T T T T The Sc he Sc he Sc he Sc he Schumpeterian T humpeterian T humpeterian T humpeterian T humpeterian Theory heory heory heory heory

(1)

INTRODUCTION INTRODUCTION

Josep

Joseph Alois Schumpeh Alois Schumpeter first presenteter first presented his theory of d his theory of econoeconomic growth inmic growth in Theory of EconomicTheory of Economic

Development

Development publishedpublished in German in 1911 (its English edition appeared in 1934) which wasin German in 1911 (its English edition appeared in 1934) which was

elaborated and refined but in no way altered in any essential respect in his

elaborated and refined but in no way altered in any essential respect in his Business CyclesBusiness Cycles

(1939) and

(1939) andCapitalismCapitalism , ,Socialism and DemocracySocialism and Democracy (1942).(1942).

THE THEORY THE THEORY

To start with, Schumpeter assumes a perfectly competitive economy which is in stationary

equilibrium. In such a stationary state, there is

equilibrium. In such a stationary state, there is perfect competitive equilibrium: perfect competitive equilibrium: no profits, nono profits, no

interest rates, no savings, no investments and no involuntary unemployment. This equilibrium

is characterised by what Schumpeter terms the “circular flow” which continues to repeat itself

in the same manner year after year, similar to the circulation of the blood in an animal organism.

In the circular flow, the same products are produced every year

In the circular flow, the same products are produced every year in the same manner. “For everyin the same manner. “For every

supply there awaits somewhere in the economic system a corresponding demand. For every

demand the corresponding supply.” In other words, all economic activities are repetitive in a

(2)

Trusted by over 1 million members

Try Scribd FREE for 30 days to access over 125 million titles without ads or interruptions!

Start Free Trial Cancel Anytime.

(3)

1

11188 TThhe e EEccoonnoommiiccs s oof f DDeevveellooppmmeennt t aannd d PPllaannnniinng g

timeless economy

timeless economy. To Schumpeter, “The circular flow . To Schumpeter, “The circular flow is a stream is a stream that is fed that is fed from the continuallyfrom the continually

flowing springs of labour-power and land, and flows in every economic period into the reservoir

which we call income, in order to be transformed into the satisfaction of wants.” Development,

according to him, “is spontaneous and discontinuous change in the channels of the

according to him, “is spontaneous and discontinuous change in the channels of the circularcircular

flow, disturbance of equilibrium, which for ever alters and displaces the equilibrium state

previously existing.”

previously existing.”11_{These ‘spontaneous and discontinuous’ changes in economic life are not}_{These ‘spontaneous and discontinuous’ changes in economic life are not}

forced upon it from without but arise by its own initiative from within the economy and appear

in the sphere of industrial and commercial life. Development consists in the carrying out of

new combinations for which possibilities exist in the stationary state. New combinations come

about in the form of innovations.

Innovations.

Innovations. An innovation may consist of: (1) the introduction of a new product; (2) theAn innovation may consist of: (1) the introduction of a new product; (2) the

introduction of a new method of production; (3) the opening up of

introduction of a new method of production; (3) the opening up of a new market; (4) the conquesta new market; (4) the conquest

of a new source of supply of raw materials or semi-manufactured goods; and (5) the carrying

out of the new organisation of any industry like the creation of a monopoly. According to

Schumpeter, it is the introduction of a new product and the continual improvements in the

existing ones that lead to development.

Role of Innovator.

Role of Innovator.Schumpeter assigns the role of an innovator not to the capitalist but to theSchumpeter assigns the role of an innovator not to the capitalist but to the

entrepreneur. The entrepreneur

entrepreneur. The entrepreneur is not a man of ordinary managerial ability, but one whois not a man of ordinary managerial ability, but one who

introduces something entirely new. He does not provide funds but directs their use. The

entrepreneur is motivated by:

entrepreneur is motivated by:(a)(a)the desire to found a private commercial the desire to found a private commercial kingdom,kingdom,(b)(b)the willthe will

to conquer and prove his superiority, and

to conquer and prove his superiority, and (c)(c) the joy of creating, of getting things done, orthe joy of creating, of getting things done, or

simply of exercising one’s energy and ingenuity

simply of exercising one’s energy and ingenuity. His nature . His nature and activities and activities depend on his social-depend on his

social-cultural environment. To perform his economic function, the entrepreneur requires two things:

cultural environment. To perform his economic function, the entrepreneur requires two things:

first, the existence of technical knowledge in order to produce new products; second, the power

of disposal over the factors of production in the form of credit. According to Schumpeter, a

reservoir of untapped technical knowledge exists which he can make use of. Therefore, credit i

reservoir of untapped technical knowledge exists which he can make use of. Therefore, credit iss

essential for development to start.

