The Nature and Essence of Economic Theory

Joseph A. Schumpeter

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781351478922
• Edition: 1
• Topic: Volkswirtschaftslehre
• Subtopic: Wirtschaftstheorie

Joseph A. Schumpeter was a monumental figure in the history and development of economics. This work brings together his brilliant lectures, delivered more than a century ago, in its first English-language paperback edition. Here, readers will discover Schumpeter's search for an economic science devoid of moral or political dogma. The Nature and Essence of Economic Theory works out what people should think of pure economics, what its nature is, what its methods and findings are, and where thought takes off from there. The book shows the limitations and weaknesses of nineteenth-century economics and how the field could be and was improved by establishing a fundamental differentiation between 'statistics' and 'dynamics'. To convey his arguments, Schumpeter uses certain axioms that form a consistent, self-contained system and show how sound economic science is based on facts and events rather than presuppositions or definitions. Schumpeter's larger aim, beyond a pedagogic tool, was to deduce changes in the market, trade, and exchange of goods and services. He defined the task of economy as the description of the system and its change tendencies. If that can be achieved unequivocally, without resorting to doctrine or dogma, then the field can be considered self-contained.

Part I

1

Introduction

I

Even those people who know our discipline just superficially, know about the multitude of approaches and the quarrels between their disciples. It might confuse, even deter, the beginner or the layman but it is neither special nor disturbing. Of course it is irritating that one cannot name one book that is widely recognized and that could summarize the position of the science so that one could recommend it to the public as general information about our field. The reason is not that the dichotomies were insurmountable; actually, I hope to be able to show the opposite in this book. Also, we cannot say that this dichotomy does not exist in other sciences as we will see shortly. The reason for this unpleasant situation is thank God a superficial one: The bitter quarrel is a rather recent phenomenon because each economist, instead of stressing what we have in common, seems to reject all positions that are not his and tries to pull the beginner to his side and make him into a warrior for his own position. So, these beginners are pulled into the controversy too early, way before they understand the problems. They often have an opinion before they have even started to work independently. Political or other tendencies that are outside the field are also to blame.

But, as I said before, the field of economics is not in any worse situation than other sciences. It would be wrong to conclude that the field needs useful methods, assured results, or even a clearly-delineated field of study, as understandable as it is that some people—tired of the constant infighting—may think that way. Since this declaration seems paradoxical considering the high noise level of our discussion about methods, we would like to briefly explain. We could name philosophy, political science, and other fields that can hardly be described as exact. In the field of psychology, for example, there are many different directions and we can safely state that in our field there is no difference bigger than between introspective and experimental psychology. Scientists coming out of totally different disciplines work in these subfields, of which the one tends towards philosophy, the other one towards psychology. Methods and findings of these two are hardly related and psychologists spend at least as much energy on the defense of their basic viewpoints as economists do. In the field of logic it is not any different: There are worlds between “categorical” and “modern” and these two areas have not been found together. But please do not confuse this dichotomy with controversies about single problems: Not a single question but rather whole approaches, whole systems with all their basic assumptions are at stake here.

It is even more significant that we also find this phenomenon in the exact sciences, which the laymen see as the quintessence of certainty and unity. The best example is chemistry: The exact and the experimental are represented by different people and they have little in common concerning their methods and their goals. They go their separate ways and only meet to quarrel.

And the same is true for the most exact of them all, the mechanics. That is especially peculiar since all the workers in this old traditional field have a remarkably similar training, career path, and opinions phenomena in their field. In addition, they pretty much agree on all concrete findings. But all of this still cannot create unity when it comes to methods and basic principles. Not only is the difference between classic and modern mechanics considerable—which is the natural result of scientific development – but there are also clearly distinct parties within modern mechanics that fight about more or less everything, the complete interpretation of nature and the values of the discipline. And as in our field, the practitioners do not seem to be interested in anything but what is of practical interest. Scanning the battlefield, it becomes apparent that today the foundation of this proud building is shaken and that there is a general feeling of dissatisfaction. Doesn’t this show us that all sciences go through these quarrels, not just economics; that all systems have to make room for new ideas? And wouldn’t it be wrong to be in despair over the fall of classic economics? One could actually interpret it as a sign of its capacity for development.

