Date: Dec 6, 2019
Category: Economics Essay
Schumpeter’s Economic Views

One of the best known and most famous economists of the first half of the XX century is Joseph Alois Schumpeter (1883-1950). His theoretical heritage is extremely broad and diverse. His works The Nature and Essence of Economic Theory (1908), and History of Economic Analysis (1954) are devoted to the history and methodology of economic analysis. On the Concept of Social Value (1909) is devoted to the economic dynamics while Capitalism, Socialism and Democracy (1942) tell about the theories of social development.

Joseph Schumpeter often said that in his young years, he had three dreams: to become the best rider, the most desirable gallant, and the most outstanding economist. Although it remains unknown whether his other two dreams have come true, his contribution to economics is enormous. Nowadays, the ideas suggested by Schumpeter have spread far beyond the economic area. Today, many companies (including big corporations) successfully transform into business organizations, in which innovative solutions are approved not only by senior management. The entrepreneurial organization seeks to actualize the innovations with benefits regardless of their source. In addition, Schumpeter in his Theory of Economic Development prognosticates the emergence of entrepreneurial organizations. While Schumpeter adapts his teachings for different models of the economy, considers the introduction of private ownership, and new forms of production, his contribution appears extremely important and useful for the modern development of the economy.

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Schumpeter’s Economic Views

The problems of dynamic development of a market economic system, reasons and factors that ensure progress and economic growth are principal in Schumpeter’s system. Such a research perspective distinguishes him significantly from the representatives of all known economic schools. Schumpeter is the first person who has initiated the exploration of economic dynamics as opposed to static neoclassical analysis. Innovations, novelties, and entrepreneurship in the theory of Schumpeter play the same central role as price or free competition in the economic theory of Marshall. Schumpeter believes that the explanation of economic development is possible only by studying the dynamic laws of the commodity-capitalist economy. As a result, Schumpeter believes that the use of neoclassical analytical apparatus is insufficient. However, there is some ideological affinity with the views on the economic system’s statics and dynamics of the American school of marginalism representative – John Bates Clark. Developing Clark’s ideas, Schumpeter enriches them with new content: he clearly distinguishes between a static equilibrium system and its dynamic development that transforms the economic structure and the relationship between "new" and "old" manufacture. The scientist feels the need to combine the static theory of equilibrium with the theory of economic growth raising the equilibrium approach to a new evolutionary dynamic level.

A comprehensive study of the economic analysis history drives Schumpeter to the conclusion that the most advanced concept in the political economics of that time is Walras’ theory of general economic equilibrium. Although, he notices in it a significant drawback concerning the fact that the theory of economic equilibrium reflects the static condition of the economy and does not take into account the factors of economic processes development. Trying to overcome this limitation of Walrus’ theoretical concept, Schumpeter concentrates his research on the system development and the factors that serve as driving forces for this development. The main feature of his approach is that analyzing the causes of dynamic change, he pays attention to other manufacture factors than those traditionally considered by his forerunners. The entrepreneur whose social defining features are not the ownership but personal qualities (e.g. credibility, leadership, ambitions, ability to innovate) becomes the driving force of development in Schumpeter’s theory. The entrepreneur possessing the above-mentioned features becomes the main subject of technical progress.

The determination of different categories is connected with the determination of an entrepreneur. In particular, interest is the price paid for the acquisition of new productive forces of profit. Profit is also a reward for the entrepreneur’s activity. It is temporary and disappears when innovation is replaced by routine.

In 1942, one of Schumpeter’s most famous works, Capitalism, Socialism and Democracy - the study of the historical fortune of capitalism, was published. The author summarizes the theoretical analysis of capitalism based on qualitative changes that have occurred in the structure of bourgeois society in the first half of the XX century. In addition, the author advances the concept of self-denial and the slow death of capitalism. However, Schumpeter interpreted the essence of capitalism in a peculiar way. He believes that the principal feature of capitalism is the activity of the innovative entrepreneur - the protagonist of bourgeois economic relations who performs his/her historic function by means of money capital. Accordingly, he considers capitalism rather limited interpreting it as a classical type of private business system based on the small and medium property. The corresponding system of values reflects the nature of the Puritan individualism. With the development of the capitalist system, the accumulation of wealth and its institutionalization takes place. Along with that, in Schumpeter’s opinion, the appearance of large corporations and the increase of the state’s role in economic life are the features of capitalism’s decomposition and crisis, meaning that capitalism becomes the victim of its own success.

