Schumpeter’s Economic Theories: Innovation, Cycles, and Capitalism’s Future

Posted on Nov 28, 2024 in Social sciences

Joseph Alois Schumpeter (1883-1950)

Born in Austria, Schumpeter was one of the most prestigious economists of the twentieth century. He combined teaching with his work as a lawyer and banker, and also held political responsibilities as finance minister. His most important works are: Theory of Economic Development and Business Cycles. Schumpeter, like Marx, perceived that economic reality is only part of total reality. In Capitalism, Socialism, and Democracy, he contributed to the understanding of economic phenomena, especially sociological ones, reaching the conclusion: “the success of capitalism will lead it to suffer greater difficulties,” a phenomenon observable today in the globalization process. Recession and recovery phases are processes of adaptation; expansion and depression phases are deviations from equilibrium resulting from innovation or speculation.

Theory of Economic Development

Schumpeter noted that development refers to changes in economic life that originate internally, not externally. Economic growth accompanying population and wealth growth is not a development problem but an adaptation process that doesn’t produce qualitative changes. For Schumpeter, innovation is the productive use of an invention. There are five types of innovation:

  1. Introduction of new goods.
  2. New production processes.
  3. Opening of new markets.
  4. New sources of raw materials.
  5. New organizational structures.

To innovate, entrepreneurs must overcome these difficulties:

  1. Uncertainty.
  2. Instinctive rejection of novelty.
  3. Company strength for innovation.

The purpose of business is to introduce innovation and profit. We distinguish these phases of capitalist development:

  1. Competitive capitalism: characterized by small and medium-sized enterprises and a broader market.
  2. Monopoly capitalism: characterized by large companies capable of fueling the innovative process with their resources.

Competition and Monopoly

Schumpeter understood that innovative activity tends to create “near monopoly” positions, which stimulate further innovation. In Capitalism, Socialism, and Democracy, he softened his earlier views from Theory of Economic Development, stating that “the existence of monopoly positions does not exclude competition.” The competitive struggle focuses on the introduction of innovations, often resembling perfect competition.

Process of Economic Development

Economic development, driven by entrepreneurial activity, occurs cyclically. It has two phases:

  1. Boom phase: Initially driven by innovation, it results in increased demand for production factors and rising prices. To meet increasing demand, the economy tries to increase production. Trust is generated, facilitating credit from the banking system. General euphoria is heightened by speculation, leading to accelerated expansion.
  2. Recession phase: After a while, the innovation process and speculative boom are absorbed by the economy. Increased supply surpasses purchasing power, leading to unsold goods. Early innovators pay their debts while falling prices reduce profits. This process causes bankruptcies of companies that joined the innovative process later or did not innovate.

Schumpeter distinguishes three types of cycles:

  1. Kondratrieff long waves: lasting between 54 and 60 years.
  2. Juglar cycles: lasting between 9 and 10 years.
  3. Kitchin cycles: lasting about 40 months.

Future of Capitalism

Schumpeter argued that capitalism was doomed due to periodic crises and profound social change. Unlike Karl Marx, he claimed the reasons for the crisis were sociological, not economic. The end of capitalism would occur for these reasons:

  1. The obsolescence of the entrepreneurial function, as capitalist progress makes innovative activity less uncertain and more routine.
  2. The economic decline of employers ends their business function and that of the bourgeoisie. The development of society increasingly criticizes private property.
  3. Capitalism produces a social atmosphere that generates policies impeding the system’s functioning.

These factors make the collapse of capitalism inevitable, leading to the emergence of another system where control of the means of production is returned to a central authority. This “Schumpeterian” socialist order differs from proposals by other authors.