Note: some of the ideas in this post have been absorbed from my various
readings on the subject over time and retrieved from my folder under S.
Not being an academic economists, I apologize for not providing a
detailed bibliography and notes. Schumpeter has been dead for 49 years,
his ideas are really in the public domain. My interest in economics is
its potential usefulness and not proprietay authorship and if any reader
feel the need to identify specific ideas to a particular economist, he
would be welcome to so so. Again I apologize for my sloppy personal
research methodolgy. This post represents what I understand of what
many have said; I claim no originality in economic thought. I am a
consumer, not a producer of eocomic theory.
---- Henry C.K. Liu
Having been proven wrong by recent events on Hayekian claims on the
inherent efficiencies of free markets, neo-liberalism now drops Hayek
and parades Schumpeter and his creative destruction as the new banner of
ideology as truth. The term has been used in recent days by Greensapan
and a whole chorus of policy makers to expain the US economy as the
remaining pocket of properity in the a world left in ruins by free
market globalization.
Schumpeter conceptualizes long waves as disturbances in the equilibrium
of an economic system, the exhaustion of these disturbances, and an
eventual return to equilibrium. It is this repeated return to a state of
equilibrium, and not the repeatability of the wave form, which gives
long waves their cyclical character.
Schumpeter designates this equilibrium state as "the circular flow of
economic life" or the "stationary flow". This state refers to a
condition comparable to simple reproduction and characterized by an
absence of any change or development. But Schumpeter is also explicit
that this "stationary flow" is only a theoretical norm, not a real state
of affairs: it serves as a reference point from which to define
phenomena such as overproduction, excess capacity, and unemployment.
"These terms, as commonly used, do not carry any precise meaning at
all, and the fact that they do not explains the inconclusiveness of much
argument that goes under these headings. As soon as we find such precise
meanings for them and to fit them for the task of identifying definite
states of an economic organism, the necessity of falling back on
equilibrium relations becomes apparent".
In actuality, economic systems never achieve equilibrium. At best, they
move into what Schumpeter calls "neighborhoods of equilibrium...in which
the system approaches a state which would, if reached, fulfill
equilibrium
conditions".
All economic systems have a fundamental tendency towards equilibrium
within their separate given levels of free exchange and automatically
move toward these neighborhoods after the disruptions caused by factors
of change have exhausted themselves. For his theory of long waves, the
most important characteristic of these neighborhoods of equilibrium is
that economic conditions are relatively stable and this permits what he
calls "tolerably reliable calculations" about the future. As a result,
the risks associated with engaging in new activities are at their
lowest.
In his general model, Schumpeter suggests that all cycles depart from
these neighborhoods of equilibrium. When he introduces the notion of
several simultaneous cycles, he relaxes the assumption that the shorter
cycles begin from equilibrium in the strict sense of the term - "the
sweep of the longer waves provides the neighborhood of equilibrium for
the waves of the next lowest order." In other words, neighborhoods of
equilibrium, in the strict sense, are only associated with long waves
when "all cycles pass their normals".
Economic development is the result of many factors: external factors
such as demand by government for new weapons and/or social justice;
factors of gradual changes in socio-economic life and "the outstanding
fact in the economic history of capitalist society" - innovation. For
Schumpeter, innovation is the chief force in what he calls "economic
evolution."
Economic evolution is however discontinuous and takes the form of long
waves because of a discontinuity in the introduction of major
innovations into the economic system.
While the importance of innovation in Schumpeter's thought is well
known, less attention has been paid to what Schumpeter meant by
innovation.
It appears that Schumpeter's concept of innovation is both `broader' and
`narrower' than is generally assumed by what are considered his most
direct disciples, Neo-Schumpeterians or innovation theorists.
Schumpeter's concept is broader because, unlike innovation theorists, he
does not restrict the concept of innovation to the patenting or
commercialization of new inventions. In addition to these activities,
Schumpeter includes other activities such as "new combinations" in
organization,
commerce, and the market, e.g., the opening of new markets, the
discovery of new sources of raw material and supplies, and improved
handling and transport of materials and goods, as well as the creation
of new business organizations such as department stores, cartels and
monopolies.
The aspect is dearly embraced by neo-liberalism with regard to finance
caoitalism and globalization.