Role of Profits.

Role of Profits.An entrepreneur innovates to earn profits. Profits are conceived “as a surplusAn entrepreneur innovates to earn profits. Profits are conceived “as a surplus

over costs: a difference between the total receipts and outlay–as a function of innovation.”

According to Schumpeter, under competitive equilibrium the price of each product just equals

its cost of production, and there are no profits. Profits arise due to dynamic changes resulting

from an innovation. They continue to exist till the innovation becomes general.

Breaking the Circular Flow.

Breaking the Circular Flow. Schumpeter’s model starts with the breaking up of the circularSchumpeter’s model starts with the breaking up of the circular

flow with an innovation in the form of a new product by an entrepreneur for the purpose of

earning profits. In order to break the circular flow, the innovating entrepreneurs are financed

by ba

by bank-crnk-crediteditexpansion. Since investment in innovations is riexpansion. Since investment in innovations is riskysky, they must pay , they must pay interest on it.interest on it.

Once the new innovation becomes successful and profitable, other entrepreneurs follow it in

“swarm-like clusters.” Innovations in one field may induce other innovations in related fields.

The emergence of a motor car industry may, in turn, stimulate a wave of new inv

The emergence of a motor car industry may, in turn, stimulate a wave of new investments in theestments in the

construction of highways, rubber tyres and petroleum products, etc. But the spread of an

innovation is never 100 percent.

The spread of innovation is shown in Fig. 1

The spread of innovation is shown in Fig. 1 where the percentage of firms adopting a partiwhere the percentage of firms adopting a particularcular

innovation is shown on the vertical axis and time taken on the horizontal axis. The curve

innovation is shown on the vertical axis and time taken on the horizontal axis. The curve OI OI

1. A. Schumpeter,

(4)

(5)

T

Thhee SScchhuummppeetteerriiaann TThheeoorryy 111199

shows that firms adopt an innovation slowly to start

shows that firms adopt an innovation slowly to start withwith

but soon the

but soon the adoptioadoption of n of innovinnovation gains momentuation gains momentum.m.

But it never reaches 100 per cent adoption by firms.

Cyclical Process.

Cyclical Process. Since investment is assumed to beSince investment is assumed to be

financed by creation of bank credit, it increases money

incomes and prices and helps to create a cumulative

expansion throughout the economy. With the increase in

the purchasing power of the consumers, the demand for

the products of the old industries increases in relation to

supply. Prices rise, profits increase and old industries

expand by borrowing from the banks. It induces a

secondary wave of credit inflation which is superimposed

on the primary wave of innovation. Over-optimism and speculation add further to the boom.

After a period of gestation the new products start appearing in the market displacing the old

products and enforcing a process of liquidation, re-adjustment and absorption.

products and enforcing a process of liquidation, re-adjustment and absorption.22_{The demand}_{The demand}

for the old products is decreased. Their prices fall. The old firms contract output and some are

even forced to run into liquidation. As the innovators start repaying bank loans out of profits,

the quantity of money is decreased and prices tend to fall. Pr

the quantity of money is decreased and prices tend to fall. Profits decline. Uncertainty and risksofits decline. Uncertainty and risks

increase, the impulse for innovation is reduced and eventually comes to an end. Depression

ensues.