One could reply that the discussion about methods in our field is characterized by such a high level of intolerance towards the viewpoint of the opponent, that people do not even know their approaches and findings. But that is the case everywhere: The introspective psychologist feels misunderstood by the experimental, and the latter is inclined to deny the former any right to his way of thinking. The mathematical and exact chemist often disdains the experimental one and the latter, as I have experienced, sometimes does not even know the first one exists or what he does. And today the field of mechanics is in a similar situation, and even pure mathematics suffers from it.

We actually should not be too surprised since not only is the knowledge so vast but the methods also so varied that only a few people have a handle on one whole discipline with all its subfields. He chooses what is closest to him and his subfield is often such a large part of his personality that is as hard to shed as the moral character—especially for the best in their fields. The result is often the incapability to compromise. But compromises are a necessary result of scientific development and fighting them is as futile as trying to unify the world religions.

So, we do not take the inner strife of economics too seriously. We are pretty sure that the state of our field today will not lead to a destruction of our discipline in the future. We are supported in this by the observation that things have turned around recently and that a healthy “communis opinio” is developing. At least, that is a result of our discussion. On the other hand, we cannot and we do not want to deny that the situation is not completely satisfactory and that we will state here what we think the reason is.

Let me take the fight between the representatives of the abstract theory and of the historical school: Usually, both are right in their general assertions. But we do not look at their limitation that they often deal with different problems. Each method has its own field of application and fighting over generalizability does not get us anywhere. We will always stress that a discussion about methodological questions only makes sense in the framework of practical scientific research. Our viewpoint is that there is no contradiction between the historical and the abstract approach—their only difference is their interest in different problems. The pure price theory, for example, cannot be dealt with historically, the problem of the organization of an economy cannot be dealt with in an abstract way. And our discussions would not be as controversial, if we would have always kept that in mind (and some other things we will discuss later). People realize that more and more, although not all of them.

II

Here we want to give a short overview over the present important approaches. We follow a long tradition. Almost all economics books, especially the systematic ones, start with such an overview. This way the reader learns about the philosophy of the author and gets an introduction to the literature. We also have to do that, even if in this case the reader is expected to have prior knowledge of the topics we will discuss here. We have an additional reason: We see it as our task to contribute to a deeper appreciation of each approach, to demarcate them better, and hopefully put them into a more precise relationship to each other. To this end, several of them will be named here without going into any type of critiquing at this point but rather discuss them pretty generally. The reader will only be able to develop a yardstick out of the entirety of the discussion; we do not want to come to a judgment at the threshold of our discussion, as it so often happens. In this general information we will stress the points to which we ourselves can contribute. The general historic development of our science as well as what is usually written in this context—all this we expect the reader to already know. The intentions of our discussions are the excuse for their incompleteness and we mention names only in examples and as sparingly as possible, and only when non-mentioning of names could lead to confusion among the readers.

We will start out with the systems of classic authors, especially A. Smith, Ricardo, and their immediate successors, without analyzing how much they are dependent on previous authors. We have to do that for two reasons. First, they are the origin of most approaches and we have to discuss them in order to understand these approaches. Secondly, they are still alive and powerful, insofar as some economists still represent them. Let us now look at the first point, which presents a window to the development of our science.

Natura non fait saltum—Marshall prefaced his work with this sentence and it really captures its character very well. But I do want to contradict him: The development of human culture, and here especially that of knowledge, happens in spurts. Colossal rushes alternate with periods of stagnation, effusive hope alternates with bitter disappointments, and even if the new is based on the old, development is not a steady one. Our science can tell stories about that.

