of innovation and include new products, new methods, new forms of business organization, new markets and new sources of raw materials.
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Entrepreneurs
The possibility of generating profits, which can be exceptionally large, is the lure that attracts to economic activity a particular type of individual, governed by an “entrepreneurial spirit” (Unternehmergeist). The will to transform existing conditions, to overcome obstacles and break with routines, to go against the current and create new things, characterizes these Schumpeterian entrepreneurs, heroes of the capitalist era who dare to launch themselves into the unknown.
Entrepreneurs are not in themselves ordinary managers or administrators of a company, nor are they technicians, but men who, acting intuitively – in a situation of uncertainty, without all the cards in their hands – put new economic possibilities into practice:
… the role of entrepreneurs is to reform or revolutionize the ways of production by putting into use an invention or, more generally, an as yet untried technological possibility of producing a new good or producing a known good in a new way: by opening a new source of supply of raw materials or a new market, reorganizing the company, and so on. Acting with confidence beyond the horizon of the known and overcoming the resistance of the environment requires skills that are present in only a small fraction of the population and that define both the type and function of the entrepreneur.
Schumpeter”s theory of the entrepreneur underlines various psychological aspects and denies, although it may seem contradictory to what has been said above, that the behavior of the entrepreneur can be understood as an action whose ultimate motive is profit itself, the simple desire to accumulate money or wealth. Obtaining large profits is but the way to establish and prove the success of the entrepreneur”s creative action. For Schumpeter, the case of the entrepreneur is but a specific form of the phenomenon of leadership in general and must be studied within that framework. This is, by the way, a highly debated part of Schumpeter”s theory. Among his fiercest critics are those who, inspired by Marx, see the development of capitalism as an impersonal process, where individuals count for little and the entrepreneur acts only as “the personification of economic categories”, as a mask of capital, the bearer of a logic that imposes itself independently of individual subjectivities.
The Schumpeterian entrepreneur is, from the point of view of capitalist economic rationality, a scarcely rational figure. This character, however, is conceived as the driving force behind the emergence of “capitalist civilization”. He is the fundamental impulse for its emergence, but he does not really belong to that civilization. Schumpeter, influenced by Max Weber, defines capitalist civilization as “rationalist and anti-heroic”, and therefore not very compatible with such a romantic character as the one represented by the entrepreneur.
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Theory of economic cycles
The conception of capitalism as a system that generates qualitative changes is not a characteristic unique to Schumpeter”s thought. In this sense, Schumpeter merely repeats, however different his arguments may be, already classical ideas. What most distinguishes his thought is the idea that the development characteristic of capitalism is not evenly distributed over time. In his view, what is characteristic of capitalist economic development is its uneven rhythm, its discontinuous and undulating form, both in the short and in the long term. This is the part of Schumpeterian theory that has been most debated and influential, and defines modern Schumpeterianism as such. It is the theory of the business cycle in general and of the long waves or Kondratiev cycles in particular.
The explanation given by Schumpeter for this special rhythmicity of the capitalist system is a consequence of his theory of the entrepreneur and innovations. If it is true that the innovative action of the entrepreneur explains economic development in general, then it is pertinent to seek the explanation of its irregularities in the uneven distribution over time of entrepreneurial and therefore innovative activity. And this is precisely what Schumpeter does. His explanation is as follows: “Why does economic development not proceed, in our sense, with the same regularity with which trees grow, but in leaps and bounds? Why does it present these characteristic ups and downs? Exclusively because the new combinations are not distributed equally in time, as might be supposed by the general principles of probability, but if they appear, they do so discontinuously, in groups or flocks”.
The problem to be solved is then the reason or motive for this discontinuity in the temporal distribution of innovative activity. This point, which is key to the Schumpeterian theory of economic cycles, is “solved” with a simplicity that does not fail to surprise: “Why do entrepreneurs not appear continuously, i.e. individually, in each appropriately chosen interval, but in groups? Exclusively because the appearance of one or more entrepreneurs facilitates the appearance of others, and these in turn facilitate the appearance of new groups, each time in greater and greater numbers”.