Schumpeter's concept of innovation is `narrower' because he stresses
that innovation per se, i.e., simply as new ideas or new combinations,
is not a force in economic development. Rather the true force in
economic development is the consequences of these innovation: 1. ) the
construction of new plants and the rebuilding of old plants "requiring,
non-negligible time and outlay," 2) new firms which are founded for the
purpose of capitalizing on specific innovations, and (3) the rise to
leadership of new men (Schumpeter 1964, 68-71). These consequences make
innovations a
force in economic evolution and innovations which do not produce these
consequences, which do not, in other words, produce other changes in the
"stationary flow" would not and could not be a force in the economic
development of a society.
Economic evolution begins when an entrepreneur of exceptional ability -
"the conductor"- introduces, in the above sense, an innovation. This
enables the individual to make monopolistic profits and stimulates the
borrowing of capital in order to increase the investment.
The activity of the first entrepreneur also smoothes the path for other
entrepreneurs to introduce innovations in associated or related fields.
This "swarming of entrepreneurs" is financed through credit creation,
which Schumpeter calls, "the monetary complement of innovation." Credit
permits these firms to `bid away' factors of production from older
non-innovating firms. This produces a rise in prices and a
general economic expansion which characterizes the first phase of
Schumpeter's four phase model, Prosperity.
This describes globaliztion of the last 2 decades.
Prosperity peaks, i.e., reaches its upper turning point, for several
reasons. Unable to compete with successful new firms, older
non-innovating firms and unsuccessful new firms suffer losses. New
investments are halted because the economy is disrupted and it becomes
impossible to make reliable calculations about the future. The
possibilities offered by the current cluster of innovations are
exhausted. Interest rates rise. The subsequent downturn is the second
phase of the cycle - Recession.
The decline of Recession continues however, past equilibrium in a
secondary wave which Schumpeter attributes to "errors, excess of
optimism and pessimism. ...
Reckless, fraudulent and otherwise unsuccessful enterprises created in
the optimism of expansion cannot stand the test administered by
Recession"
(Schumpeter 1964). They are liquidated. These liquidations, in turn,
undermine the debt structure which begins to "crumble" and this causes a
"panic." Deposits shrink and credit tightens even further. Firms which
would have been able to withstand the contraction had it not resulted in
panic are liquidated in what Schumpeter calls `abnormal'
liquidations and among other enterprises there is "a shrinkage of
operations that reduces them, quite erratically, below their equilibrium
levels".
This is eseentially a description of the Asian financial crisis that
began in July 1997 and that since has spread its "contagion" through
Russia and Brazil, with the EU next and eventually the US.
For Schumpeter, these abnormal liquidations and the `excess' shrinkage
of enterprises mark the third phase of the cycle - Depression.
Depression continues until all unsuccessful and excess investments are
liquidated. Once this point is reached (and it is by no means
automatic), a movement towards a new "neighborhood of equilibrium" is
initiated. This movement is the fourth phase of the cycle - Revival.
What throws Schumpeter's neat economic theory off is that before the
revival phase, soico-political instability will occur to choke of the
revival phase, as is likely to occur in SE Asian and Russia.
Schumpeter emphasizes that every cycle is "a historical individual and
not merely an arbitrary unit created by the observer". Hence, the
periodization of long waves can only be from the neighborhood of
equilibrium preceding Prosperity to the neighborhood of equilibrium
following Revival. This is an important clue to Schumpeter's
understanding of causality and stands in marked contrast to innovation
theorists who search for the `causes' of the next prosperity in the
unsettled times of depression.
For Schumpeter, long waves are formally similar but differ substantially
in their result. Each long wave is a break with the past and the
economic system which emerges in the Revival phase is qualitatively
different from the economic system of the Prosperity phase of the same
cycle. In other words, long waves are not merely passing distortions or
`imperfections' in the economic system. Instead, the innovations which
propel each long wave produce real qualitative changes in the
economic system.
[The] historic and irreversible changes in the way of doing things
we call "innovation" and we define: innovations are changes in
production
functions which cannot be decomposed into infinitesimal steps. Add as
many
mail coaches as you please, you can never get a railroad by so
doing...The kind of wave-like movement, which we call the business
cycle, is incident to industrial change and would be impossible in an
economic world displaying nothing except unchanging repetition of the
productive and consumptive process.