The works of the classic authors seem very fresh, still. That a cornucopia of facts and findings, of points of departure of which even today not all have been utilized, is offered by the “Wealth of Nations”! Scientists pushed forward without checking the reliability of the direction and exploited the break with the past. These new ideas broke through into wider circles—often misrepresented and always over-generalized. Disillusionment followed fast and we had a situation like an economic crisis: Exhaustion followed a period of productivity, exaggerated mistrust followed unconditional trust. What is characteristic in this situation is not the attitude of wider circles towards economics but rather its internal condition. Suddenly we have a standstill in its development, it looked as if the field had been exhausted and nothing could be extracted any more—and that in spite of obvious flaws that invited further work: No workers could be found. Only half built and already half dilapidated was the building of economics, when powerful opponents appeared. I cannot explain this strange standstill, these Hippocratic elements in our literature between 1830 and 1870. Most people with knowledge of the literature would probably support me if I said: The classic system was not destroyed by outside enemies but rather by internal paralysis (as the demise of societies cannot sufficiently be explained by the existence of outside enemies). The historical school stormed a fortress and only found a bunch of invalids in it. The works of the epigones would be of little value, even if a historic approach had never existed. We do not want to deny that something was achieved during that time: Almost every author contributed this or that detail. But the creative power was exhausted. That is especially true for J. St. Mill, as embarrassing as it is to judge an individual this quickly. There are also some beginnings that indicated promise but it is characteristic for the paralysis of the field of economics that they did not get any attention.

The impression I got from the literature at that time cannot be described any better than through the term “being stuck.” Perhaps even Smith and Ricardo would not have known where to go next. That is definitely true for their successors. Their approach came to the end of its productivity, and there was no replacement. It makes sense that people generalized what was only true for one approach and thought that the whole field of economics would not have a shining future. Some thought the system was perfect and complete—something that is always a dubious symptom—others had a feeling of uneasiness without having a solution.

This situation became very clear during the celebration of the 100-year anniversary of the “Wealth of Nations” at the Political Economy Club in London. Actually, the year 1876 is already part of the new period. But the works of the new writers were still being ignored and our discipline seemed to be shrouded in the tranquility of death. Mr. Lowe who opened the debate expressed it perfectly: “I am not sanguine as to any very large or any very startling development of political economy. I observe that the triumphs which have been gained, have been rather in demolishing that which has been found to be undoubtedly bad and erroneous, than in establishing new truth; and imagine that, before we can attain new results, we must be furnished from without with new truths, to which our principles can be applied … the great work has been done.” In other words, it means that the field of economics was “done,” that nothing new and noteworthy could come out of it anymore and that one had to go beyond its confines to learn anything interesting. The only ones who showed self-confidence and initiative and were forward-looking were the “historians,” especially Cliffe Leslie. And a newspaper expressed the impression of wider circles perfectly when it described the get-together as a “wake,” not as an anniversary of economics.

With the loss of its internal power, our field also lost its external influence, especially since at the time of its upswing the field had gone out on a limb by tackling the area of practical problems and had given short and general answers to questions, which were too complex to solve on the first try. As the scientific building started disintegrating brick by brick (wage fund theory, population theory, etc.), one practical finding after the other came apart. And people had heard so much about economics, and the field was so pretentious, and the misuse of this science so evident, that people turned their backs on it.

This way the historical approach showed one huge success: The theory with which one could show everything or nothing, that became paralyzed in empty phrases, was thrown overboard and the field began to concentrate on collecting facts and practical problems of social and economic politics. But it was not a complete success. The discussion of current problems was still based on classical arguments and the free-trade party and the Manchester party still did not want to let go of their beloved theories. That alone, though, would not have had a big impact on the science. But many scientific economists also stuck with the theory. For a while there was the hope that these would be swept out after a short while. But that never happened. Instead, new activity sprouted in the ruins, and the flock of theorists began to regroup to grow and go on the attack again. The historians were not aware of the fact that they were faced by different opponents—they thought they were the remnants of the successors of the classical authors. But they were new warriors who picked up the same old quarrel about methods. It was a mistake to fight them with the arguments used against the classical authors. But they brought it on themselves by seeing themselves as grandchildren of those authors.