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The role of innovation
The simplicity and inadequacy of Schumpeter”s answer is not surprising inasmuch as the absence of a real explanation for the appearance of groups or flocks of entrepreneurs (without discussing the empirical reality of this assertion) had already been brought to his attention since the appearance of the German edition of the Theory of Economic Development. To say that a flock of entrepreneurs is formed because one or more precursors appear to open the way is simply to shift the problem. Some years after Schumpeter”s death, Vernon Ruttan was able to see that, despite Schumpeter”s extensive output from 1911 onwards, there remained a major gap in his theoretical construction:
Neither in Business Cycles nor in Schumpeter”s other works is there anything that can be identified as a theory of innovation. The business cycle in Schumpeter is a direct consequence of the emergence of innovations in clusters. But no real explanation is provided as to why innovations appear in clusters or why these clusters possess this particular type of periodicity.
The above point is central since for Schumpeter, as Ruttan suggests, both the existence and the periodicity of the business cycle are governed by the rhythmicity of the innovative process. According to Schumpeter this rhythmicity operates in the following general way. One or more forerunners lead the way, then, through the “imitation effect” just described, more and more entrepreneurs emerge. In this way, “flocks of entrepreneurs” or, in practice, “flocks of innovations” are formed. The equilibrium situation, the circular flow, then gives way to a strong upward movement. The flock of innovations gives rise to vast sources of profit. The boom produces an increasingly fierce struggle for credit, means of production and labor. Prices rise and the margins of economic survival shrink for many. Old businesses, dominated by routine, are forced to transform or disappear.
At last the Schumpeterian entrepreneurs emerge with the victory but only to discover that their triumph has been only “apparent”. What had previously been an innovation has now become the norm; it has become part of the new technological, organizational and commercial common sense. The spread of the new methods, the mass production of the new goods, the widespread access to the new sources of raw materials and to the new markets, and the reorganization of most of the enterprises make the situation “normal” again. Profit disappears and the Schumpeterian entrepreneurs, the innovators, are transformed into normal company managers, administrators of a territory already conquered. The system (or the industrial branch) thus enters a new period of equilibrium or depression as Schumpeter also calls it in his Theory of Economic Development:
… the appearance in groups demands a special and characteristic process of absorption, of incorporation of the new things and adaptation to them on the part of the economic system; a process of liquidation or, as I used to say before, a process of approaching a new static situation. This process is the essence of the periodic depressions which can, therefore, be defined from our point of view as the struggle of the economic system to reach a new position of equilibrium, or its adaptation to the data altered by the disturbance produced by the expansion.
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Types of economic cycle
Schumpeter distinguishes three types of economic cycles, which he identifies as Kitchin cycles (40 months), Juglar cycles (10 years) and Kondratiev cycles (60 years). The latter are the most important, occurring as a result of “first-degree” innovations that transform the very foundations of the economic system. This gives rise to long waves of development lasting between 45 and 60 years. The waves comprise an ascending phase, or period of creative disruption, and a “descending” phase, or the domain of the tendency to equilibrium.
These main phases can, although not strictly necessary from a theoretical point of view, be completed by a phase of acute depression or crisis and another of recovery. These long ascending S-shaped waves were called by Schumpeter Kondratiev cycles, in honor of the Russian economist Nikolai Kondratiev, who was the first to attempt to prove empirically the existence of these waves. The innovations that give rise to the long waves of economic development have also been called by Schumpeter, to emphasize their enormous significance, as “industrial revolutions”. Thus, each long wave is made up of one
industrial revolution and the absorption of its effects. For example, we can observe empirically and historically the emergence of one of these long waves towards the end of the 1780s, its culmination around 1800, its fall and then a sort of recovery that ends in the early 1840s. That was the Industrial Revolution so beloved of textbook authors. Hot on its heels came, however, another of these revolutions, producing another long wave that arose in the 1940s, culminated just before 1857 and disappeared around 1897, to be followed in turn by the one that reached its zenith around 1911 and is now on its way to disappear.
As Schumpeter himself has pointed out, the choice of his three-cycle scheme is nevertheless a matter of convenience, a simplification of a complex reality that theoretically admits infinite cycles and avoids the expectation of an exact periodicity. Business Cycles, which is Schumpeter”s major work on the subject, can be cited to elucidate this aspect:
For our purpose, as well as for many others, it would be very inconvenient to leave things at the above point and try to work with an indefinite number of cycles or types of cycles We therefore decide now, for the general purposes of this volume, to content ourselves with three classes of cycles which we shall call simply Kondratiev, Juglar, and Kitchin This choice just made of three classes of cycles has no special virtue. Five might perhaps be better, but after some experimentation the author has come to the conclusion that the improvement in description thus obtained would not compensate for the increased difficulties. In particular it cannot be emphasized strongly enough that the three-cycle scheme does not follow from our model – although the multiplicity of cycles does – and that accepting or objecting to it neither detracts from nor adds to the value of our fundamental idea.