Schumpeter believes in the

Schumpeter believes in the existence of the Kondratieff long-wave of upswings and existence of the Kondratieff long-wave of upswings and downswingsdownswings

in economic activity. Each long-wave upswing is brought about by an innovation in the form

in economic activity. Each long-wave upswing is brought about by an innovation in the form ofof

a new product which leads to further innovations in the methods of production, new forms of

busine

business orgass organisationisation, new sn, new sources ources of suppof supply of raw mly of raw materials aaterials and intend intermediarmediate prodte products, anucts, andd

new markets. Thus there is abundance to goods available for the masses.” In the words of

Schumpeter, “mass production means production for the masses.” Once the upswings ends,

the long-wave downswing begins and the painful process of readjustment to the “point of

previous neighbourhood of equilibrium” starts. Ultimately the natural forces of recovery bring

about a revival. Once

about a revival. Once again equilibrium is restored. again equilibrium is restored. Then smite Then smite enterprising enterprising entrepreneursentrepreneurs

begin

begin with with a a new new set set of of innoinnovatiovations, ns, otheothers rs follofolloww, , and and a a new new boom boom begibegins. ns. SchumSchumpetepeter r descdescribesribes

this process of ‘capitalist development as one of “creative destruction” wherein the old economic

structures of society are

structures of society are being continually destroyed and the new structures are being continually destroyed and the new structures are being continuallybeing continually

created in their place.

This is shown in Fig. 2 where time is taken on the horizontal

This is shown in Fig. 2 where time is taken on the horizontal axisaxis

and national output on the vertical axis. The curve

and national output on the vertical axis. The curve YPT YPT showsshows

the long-run cyclical upswings and downswings. When there is

a new innovation, the economy moves upwards from

a new innovation, the economy moves upwards from Y Y andand

production increases upto

production increases upto PP. When this innovation ends and a. When this innovation ends and a

new innovation starts and replaces the earlier one the, output

level falls from

level falls from PPtoto T T . In . In this waythis way, “the creative , “the creative destruction”destruction”

process leads to the new equilibrium

process leads to the new equilibrium T T of the economy that isof the economy that is

higher than the earlier point

higher than the earlier pointY Y which shows the development ofwhich shows the development of

the economy.

Schumpeter’s cyclical process of economic development is

illustrated in Fig. 3 where the secondary wave is superimposed

on the primary wave of

on the primary wave of innovation. With over-optimism and speculation, development proceedsinnovation. With over-optimism and speculation, development proceeds O O I I Time Time 1 1 0 0 0 0 P P e e r r c c e e n n t t Fig. 1 Fig. 1 O O Y Y P P T T Time Time O O u u t t p p u u t t Fig. 2 Fig. 2

(6)

(7)

1

more rapidly in the prosperity phase. When

recession starts, the cycle continues downward

below

below the the equilibrium equilibrium level level to to the the depressiondepression

phase. Ultimately, another innovation brings

about revival.

In fine, entrepreneurs are the key figures in the

Schumpeterian analysis. They bring about

economic development in spontaneous and

discontinuous manner. And “cyclical swings are

the cost of economic development under

capitalism,” a permanent feature of its dynamic

time-path.

Secularly, continued technological progress will

result in an unbounded increase in total and per

capita output, since historically there are no

diminishing returns to technological progress.

As long as technological progress takes place, the rate of the profit will be positive. Hence there

can be no drying up

can be no drying up of sources of investible funds nor any of sources of investible funds nor any vanishing of investment opportunities.vanishing of investment opportunities.

“There is therefore no a

“There is therefore no a priori priori ceiling to the level of per capita income in a capitalist society.ceiling to the level of per capita income in a capitalist society.

Nonetheless, the economic success of capitalism will eventually lead to its decay. For the very

process of capitalist development we

process of capitalist development weakens the institutions akens the institutions and values basic to its own survival.”and values basic to its own survival.”22

“Can capitalism survive? No, I do not think it can,” wrote Schumpeter, as his final appraisal of

the future of capitalism. To him, the very success of capitalism

the future of capitalism. To him, the very success of capitalism “undermines the social institutions“undermines the social institutions

which protect it, and “inevitably” creates conditions in which it will not be able to live and

which strongly point to socialism as the heir apparent.”

which strongly point to socialism as the heir apparent.”33

Process of End of Capitalism.

