The Contribution of Joseph A. Schumpeter to Economics

Richard Arena, Cécile Dangel-Hagnauer, Richard Arena, Cécile Dangel-Hagnauer

• Publisher: Routledge
• Year: 2002
• ISBN:
  9781134585861
• Edition: 1
• Topic: Commerce
• Subtopic: Commerce Général

This collection constitutes an examination of Schumpeter's legacy that is wider than any yet attempted. As one of the key economists of the twentieth century, Schumpeter's economics is viewed in the context of its relation to purer Austrian theories of the free market, Keynesian macroeconomics, the early neoclassicism of Marshall and Walras, and a persuasive argument made for its centrality to the discipline as a whole.

Part I: History of economic analysis

1 Schumpeter and the old Austrian school: Interpretations and influences

Sandye Gloria-Palermo

Introduction

Schumpeter is at the root of the ongoing historiographic practice of classifying Menger along with Jevons and Walras as the three protagonists of the so-called marginalist revolution. All three authors are presented as the independent discoverers of very much the same marginal utility principle.¹ To Schumpeter, the marginalist revolution boils down to the simultaneous and independent rediscovery of this principle. However, he acknowledges that it is not the idea of marginal utility per se which is revolutionary. Indeed, this idea had already been formulated by Gossen earlier on, and, when expressed in basic terms, seems to flow from mere introspection, revealing little more than a triviality. In fact, the label ‘revolutionary’ is bestowed on these three economists not so much for their exposition of the idea that the evaluation of goods depends on the intensity of individual needs, but rather for the radical change in the orientation of economic theory this principle entails. It is a ‘marginalist revolution’ in the specific sense that it proposed totally new foundations of economic thought to replace those of the classical tradition. In this sense, Menger’s contribution is undoubtedly as path-breaking as those of Walras and Jevons.² What is essential to Schumpeter is the acknowledgement of the marginal utility principle as the foundation of all economic analysis and of human needs as the primary driving force of economic mechanisms.

In the 1970s, two articles were to mark the beginning of an alternative interpretation of the marginalist take-off. Streissler (1972) explicitly asks ‘to what extent was the Austrian school marginalist?’, and Jaffé (1976) proposes a ‘dehomogenisation’ of Walras, Jevons and Menger. Jaffé insists that the application of a single, unifying label to all three authors leads one to overlook the differences between the distinct traditions founded by Walras, Menger and, to a lesser extent, Jevons. Streissler’s objective is to show that, in many respects, the Austrian school cannot be considered representative of the marginalist tradition. He thus emphasises Menger’s originality.

There is no doubt that Walras’s and Menger’s work has followed different analytical paths and that, today, the Austrian tradition can legitimately claim to constitute a competitive and independent stream of thought. Therefore the question arises of how it was possible for Schumpeter, himself extensively trained in the Austrian tradition, to have failed to mention the crucial differences separating Menger and Walras and to have subsumed them under a single indistinct movement.

The fact that Schumpeter underrates the differences between Menger and the marginalists might lead one to think that he fails to discern any element of originality in the early Austrian tradition. This interpretation, however, ceases to be convincing if one takes into consideration the gist of Schumpeter’s own analytical work on which Austrian originality has clearly left its mark. Certain aspects of the Austrian tradition were subsequently taken up by Schumpeter, and it is precisely these aspects which account for his own originality as a theorist. Thus, Schumpeter develops a dynamic conception of the role of the entrepreneur, breaking with the static framework of general equilibrium – which he so ardently admired – and providing a theory of economic evolution in which change originates from within the system.

We are then faced with a striking paradox: as a historian of thought Schumpeter provides an interpretation of early Austrian thought according to which its early exponents are mere marginalists, revealing little originality vis-àvis Walrasian and Jevonian logic. As a theorist, though, he makes use of precisely those elements which constitute Austrian original thought, and which he chose to ignore earlier on, to develop his theory of economic evolution. It is by solving this paradox that we intend to shed some light on the nature of the relationship between Schumpeter and the early Austrian tradition.