Schumpeter therefore identifies three specific long waves and their
corresponding innovations: the Industrial Revolution Kondratieff, 1787
to 1842, (cotton, textiles, iron, and steam power); the Bourgeois
Kondratieff, 1842 to 1897, (railroads); and the Neo-Mercantilist
Kondratieff, 1897 to ?, (electrification, motorization, and chemical
industries).
In his first major work, the Theory of Economic Development, Schumpeter
wrote:
Social facts are the result of human conduct, economic facts result
from economic conduct and the latter may be defined as conduct directed
towards the acquisition of goods ... through production and exchange.
The
field of economic facts is first of all delimited by economic conduct.
Had he been alive now he might has added the Golbalization Kondratieff,
1971 (Bretton Wood death)-2000?
Schumpeter's emphasis on actors and conduct, as opposed to economic
facts, has several important, yet unexplored, ramifications for his
theory of long waves.
First and foremost, innovation, for Schumpeter, is not an "economic
facts" but rather, a type of conduct. This explains the earlier
observations about both the `breadth' and `narrowness' of Schumpeter's
concept of innovation. Its breadth is due to the fact
that, as a type of conduct, innovation can take many forms. Innovation
is not merely the commercial exploitation of new inventions and
technology but rather the conduct, i.e., the forms of activity and the
modalities of action, which makes this possible.
Moreover, because innovation is first and foremost a conduct and
therefore not necessarily tied to any specific context or field of
action (such as that defined by technology and new inventions), this
conduct can occur in almost all arenas of social life. Its `narrowness'
is due to the fact innovation can only have an impact on an economic
system if it engenders other, related forms of conduct such as the
construction or modernization of new plants, or the founding of new
firms.
For Schumpeter, an adequate explanation of economic phenomena is not
simply explaining one economic fact, namely the conduct of innovation,
as the result of other economic factors. Instead, an adequate
explanation consists
in finding a definite causal relation between two phenomena ... if
the one which plays the causal role is non-economic. If, on the other
hand,the causal factor is economic in nature, we must continue our
explanatory effort until we ground on the "non economic" bottom. Always
we are concerned with describing the general form of causal links that
connect the economic with the non-economic (Schumpeter).
Already it is apparent that for Schumpeter long waves can not, in the
strict sense, be caused by the clustering of innovation - the clustering
of innovation, an economic fact, does not represent the ""non-economic"
bottom." The clustering of innovations, (actually, the clustering of
innovative conduct) explains the dynamics of the cycle and
its duration, but to explain this clustering it is necessary to move
even further "backwards" into the non-economic. Hence, the `mere'
clustering of innovations is not, in terms of Schumpeter's requirements
for an adequate explanation of economic phenomena, the cause of the long
wave.
For Schumpeter, causality must be sought at level of motives. Motives
are the residual factor and an adequate explanation of the causes of
economic phenomena must link economic conduct to motives. Thus, for
Schumpeter, the real cause of long waves lies at the level of what
motivates the entrepreneur to undertake his or her special and unique
form of conduct, innovation.
Although entrepreneurs possesses an ability to effect this conduct and
this ability is continuously present, the conduct occurs
discontinuously. Entrepreneurs are not, in other words, always
`galvanized' to innovate. Thus, to explain what causes a clustering of
innovations it is necessary to explain what galvanizes entrepreneur to
his/her sui generis form of conduct. These factors can be accounted but
the actual individual subjective meanings underlying the innovative
activity of individual entrepreneurs, can not. In other words,
entrepreneurs may innovate for reasons of love, hate, greed, revolution,
etc., but these remain unknown. At most, links can be established
between factors which spark or galvanize the entrepreneur and the
consequences of this motivation, i.e., innovative conduct. The actual
motives are the "non-economic" bottom and once the analysis has reached
this level, causality has, for Schumpeter, been explained.
According to Schumpeter, entrepreneurs are galvanized into action under
the following conditions: [1] the existence of new possibilities more
advantageous from the private standpoint - a necessary condition; [2]
limited access to these possibilities because of personal qualifications
and external circumstances, and [3] an economic situation which allows
tolerably reliable calculations. To the above, a further condition may
be added to account for the swarming of entrepreneurs - (4) the
smoothing of the way by the first entrepreneur.