Process of End of Capitalism.According to Schumpeter, capitalism can maintain itself only soAccording to Schumpeter, capitalism can maintain itself only so

long as entrepreneurs behave like knights and pioneers. But such daring innovators are being

destroyed by the capitalist system itself which rests on a rational attitude. This enquiring,

sceptical and rational attitude permeates the entire capitalist society. As a result,

sceptical and rational attitude permeates the entire capitalist society. As a result,threethreeforces areforces are

discernible that are the beginning of the creeping death of capitalism. They are: (1) the decadence

of the entrepreneurial function; (2) the disintegration of the bourgeois family; and (3) the

destruction of the institutional framework of the capitalist society.

In the early stages of capitalism, the driving force came from entrepreneurs who dared to

innovate, to experiment, and to expand. But now innovati

innovate, to experiment, and to expand. But now innovation is reduced to a routine. Technologicalon is reduced to a routine. Technological

progress has become the business of teams of trained specialists. The new ‘lords’

progress has become the business of teams of trained specialists. The new ‘lords’ of business areof business are

the managers, depersonalized owners and private bureaucrats. This reduces the industrial

bourge

bourgeoisie oisie to a to a class class of wof wage-eage-earners arners and and thus thus undermundermines ines the the functifunction aon and tnd the phe position osition of tof thehe

entrepreneur as the “warrior knight.”

There is also the destruction of the bourgeoisie

There is also the destruction of the bourgeoisie family. Parents adopt a rationalistic attitude infamily. Parents adopt a rationalistic attitude in

their behaviour towards children. The traditional family idea is weakened. The desire to found

a “private kingdom” , a “dynasty” is no longer there. The will to accumulate wealth gradually

disappears and along with it another important aspect of the capitalist society.

disappears and along with it another important aspect of the capitalist society. O O _Time_Time I I c c n n o o m m e e D D _E_E P P _R_R E E _S_S S S _I_I_O_O

N N R R _E_E C C _E_E S S _S_S I I _O_O

N N

R R E E V V

I I V V A A L L

P

P R R I I M MAA R R Y Y W WAA V V E E EQUILIBRIUM EQUILIBRIUM PATH PATH SECONDARY WAVE SECONDARY WAVE P P R R O O S S P P E E R R I I T T Y Y Fig. 3 Fig. 3 2. I. Adelman,

2. I. Adelman,Theories of Economic Growth and DevelopmentTheories of Economic Growth and Development , p. , p. 108.108. 3. J.A. Schumpeter,

(8)

(9)

T

Finally, Schumpeter contends that the entrepreneur also tends to destroy the institutional

framework of the capitalist society. The tendency towards concentration into big concerns

weakens and destroys the twin institutions of private property and freedom of contract. In the

case of big concerns, the proprietors are the small and large shareholders who are

“dematerialized” and “defunctionalized” by the professional, salaried managers. The

proprietors’ role is performed by the latter while the former are totally divorced from active

management. Accordin

management. According to Schumpeter, it wg to Schumpeter, it was rationality that had destroyed as rationality that had destroyed the royal powerthe royal power

in the past. Now again, it is the rationalistic attitude of the ruling group towards domestic and

international problems that will be the bane of capitalism. But all these forces are not enough to

ring the death knell of capitalism. It is, however, the active hostility of the intellectuals which is

bringin

bringing the dg the day nearay nearerer. The in. The intellectellectuals sotuals sow seew seeds of dds of doubt anoubt and discod discontentmntentment in ent in the minthe mindsds

of the masses against the social and political framework of

of the masses against the social and political framework of the capitalist order. By inciting thethe capitalist order. By inciting the

white-collar groups and the labouring classes they are able to secure anti-capitalist political

reforms. As a result, the institutional framework upon which capitalism rests starts crumbling

and there is a gradual movement towards socialism. Eventually capitalism would fade away

without any bang or whimper.

CRITICISMS OF THE THEORY

“Schumpeter’s theory must be ranked as a major performance, one worthy of such great

economists as

economists as Smith, Mill, Marx, MSmith, Mill, Marx, Marshal and Keynarshal and Keynes.”es.”44_{No doubt it is replete with brilliant}_{No doubt it is replete with brilliant}

reasoning and insight of a great theorist, yet it is not free from criticisms.

