Joseph Alois Schumpeter

7.4.1. Equilibrium and development

Schumpeter (1883-1950) was a great admirer of Walras’s work but, as Keynes with Marshall, he was hindered rather than helped by his master’s work.

Schumpeter considered the Walrasian model of general economic equi­librium as the greatest achievement of nineteenth-century economic science, the culminating point of a strand of research started in the eighteenth century by Quesnay. In Schumpeter’s view, the general-equilibrium model aimed at studying the conditions that allow a system made up of independent economic agents to reproduce itself through time. He defined these condi­tions in terms of the ‘circular flow’ of exchanges which are established among economic agents when the choices and behaviour of each are compatible with those of all the others. The equilibrium conditions, when they are realized, allow the economic system to reproduce itself by maintaining its own structure unaltered. In this way, the Walrasian model of general eco­nomic equilibrium was reinterpreted as a stationary-equilibrium model.

The stationary equilibrium is reached by the operation of ‘traditional economic agents’, agents who behave in an adaptive and routine way. On the other hand, rational economic agents can follow this type of behaviour only if the economy actually moves around a stationary-equilibrium path, a situation in which there are no relevant endogenous changes.

The real dynamics of the capitalist system is generated by the behaviour of a type of agent different from the traditional ones: the ‘innovator entre­preneur’. He aims at making profits, and therefore cannot exist in a system in which ‘neither profits nor losses’ are admitted. The entrepreneur differs from the company manager in that he aims at introducing new combinations of productive factors into the productive process, while the manager simply endeavours to organize the factors efficiently on the basis of the possibilities offered by the given techniques. Thus the manager’s income is a functional income, like the worker’s, and is positive in a stationary equilibrium. The entrepreneur’s income, instead, arises from a break in the stationary equi­librium. Profit is created by the difference between revenues and costs, and is a residual income activated by innovation. It originates, for example, from the possibility of introducing a new productive method which allows the production of a given good at lower cost than the competitors, or from the possibility of exploiting a new market, a new product, a new source of raw materials, or a new organizational method before the competitors. Therefore this income, which is in fact a monopoly rent, is of a temporary nature. Competition will induce, sooner or later, the diffusion of innovations and, with it, the gradual elimination of the entrepreneur’s differential earnings. At the end of the diffusion process—in which the imitator entrepreneur is at work—the economy will again approach equilibrium, the rate of growth in productivity and production will stop, and firms will again make ‘neither profits nor losses’. The temporary advantages arising from the innovation have gone to the entrepreneur, but society has drawn a permanent advantage from the innovation in the form of a reduction of prices or an increase in the range of products available.

A conception of the competitive process emerges from this theory which is totally different from the neoclassical one. Schumpeter found little interest in the traditional theory of atomistic and static competition. He denied the importance of the idea that there are markets characterized by a large number of competitors, and also opposed the idea that agents aim at max­imizing profits in the short run by taking prices as parameters and techno­logy as given. In the real world, Schumpeter argued, competition occurs within markets in which, usually, a few large firms operate. Each tries to make profits, not statically, by choosing the quantity to produce under the con­straints represented by the available technology at a given moment, but dynamically, by choosing an innovative long-run strategy. It is not by accepting the technological constraints, but by breaking them, that firms compete with each other. The competitive process is one of ‘creative destruction’—as Schumpeter called it—a process that triggers economic growth by continually destroying the old while creating the new.

Of course this theory does not refer to an abstract ‘market economy’; rather, it takes the capitalist economic system as its own subject of study. This means that Schumpeter is closer to the classical economists and Marx than to the neoclassical economists and Walras. And, just like Marx, Schumpeter did not limit himself to defining capitalism historically, but also tried to study its structural transformations in an evolutionary way: on the one hand, the phases of its development and, on the other, the conditions for its transformation into something else.

He argued that the evolution of capitalism was marked by two great epochs: ‘competitive capitalism’ and ‘trustified capitalism’.

A problem which worried Schumpeter was this: who carries out the entrepreneurial function in trustified capitalism? To the extent to which technical progress originates in the research and development departments of large firms, the capitalist who owns the capital and the entrepreneur­innovator capitalist are no longer the same person. Innovation increasingly becomes a concern of employees and managers, if not even of research teams. In this way the bourgeois class, which had initiated the process of modern social transformation by risking its own wealth, tends to disappear, along with its ethical and political values. On the other hand, with the emergence of other social classes and values, there is the tendency to legitimize political conceptions that justify State intervention both in productive activity and in the distribution of income. In this way, while the impulse towards individualistic accumulation of capital weakens, the social drive towards the construction of an economic organization based on central planning is reinforced.

7.4.2. The trade cycle and money

Economic growth, according to Schumpeter, does not take place through time in a regular way, but through cyclical fluctuations. Or, rather, it is precisely the cyclical movement that is the regular evolutionary form of the capitalist economy. The main reason for this is that innovations tend to appear in clusters in determinate periods. These clusters of innovations, by breaking the stationary equilibrium, trigger the development process.

The main theoretical problem of this model is this: why should innova­tions tend to distribute themselves unevenly over time, if inventions are distributed randomly? The solution suggested by Schumpeter is not very convincing, yet still attractive. The introduction of innovations entails breaking down strong social and psychological resistance from the tradi­tional agents. This resistance means that the inventions are not immediately transformed into innovations, but remain, we could say, inert for a while. In this way a potential of unexploited innovations mounts up. Nevertheless, once part of the resistance has been overcome or weakened by some major innovative actions, it becomes easier for the other entrepreneurs to avoid being slowed down by the resistance. Thus many other innovations follow suit, like a swarm: one or a few make the breakthrough and all the others crowd in behind, and the innovative potential is off-loaded all at the same time.

Schumpeter believed that the duration of the cycles basically depends on the type of capital goods in which technical progress is incorporated, but it is not quite clear if the factor of periodicity is related to the duration of the capital goods or to the time necessary for the diffusion of the innovations to be completed.

An interesting feature of Schumpeter’s theory of the business cycle con­cerns the monetary factors of economic dynamics. The central problem of a growing capitalist economy is that of financing innovative investments. Entrepreneurs who wish to exploit an innovation do not, generally, have the finance necessary to do so. Finance comes from profits, but innovations only produce profit after they have been activated, which is often quite a long time afterwards. Therefore, credit is necessary. The banking system does not limit itself to redistributing the savings from the savers to the users. The banks, with credit, create new money, i.e. they produce new purchasing power, liquidity added to the existing stock of money; and it is this added liquidity which allows entrepreneurs to finance innovations and society to increase the stock of capital. In real terms, credit produces a sort of forced savings. In fact, it allows entrepreneurs to appropriate tangible resources they have not produced, and, by means of inflation, forces traditional agents to give up part of the resources they have produced. Thus, credit serves to transfer resources from consumption to investment and from less productive to more productive investments.

On the other hand, it is precisely this greater productivity of innovative investments that explains the rate of interest, which, for the banks, is the selling price of credit, while, for the entrepreneurs, it is the cost of finance. Therefore it is a monetary variable. Its existence is made possible by the existence of profits. In fact, only if there are profits are the entrepreneurs prepared to pay interest. This is why Schumpeter thought that the rate of interest had to be zero in an economy in stationary equilibrium. And this is why he was sceptical about those neoclassical theories that try to explain the interest rate in terms of a certain equilibrium relationship between the (psy­chological) sacrifice inherent in the act of saving and the advantage derived from its productive use.