Joseph Schumpeter, the Austrian economist of world acclaim, taught at
Harvard University for nearly twenty years. Born in Moravia in 1883, he
raised the specialized scope of economics to interdisciplinary,
political, historical and social dimensions. His theories, characterized
by his open-minded approach and his desire to integrate a variety of
impulses from different cultural milieus, scientific areas and
disciplines, are even more relevant today, as Eastern Europe begins to
experiment with capitalism.
Schumpeter recognized the vital importance of entrepreneurs in business.
He emphasized the entrepreneur's role in stimulating investment and
innovation, which determine the rise and ebb of prosperity. The
distinction between statics and dynamics was essential to his account of
capitalism - certain periods approximating to equilibrium, and other
exhibiting considerable change.
His analysis of business cycles started from this point and
distinguished the types and behaviour of cycles. The posthumous
History... shows a prodigious grasp of the literature of economics. In
this, as in his major book Capitalism, Socialism and Democracy, he
relates economic phenomena and ideas to a wider context of social
analysis. The latter, whilst rejecting the Marxian analysis, still
envisages capitalism as moving by its own internal forces towards
Schumpeter's vision of a socialist society.
He held a permanent faculty appointment at Harvard University in 1932.
Schumpeter's theories emphasized the role of the entrepreneur in
stimulating investment and innovation, thereby causing creative
destruction.
Creative destruction occurs when innovation makes old ideas and
technologies obsolete. Schumpeter also predicted that capitalism would
be undermined eventually by its own success because it would create a
class of intellectuals who would attack it. Are they on this list?
Laissez faire came to be perceived as promoting monopoly rather than
competition and as contributing to boom-and-bust economic cycles, and by
the mid-20th cent. the principle of state noninterference in economic
affairs had generally been discarded. Nevertheless, laissez faire, with
its emphasis shifted from the value of competition to that of profit and
individual initiative, remains a bulwark of conservative political
thought, influential in the 1980s in such government administrations as
that of REAGAN/THATCHER.
What is amzing and disappointing is that Clinton/Rubin/Greenspan are
also buying into it wholesale and in the process, pushing the world into
an enduring economic abyss.
Henry C.K. Liu
>From Forbes:
WITH THE DISMEMBERMENT of
the Soviet empire, the retreat of
socialism and the spread of global
capitalism, Karl Marx is out.
Joseph Schumpeter, so often
praised in Forbes but for long
ignored by the rest of the media,
is now in. Published in the year
of Schumpeter's death (1950), his
Capitalism, Socialism and
Democracy unfolds like a play.
Act I describes and extols the
dynamism of capitalism. "Unlike
other economic systems, the
capitalist system is geared to
incessant change...," he wrote.
"This process of Creative
Destruction is the essential fact
about capitalism." It keeps the
system healthy by weeding out
the weak businesses, nourishing
the strong ones and thereby
raising living standards by
promoting efficiency and
innovation. The capitalist society
Schumpeter projects is not a
comfortable or easy place, but it
is the best means for lifting the
masses of the people out of
poverty.
In Act II, Schumpeter introduces
portents of tragedy when he
argues that capitalism's success
sows the seeds of its own
destruction. Societies become so
rich that they can support a
growing class of chatterers who,
feeling slighted by the success of
the entrepreneur and dismayed
by the growing satisfaction of the
masses, seek to undermine the
system. What the entrepreneur
creates, Schumpeter warns,
left-leaning intellectuals can
destroy.
In Western Europe, alas,
Schumpeter's Act II seems to be
unfolding on schedule. The
chatterers, their message
reinforced by the inevitable
turmoil caused by Schumpeter's
"creative destruction," are having
their way. France, a country that
has resisted capitalism and
embraced the welfare state more
aggressively than most other
European countries, has
stagnated since the mid-1970s.
The portion of the working-age
population that is employed has
dropped from 65% to 59%. And
the private sector's share of total
employment has steadily
withered from 56% in the
mid-1970s to only 49% today. In
consequence, France is on the
brink of bankruptcy and
international irrelevance. The
other welfare states of Western
Europe aren't far behind.
President Chirac and
Chancellor Kohl
refused to be fitted out
with jeans, cowboy hats
and boots.
If his fellow liberals in Europe
haven't gotten the message,
however, the ever opportunistic
Bill Clinton has. At the June G-7
Summit in Denver, Clinton said,
"America's economy is the
healthiest in a generation and
the strongest in the world." His
aides passed out charts depicting
vigorous U.S. growth and job
creation, compared with the
dismal performances in Europe.