1. The entire process of Schumpeter’s theory is based on the innovator whom he regards as

an ideal person.

an ideal person. Such persons were to be found in the 18th and 19th centuries. At that timeSuch persons were to be found in the 18th and 19th centuries. At that time

innovations were made by entrepreneurs or inventors. But now all

innovations were made by entrepreneurs or inventors. But now all innovations form part of theinnovations form part of the

functions of a joint stock

functions of a joint stock companycompany. Innovations are regarded as the . Innovations are regarded as the routine of industrial concernsroutine of industrial concerns

and do not require an innovator as such.

2. Economic development is not the result of the cyclical process.

2. Economic development is not the result of the cyclical process. The downswings and theThe downswings and the

upswings are not essential for economic development. As Nurkse pointed out, economic

development is related to continuous changes.

3. Schumpeter’s contention that cyclical changes are due to innovations is also not correct.

As a matter fact, cyclical

As a matter fact, cyclical fluctuations may be due to psfluctuations may be due to psychological, natural, and financial causes.ychological, natural, and financial causes.

4. Schumpeter regards innovations as the main cause of economic development.

4. Schumpeter regards innovations as the main cause of economic development. But this isBut this is

far from reality because economic development not only depends an innovations but also on

many economic and social changes.

5. Schumpeter gives too much importance to bank-credit in his theory.

5. Schumpeter gives too much importance to bank-credit in his theory. Bank credit may beBank credit may be

important in the short run when industrial concerns get credit facilities from the banks. But in

the long run when the need for capital funds is much greater, bank credit is insufficient. For

this, business houses have to float fresh shares and debentures in the capital market.

6. Schumpeter’s analysis of the

6. Schumpeter’s analysis of the process of transition from capitalism to socialism is not correct.process of transition from capitalism to socialism is not correct.

He does not analyse how a capitalist society is transformed into socialism. He simply tells that

the institutional framework of a capitalist society is transformed with changes in the functions

of the entrepreneur. His analysis of the end of capitalism is emotional rather than real.

To conclude with Meier and Baldwin,

To conclude with Meier and Baldwin, “Schumpeter’s broad socio-economic analysis of capitalist“Schumpeter’s broad socio-economic analysis of capitalist

process is generally admired. Yet few seem prepared to accept its conclusions. His arguments

4. G.M. Meier and E. Baldwin,

(10)

(11)

1

are stimulating but not

are stimulating but not completely convincing.... Although Schumpeter’completely convincing.... Although Schumpeter’s analysis is s analysis is provocative,provocative,

it seems one-sided and over-emphasized.”

it seems one-sided and over-emphasized.”55

SCHUMPETER

SCHUMPETER’S ’S ANALYSIS ANALYSIS AND AND UNDERDEVELUNDERDEVELOPED OPED COUNTRIESCOUNTRIES

The applicability of Schumpeter

The applicability of Schumpeter’’s theory to s theory to underdevelounderdeveloped countries is limited ped countries is limited for the followingfor the following

reasons:

1. Different Socio-Economic Order.

1. Different Socio-Economic Order. Schumpeter’s theory corresponds to a particular socio-Schumpeter’s theory corresponds to a particular

socio-economic order that existed in Western Europe and America of the 18th and 19th centuries. In

economic order that existed in Western Europe and America of the 18th and 19th centuries. In

that period, some of the prerequisites of growth already existed. In underdeveloped countries,

the socio-economic conditions are altogether different and the prerequisites for development

in the form of economic and social overheads are non-existent.

2. Lack of Entrepreneurship.

2. Lack of Entrepreneurship. The Schumpeterian analysis depends upon the existence of anThe Schumpeterian analysis depends upon the existence of an

entrepreneurial class. However, in underdeveloped countries adequate entrepreneurship is

lacking. In such economies, there are low profit expectations and low state of technologies

which do not encourage innovational investments in new plant and equipment. Moreover, the

lack of adequate power, transport, skilled personnel, etc. act as disincentives to entrepreneurial

activity.