First of all, the function of the entrepreneur becomes extinct due to the rapid increase in the power of big business as a result of technological progress. A large corporation with highly professional management and propensity for monopoly successfully adapts to technical progress, but big business threatens the survival of the business initiative while it rationalizes and puts the innovation process on a scientific basis. According to Schumpeter, the extinction of the individual entrepreneurship due to the above-mentioned reason has a destructive effect on the capitalist system. The progressive disappearance of the entrepreneur accelerates the destruction of the bourgeoisie while the interest is paid from its profits. A new phase of capitalism is characterized by Schumpeter with the destruction of its social base under the influence of mass shareholding ownership, which destroys the individual owner who has always been the mainstay of the capitalist society.

According to Schumpeter, perfect competition is an incentive for society to minimize costs and maximally assimilate the wages to its marginal productivity. For the entrepreneur, it is an incentive to minimize costs and maximize profits. Accordingly, the profit is the result of entrepreneurial activity in terms of equal conditions. Its growth becomes the main purpose of the manufacture. Schumpeter calls this economic situation and such profit static profit and the competition ineffective while under these conditions, it cannot be guaranteed that the manufacturer will be promoted to a new level.

The economist believes that effective competition is possible only in terms of economic dynamics. This condition is provided by a qualitatively new level of production based on the continuous introduction of innovations, novelties at all levels - the technological, management and organization of production, product quality, development of new markets and raw materials. Therefore, effective competition is a competition of a new type based on innovation. It is not related to traditional pricing but means the competition in all areas. In addition, such competition opens new opportunities to improve production conditions, changes the structure of the relationship between manufacturers, the structure of supply and demand, and the conditions of the production costs and price formation. Pricing is no longer limited to the influence of supply and demand only.

The main agent of effective competition is an innovative entrepreneur while its significant condition is the monopolization of production, which makes it possible to accumulate funds for implementing innovative programs. Schumpeter admits that "any successful innovation leads to monopoly, and any monopoly promotes innovation."

As Schumpeter points out, competition in the classical form becomes impossible. Perfect competition loses its value and cannot be regarded as a model of maximum efficiency. In terms of ideal competition, the stimulus concerning the technological progress becomes very weak because the super profit from innovations is quickly eliminated by competitors that do not spend costs on development and innovation but immediately adopt them. As a result, the achieved benefits turn into losses. Additionally, large amounts of capital become increasingly required for economic development.

Monopoly

Schumpeter believes that economic efficiency in terms of a balanced state of the economy is hampered by the problem of resources and technological capabilities’ application. The ideal competition is impossible while sellers (buyers) are in unequal conditions. As a result, the win is provided by the objective conditions and is not achieved at the expense of others.

Benefits received by the manufacturer due to the exceptional situation on the market are considered monopolistic advantages. Novelties and innovations give the most significant results while they provide the entrepreneurs with a breakthrough both in pricing and market coverage.

However, Schumpeter argues that monopoly does not exist in its pure form considering it a temporary phenomenon. He believes that oligopoly (associative groups of competitors) is more important for the market and economy in general. Although other economists explore oligopoly as well, only Schumpeter claims that it facilitates technical progress.

The Economic Balance

Schumpeter emphasizes that a dynamic state of the economy prevents the equilibration effect of competition. On the contrary, effective competition leads to imbalance, economic restructuring, and jump in the development of the productive forces.

Schumpeter’s theory of innovations has created an opportunity to conform to such phenomena as free competition and monopoly, which were regarded earlier as economic situations that exclude one another. Schumpeter introduces the concept of competition outside the trading world and market relations. However, Schumpeter emphasizes the existence of such a phenomenon as the evolution of economic dynamics when there is no place for ideal competition as it is replaced by an alternative form - imperfect competition.