This did not go down well.
President Chirac and Chancellor
Kohl refused to be fitted out with
jeans, cowboy hats and boots for
one of the Denver banquets.
They were damned if they were
going to be seeming to endorse
America's "Wild West" capitalism.
If the rest of the world is moving
toward capitalism, they want to
stop the world so they can get
off.
Lest we become complacent
about the final triumph of
capitalism, we should pay
attention to Western Europe's
stubborn resistance to
Schumpeterian doctrine. The
summer 1997 issue of the
respected journal Foreign Policy
contained a piece titled "The
Crash of Civilization: the Limits of
the Market and Democracy." It
was penned by none other than
Jacques Attali, the Pico della
Mirandola of French intellectuals
and celebrated adviser to French
politicos.
Attali waxed eloquent about the
alleged dark side of capitalism.
What Schumpeter calls creative
destruction, Attali calls
dehumanizing.Listen to this:
Unless the U.S. "begins to
recognize the shortcomings of the
market economy and democracy,
Western Civilization will gradually
disintegrate and eventually
self-destruct." Right here in the
U.S., George Soros, that
speculator with intellectual
pretensions, has been uttering a
similar message.
Some of this Attali-Soros
chattering can be chalked up to
old-fashioned America-bashing.
But be careful: Joseph
Schumpeter predicted that the
anticapitalist chattering
classes—who, let us not forget,
dominate the media—would bring
the system down, despite its very
obvious successes. He might yet
be right—at least in Western
Europe.
Excerpt from a technologist:
This process is what
the famous economic historian Joseph Schumpeter called
the "creative destruction" that characterizes a
market-driven, capitalist economic system. Like everyone
else in the technology area, I have always been on the
lookout for the next new innovation that would fuel the
growth of the company that could bring it to market. What I
didn't appreciate, until I stumbled across this thread and
followed the comments for several months, is that the flip
side of most long opportunities was the opportunity to
short--Schumpeter's creative destruction at work. This is
obviously old hat to traders--witness Roger's comment that
he didn't care whether the market went up or down, so
long as he could continue to trade. But to an economist,
watching--and participating--in creative destruction
provides new insights into the functioning of markets
generally. Many thanks to all for the thread!
**************************************************************************
Capitalism's creative ability, Schumpeter argued, is only half of its
success story. Just as capitalism builds up new modes of production, so
too does it perform the less popular but equally necessary task of
eliminating and disbanding obsolete industries.
Schumpeter termed this the "creative destruction" of the free market:
The opening up of new markets, foreign or domestic, and the
organizational development from the craft shop and factory to such
concerns as U.S. Steel illustrate the same process of industrial
mutation - if I may use that biological term - that incessantly
revolutionizes the economic structure from within, incessantly
destroying
the old one, incessantly creating a new one. This process of Creative
Destruction is the essential fact about capitalism.
Schumpeter therefore has a compelling explanation for why economic
progress under capitalism has been so dramatic. Most historical economic
systems, from feudalism to mercantilism to socialism, cement economic
power in the hands of a self-satisfied orthodoxy. Statist economies
deliberately shield producers from change; the surest path to success is
to gain the favor of the government, rather than the favor of a
clientele. In contrast, laissez-faire capitalism strips established
interests of governmental protection, and throws the economic contest
wide open. While this theoretical ideal has never been fully
implemented, the facts strongly support Schumpeter's interpretation; in
relatively unregulated economies, industry leaders frequently lose their
dominance while competitors forge ahead. Thus, after Henry Ford
virtually created the modern automobile industry, he was displaced by
General
Motors; some years later, American auto-makers desperately sought
governmental protection from Japanese competitors that suddenly
threatened their entrenched position. While other firms hold their lead,
the danger of falling behind remains real:
Microsoft retains its leading position in computer software, but the
company must struggle merely to avoid falling behind.
"creative destruction" refers to the way that economic advances make
existeng economic capital ideas absolescent: thay are partially
destroyed (in value term). Existing models have only considered how
additions to economic knowledge make existing knowledge less valuable.
This paper recognises that both knowledge and capital obsolesce and
considers the effect on both.
By that definition, socialism will apply creative destruction to
capitalism.