The reader knows which group of economists we are talking about: Menger, Jevons, Walras, and their successors. Their situation was difficult in the beginning. The period of being ignored was followed by being attacked and of many misunderstandings. The theory was put aside and people were not ready to accept it again. But the new approach weathered the storm, made progress, and today we can say we are on a theoretical upswing. The classical system did not benefit, though—quite the contrary: it suffered another attack, which totally shook it.

In order to fully understand this, we have to be clear on the nature and content of what we call the classic system. The first thing that is striking when one reads the classic literature in my mind is the fact that it consists of many different elements. It is astounding that this fact has basically been ignored, and we think the reason for that lack of results of the methodological discussion is the fact that these different elements were not sufficiently isolated and arguments that fit just one of them were over-generalized. The heritage of the classical literature consists of a scientific part and a political one. I do not think we go too far when saying that the big success and the devastating defeat of the classical system can be explained by the latter rather than the former. The attack of the historical and the newer socio-political approaches were directed against free laissez faire trade, the victorious catch words during the first half of the 19th century and against practical extremes of other theories. These circles had no interest in the real economic theory. Still, it was expected that this theory would fall if faced with those practical assertions and postulates. Those are not necessarily consequences of the pure scientific classical literature and can be separated from them. It is not difficult to prove that: For example, it is easy to see that the theoretical content in Ricardo’s chapter on wage does not necessarily lead to what the author calls “poor laws.” If one rejects the latter, the former can still be true. And we are only interested in the scientific heritage of the classical authors. But even that is not completely homogeneous. Yes, economics is its most important and most valuable part. But it also contains philosophies about the topic of individualism and collectivism, about the motives of people’s actions, etc. That all that does not have anything to do with economics, we will show later. We can—and have to—admit that the attacks were legitimate in this point, too. But that is all; the pure economics of the classical authors, as paradoxical as it sounds, remained almost untouched. Attackers did not even get through to it and only charged it in general, in connection with everything around it. We can still observe this phenomenon in today’s discussion.

It was the representatives of the new theory who investigated the classic economics. Did they destroy it and put something new in its place? That is a question that is being answered in many different ways. We do not want to solve it here—the following discussions in their entirety will give an answer—but we do not want to hide our opinion: Yes, the system of the modern theory is mostly new and even those findings that concur with those of the classic system have been derived through a different method. Of course, we are indebted to the classical authors for the terminology and thought processes; sure, without the old one the new theory would not be possible but the former has become obsolete as the older literature in every other science. I regard this as very natural and is of equal distance to all extreme opinions we hear so often.

The preceding discussion builds the basis for a brief description of today’s parties in our discipline. We already saw, and will see again soon, that we can trace back almost all directions of our field to the classical authors as their take-off point. It does not matter whether one followed their orbits and tried to substitute what was dismissed, whether adored or attacked—one always started with them. One might be inclined to deny that; each new direction tries to stand on its own feet and denies the impudence within older works; but it still exists. The historical school started from a criticism of classical findings. The classical authors provided its terminology, its systematic representation, and one finds classical thinking in this direction’s work—whether it was uttered consciously or subconsciously. And that is, of course, even more true for the new theories.

So, we can see a clear development of our discipline, even if it has not been a straight, constant, and calm one. Like the branches of a river delta, the individual directions came from a common source and are closely related. One often hears that especially the German economists have lost contact with the classical authors: That is not true for the theory; as far as theory is being discussed in Germany, the classical authors are being stressed. But they are also very active outside the pure theory discussions—quietly but profoundly.

The economist who in his “introduction” discusses the different directions of economics, usually differentiates the pure theory—which he, depending on his viewpoint calls “exact,” speculative,” or “deductive”—then especially history of economics and description of economics and tries to characterize them with some general remarks. That is not sufficient because there are so many differences within the theory that a general judgment can only be made in very general terms. We therefore want to keep the different groups separate.

In our opinion, then, the classic systems are the common birthplace of all the approaches of economists, at least when we consider the pure scienti...