The scientist acknowledges that his interpretation of the competition goes beyond the analysis of the market and is not addressed to solve the problem of market equilibrium. The theory of effective competition describes the common causes of cyclical development but does not explain the internal laws of the market mechanism’s functioning.

However, such competition cannot be explained in terms of traditional forms (perfect or imperfect competition), Schumpeter’s model of effective competition fits Chamberlin’s monopolistic model of competition regarded as an attempt to differentiate the product or manufacture.

 

Schumpeter’s Theory of Economic Development

The main thesis of the book The Theory of Economic Development (1912) is the concept of dynamics developed by Schumpeter and defined by the author the following way: “Within the economic system, there is a source of energy that causes imbalance. If it so, there should be a purely economic theory of economic development that relies not only on external factors that cause movement of the economic system from one equilibrium state to another.” This is the theory he has tried to develop. Industrial revolutions periodically change the existing system of manufacture causing a constant desire for innovation.

Schumpeter distinguishes five types of innovations:

  • the production of essentially innovative goods and services;
  • the use of new equipment and technology that provides new methods of production and transportation;
  • the conquest of new markets for products;
  • improving the resource base by opening new sources of raw materials;
  • the formation of a new industrial organization - the introduction of more sustainable forms of production and management organization and management.

As a result of the application of discoveries, inventions, and innovations, the system withdraws from the state of equilibrium in order to strive for this state in the future, however, on another level of the technical base. Therefore, old products and previous forms of organization are replaced provoking a process of "creative destruction."

The central issue for Schumpeter concerns the ability of capitalism to permanently delete old elements and update economic structures through the so-called "creative destruction", which was previously investigated by the researchers of the economic cycle only. The state of equilibrium is considered the starting point of the economic system. Internal processes and new combinations of inputs that lead to innovation serve as the source of development. The balance is disrupted by the actions of the innovative entrepreneur. Schumpeter differentiates two possible ways of how to remove inputs from old combinations and attract to new, potentially more productive combinations:

  • Team authority;
  • Credit (for the market economy).

Joseph Schumpeter, as well as his economic views, is paradoxical: everything his predecessors considered destabilizing factors - monopoly, economic cycles, and competition - the scientist presents as the factors that accelerate progress. Schumpeter believes that destructive competition, the struggle for spheres of influence, restrictive business practices of firms that lead to excessive spending (advertising costs, acquisition of patents, creating excess capacity) make it possible to mitigate temporary difficulties. However, they do not inhibit but rather stimulate a long-term process of enlargement.

  

In addition, Schumpeter’s teachings are unorthodox primarily because he refuses from the frames of neoclassical comparative statics and from the conventional model of perfect competition, which leads to balance and destroys profits in favor of a dynamic approach. The defining Schumpeter’s hypothesis is the assertion that the entrepreneur whose work is motivated by profit is an innovator. While Walras’ tradition of market balance the considerations of business have no special significance, Schumpeter’s entrepreneur creates the conditions for profit himself/herself revolutionizing industrial backwardness.

Schumpeter is the first economist who introduces the terms "innovation" and "novelty" and connects them with the pace of economic development. On the microeconomic level, the innovations provide profit and are implemented through the strategy of active participation in the innovation process. On the macroeconomic level, the distribution of innovations affects the overall economic growth and, therefore, is principal for understanding cyclical fluctuations.

Schumpeter’s work Capitalism, Socialism and Democracy had considerable success in many countries. In the book that is a result of nearly 40 years of reasoning, Schumpeter admits that he has been trying to prove the position that there are no economic reasons that prevent capitalism from moving to a new stage.

Being one of the most outstanding economists and sociologists, Joseph Schumpeter left an unforgettable mark on the historic field of his era. According to his studies, the foundation of capitalism is in the classical type of private system based on the small and medium property. Schumpeter claims that the reason for the economic crisis is associated with the termination of the economic boom highlighting the psychological motive as a principal one to explain this economic phenomenon. From all the forms of capital, Schumpeter recognizes the only monetary form. His contribution to the development of the modern economy is evident while his teachings are adapted to various models of economy and are being successfully applied.