Schumpeter's Theory of Economic Development
A riddle: what is always in motion, but never moves? What lasts forever, but never began?
Well, for Schumpeter, the answer is capitalism!
The Theory of Economic Development begins with a lengthy discussion of then-prevailing economic theory at a relatively high level of abstraction. In a sense, Schumpeter (the “bourgeois Marx”, as John E. Elliot identifies him in the lengthy introduction) condemns both the classics and broad-school Utilitarian economists for the simplicity of their models. His angle is not that of Chamberlain and Robinson’s explication of monopoly competition, but a more far-ranging complaint about the static nature of all previous models — save that of Marx. For both Schumpeter and Marx, capitalism ‘moves’, so to speak, of its own volition, not as a reflex corresponding to ‘extra-economic’ shocks of war, population change, etc. This is where the similarities end.
Schumpeter’s critique of existing models and theories declares them all to be singularly obsessed with the ‘circular flow’ of the economic system, in which the totality exists within a snowglobe, a “static” permanently suspended in equilibrium. Within this circle, defined by a Say-esque call and response of supply and demand, or in his terms, a cyclone of products and money, Schumpeter’s “dynamic” system sets this whole apparatus in pseudo-motion. The effect of this is multiple: first, Schumpeter can make the claim that experience governs and dictates the vast majority of actions within capitalist markets (via a lazy appeal to pastoralism, using the example of a farmer bringing their produce to market); secondly, it is precisely the rare ability to break with this experience that defines a new pseudo-class of ‘entrepreneurs’ whom, by dint of their boldness and genius (very Futurist in nature) employ the means of production in novel ways to “carry out new combinations”.
Schumpeter’s entrepreneur, while very similar to Hayek’s avant garde elite, is nevertheless a far more complex creature. It is not a class, not permanent by any means: in fact, a successful entrepreneur may become a capitalist or a manager, and a failed one a worker again; in any case, there is no permanent social existence as an entrepreneur. In fact, by Schumpeter’s reckoning, all of capitalist society exists solely to facilitate the individual entrepreneur’s genius — all of its features and facets can be understood with reference to him, and development itself, that is the forward motion of the system, the destruction of the old and the birth of the new, is due to his singular action. This process describes the core of the book and his thought. I will summarize it here.
To begin, a capitalist or “exchange economy” is defined as a particular system which is always in a process of development within the sphere of production, a point Schumpeter insists upon — developments in consumption being wholly marginal or “faddish” and thus irrelevant to analysis within the sphere of economic science. This development is defined as new combinations in production, which should be read as, more or less, technological development, in which the economy shifts to run in “new channels”. These new combinations are overseen by entrepreneurs, mentioned previously, who directly command means of production (such as land, labor, or productive machinery) in new combinations so as to realize a new product, or an old product produced by a different process. However, given the circular equilibrium which holds as the basis of Schumpeter’s pseudo-dynamic theory, what with its perfect seal of seamless use of available materials, there are never any means of production which are not in use and available for the entrepreneur to press into service. In a less insane way, we may say that there is no vast pool of productive elements available to an entrepreneur simply on good faith. Schumpeter realizes this; and it is here that capitalism’s future time-preference, in fact its differentia specifica, appears. What makes and enables capitalism is the existence of credit. For Schumpeter, this is not a legal definition or a financial product, but the generic possibility of money advanced against future earnings available in the present. Entrepreneurs in possession of credit, that is to say capital, may use that credit-money (which is here for all intents and purposes the same as ‘real’ money) to purchase and control means of production in their carrying out of a new combination. Thus, the entrepreneur, who becomes one only by virtue of having received credit, appears first and foremost as a debtor.
Credit is overseen by banks, and specifically bankers “for the good of society”, who occupy a social role in their ability to advance credit as the producers of purchasing power, which is in fact signified in the existence of capital. “Capital is nothing but the lever by which the entrepreneur subjects to his control the concrete goods which he needs, nothing but a means of diverting the factors of production to new uses, or of dictating a new direction to production”. Given it is an advancement on the future which comes out of the social fund of existing capital, we may revise this statement by saying capital is “a social liquidity pool created by lenders (bankers), made available at any moment for the employ by entrepreneurs towards technical ends”. Though Schumpeter insists administration of capital is in the hands of private individuals and is thereby private, its origin in ‘social wealth’ makes it clear the opposite is true. This severely distorts the classic trinity formula: to labor and land, his two sources of wealth, go wages and rent as they are lent out/needed in production; and to the entrepreneur goes the surplus. This surplus is then split further: interest (“an element in the price of purchasing power”) returns to the capitalist, that is the banker/lender, while the entrepreneur keeps the remainder as profit, due to him as, essentially, a wage: “It is certainly not a simple residuum; it is the expression of the value of what the entrepreneur contributes to production in exactly the same sense that wages are the value expression of what the worker ‘produces’. It is not a profit of exploitation any more than are wages…the laws of cost and of marginal productivity seem to exclude it”. So, to sum up: the entrepreneur borrows from the capitalist (Schumpeter is careful about this split — they are by no means one and the same, even if the capitalist uses ‘saved’ money to engage in entrepreneurial activity) in order to control elements of production in the pursuit of a new combination, and the surplus derived splits into interest and profit, thus continuing the system anew, but slightly altered. The entrepreneur briefly collects quasi- or monopoly rents on their innovation as their competitors catch up. Finally new entrepreneurs appear, clustered in swarms across the historical plodding of the business cycle.