3. Not Applicable to Socialist Countries.

3. Not Applicable to Socialist Countries.Schumpeter’s analysis is not applicable to the majoritySchumpeter’s analysis is not applicable to the majority

of underdeveloped countries which have socialist leanings. For example, the introduction of

social security measures and high progressive income taxes are inimical to the development of

an entrepreneurial class because they tend to reduce profits.

4. Not Applicable to Mixed Economies.

4. Not Applicable to Mixed Economies. Moreover, Schumpeter’s innovator is a privateMoreover, Schumpeter’s innovator is a private

entrepreneur who does not fit in the present day mixed economies. In an underdeveloped

country, government is the biggest entrepreneur. The main impetus for development comes

from the public and the semi-public sectors. Thus, Schumpeter’s innovator has a limited role to

play in an underdeveloped country.

5. Institutional Changes and not Innovations Needed.

5. Institutional Changes and not Innovations Needed. To start the development process andTo start the development process and

to make it self-sustaining, it is not innovations alone but a combination of several factors like

organizational structures, business practices, skilled labour and appropriate values, attitudes

and motivations which are required.

6. Assimilation of Innovations.

6. Assimilation of Innovations. According to Henry Wallich, the development process inAccording to Henry Wallich, the development process in

underdevelope

underdeveloped countries is d countries is based, not on innovatiobased, not on innovation, but on the assimilation of existinn, but on the assimilation of existingg

innovations. For entrepreneurs in underdeveloped countries are not in a position to innovate.

Rather, they adopt innovations taking place in advanced countries.

Rather, they adopt innovations taking place in advanced countries.66

7. Neglects Consumption.

7. Neglects Consumption. The Schumpeterian process is ‘production oriented’ while theThe Schumpeterian process is ‘production oriented’ while the

development process is ‘consumption-oriented’. This appraisal is applied in the current trend

towards the welfare state in which demand and consumption play a leading role.

8. Neglects Savings.

8. Neglects Savings.Schumpeter’s exclusive emphasis on bank credit obscures the role of realSchumpeter’s exclusive emphasis on bank credit obscures the role of real

savings in investment. It also undermines the importance of deficit financing, budgetary savings,

public credit and other fiscal measures in economic development.

9. Neglects External Effects.

9. Neglects External Effects. According to Schumpeter, development is the result of changesAccording to Schumpeter, development is the result of changes

that arise from within the economy. But in underdeveloped countries, changes do not take

5.

5.IbidIbid., pp. 99 and 101.., pp. 99 and 101.

6. Henry C. Wallich, Some Notes Towards a Theory of Derived Demand, in Aggrawal and Singh (ed), 6. Henry C. Wallich, Some Notes Towards a Theory of Derived Demand, in Aggrawal and Singh (ed),

op.cit

(12)

(13)

T

place from within the economy rather they are the outcome of imported ideas, technology and

capital. Backward technology, low saving potential and outmoded social, economic and political

institutions are incapable of leading to development from “within” in underdeveloped

economies.

10. Neglects Population Growth.

10. Neglects Population Growth.Further, Schumpeter failed to take into account the impact ofFurther, Schumpeter failed to take into account the impact of

the growth of population on the economic development of a country. High growth rate of

population tends to lower the

population tends to lower the growth rate of a developing economgrowth rate of a developing economyy..

11. Unsatisfactory Explanation of Inflationary Forces.

11. Unsatisfactory Explanation of Inflationary Forces. In Schumpeter’s system, inflationaryIn Schumpeter’s system, inflationary

impulses form an integral part of the process of development, but it involves no secular inflation.

The long-term price level remains stable. However, in an underdeveloped economy the

inflationary forces are very powerful.

Conclusion.

Conclusion. All the same, Schumpeter’s theory underlines the importance of inflationaryAll the same, Schumpeter’s theory underlines the importance of inflationary

financing and innovations as the main factors in economic development. Inflationary financing

is one of the potent methods which every underdeveloped country tries to use at one time or

another. His analysis is relevant to underdeveloped countries from the standpoint of l

another. His analysis is relevant to underdeveloped countries from the standpoint of long rangeong range

increase in productivity and absorption of surplus labour in gainful employment as a result of

innovations.