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The future of capitalism
The supposed existence of this singular contradiction between the calculating spirit of developed capitalism and the chivalrous attitude of entrepreneurs is fundamental to understanding Schumpeter”s resolute pessimism about capitalism”s chances of survival in the long run. R. Heilbroner has summarized Schumpeter”s problem or dilemma as follows:
… capitalism had all the glitter and excitement of a knightly tournament. But therein lay the problem. Tournaments require a sufficiently romantic atmosphere, and in the dull, prosaic and calculating atmosphere that the company bosses themselves cultivated, the old forerunner spirit of capitalism could not survive. For Schumpeter capitalism could retain its strength only to the extent that capitalists behaved like forerunners and knights-errant, and that type was dying out. Worse, he was being annihilated by the civilization he himself had created.
It is not by its failure but by its success that capitalism would be threatening the existence of its own driving force. The adventurous, daring and visionary attitude that was necessary to create material wealth never seen before would thus end up becoming superfluous once that level of wealth was reached. In his last great work, Capitalism, Socialism and Democracy (1942), he thus posed the problem:
This social function is already losing its importance today. innovation itself is being reduced to a routine. Technological progress is increasingly becoming a matter of groups of specialists who produce what is asked of them and perform their work in a predictable manner. The romanticism of the old business adventures is rapidly disappearing. Thus, economic progress becomes depersonalized and automated. The action of individuals tends to be replaced by the work of committees and departments.
This was undoubtedly one of the most questionable forecasts of the great Austro-Hungarian economist, which even led him to postulate that his own theory of capitalist development was out of date. His pessimism reflected the routine and hierarchical tendency of large U.S. corporations. The same ones that decades later would be hit by the gale of creative destruction of new batches of entrepreneurs linked to information technologies and microelectronics.
The “Schumpeterian school” is the name given to the group of economists and economic historians who work on the idea that capitalist development is characterized by the recurrence of long-term structural cycles or long waves whose existence is related to fundamental technological changes. This type of analysis has gained particular strength since the crisis of the 1970s that put an end to the long period of exceptional economic growth that followed World War II. During that time an atmosphere of such optimism prevailed that there was little room left for a theory that, like Schumpeter”s, spoke of the necessary advent of less brilliant times. The illusion was created that Keynesian-inspired macroeconomic manipulation had made depressions and crises a problem of the past. However, the 1970s showed what illusions were worth and vindicated Schumpeter. Exactly 45 years after the crash of 1929, in 1974, a new phase of widespread convulsions and recessionary tendencies began. After that, Schumpeter”s disciples have had no difficulty in finding receptive ears for his arguments about long waves. This receptivity has increased considerably in recent years, marked by the great international crisis that began in 2007-2008.
Among the most prominent Schumpeterians are Christopher Freeman (1921-2010), Giovanni Dosi, John Bates Clark, Carlota Perez and Luc Soete, all of them related in one way or another to the University of Sussex in Great Britain. In Germany we can name Gerhard Mensch, in Holland Jacob J. van Duijn and in Sweden Erik Dahmén (1916-2005) and Lennart Schön. In the United States, Richard Nelson and Sidney Winter stand out. Yoshihiro Kogane is one of its best known exponents in Japan. Ernest Mandel (1923-1995) was its most prominent representative among Marxists.
Much of the efforts of Schumpeter”s disciples, as before those of Kondratiev himself, have been oriented to empirically prove the existence of long waves and to specify their exact evolution. These attempts cannot be considered as conclusive, although they have increased the plausibility and thus the heuristic value of this way of understanding and ordering the history of modern capitalism.
Beyond the attempts to demonstrate the empirical existence of long waves, the “Schumpeterians” have focused mainly on two problems: The first is that of trying to better understand the emergence, character and role of innovations, especially in relation to Kondratiev cycles. The second is to investigate the relationship between the long waves of technological-economic development and the movement of the rest of the social structure.
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