In order to do so, we first need to go back to Schumpeter’s analytical distinction between the circular flow and economic evolution. This distinction essentially emphasises the different roles played by consumers and entrepreneurs respectively in these two analytical frameworks. As will become clear, despite certain embryonic ideas to the contrary, Menger, Wieser and Böhm-Bawerk effectively position themselves in the circular flow logic, thus justifying the Schumpeterian view of the history of thought. As a theorist, Schumpeter builds on these embryonic ideas, organising them into the coherent and qualitatively different framework of economic evolution. More specifically, the influence of early Austrians on Schumpeter’s analysis is manifest at three levels of his analysis: his focus on the economic process, on the nature of economic rationality and on the role of institutions in economic dynamics.

The circular flow and economic evolution: a qualitative turning point

Austrians have long been struggling to assert their originality with respect, first, to marginalism and, later, to neo-classical economics. Basically, the problem stems from the ambiguity inherent in the use of identical terms to which different meanings are attributed: Austrian conceptions of competition, economic rationality and subjectivism differ from those of neo-classical economics. It was only during the inter-war period that, as a consequence of the debate on planning, Austrians progressively grew fully aware of the conceptual differences separating them from mainstream economics.³ As opposed to this, it is Schumpeter’s particular merit to have located himself clearly with regard to the Walrasian framework as soon as 1912, thereby avoiding the ambiguity initiated by Menger and passed on to two generations of economists.

In The Theory of Economic Development (TED) Schumpeter distinguishes between the circular flow and economic evolution. While Walrasian theory bears on the reality of the circular flow, it loses all relevance as soon as we turn to economic evolution. To a certain extent, general equilibrium theory is realistic: it is an abstraction from reality which captures the essence of the circular flow.⁴ Indeed, according to Schumpeter, it is realistic to consider human needs as the fundamental basis for the explanation of economic phenomena, to take individual choices as the basic conceptual unit of analysis and to focus on the general interdependence of plans which is beyond the grasp of consciousness of the individual agent.

It is, however, quite clear that Schumpeter does not adopt the framework of the circular flow uncritically as part and parcel of Walrasian theory. This is particularly evident when examining the assumption of individual behaviour. In 1908, Schumpeter identifies ‘hedonistic egoism’ with Walrasian rationality and uses this term to criticise the Austrian analysis of individual rationality, and Wieser’s psychologism in particular.⁵ However, in the TED, the Walrasian equilibrium framework is replaced with the circular flow. Simultaneously, ‘hedonistic rationality’ is no longer equated with explicit and conscious maximisation.⁶ Rather, choices are the result of past experience and are based on something close to adaptive rationality to which the concepts of rule and routine are central:

In this system of values a person’s whole economy is expressed, all the relations of his life, his outlook, his wants, all his economic combinations. The individual is never equally conscious of all parts of this value system; rather at any moment the greater part of it lies beneath the threshold of consciousness. Also, when he makes his decisions concerning his economic conduct he does not pay attention to all the facts given expression to in this value system, but only to certain indices ready at hand. He acts in the ordinary daily round according to the general custom and experience.

(Schumpeter 1912 [1934]: 39)

Individuals automatically reproduce the actions that have proved efficient in the past. Such behaviour is compatible with the framework of the circular flow as this concerns a stationary economy, free of endogenous disturbances. A stationary economy here is not simply one that reproduces itself. It may grow, but growth will be smooth, determined by gradual exogenous changes of the fundamental variables (endowments, preferences and techniques) to which individuals adapt continually. Hence, the circular flow framework coincides with the analysis of the process of convergence towards a general equilibrium position whose movement is, in turn, governed by exogenous circumstances. It describes the adaptive process of an economy whose dynamics are determined by extra-economic factors. Taking particular circumstances as a given, individuals know from experience which forms of action are best suited to satisfy their needs:

The individual household or firm acts, then, according to empirically given data and in an equally empirically determined manner. Obviously this does not mean that no changes can take place in their economic activity. The data may change, and everyone will act accordingly as soon as it is noticed. But everyone will cling as tightly as possible to habitual economic methods and only submit to the pressure of circumstances as it becomes necessary. Thus the economic system will not change capriciously on its own initiative but will be at all times connected with the preceding state of affairs. This may be called Wieser’s principle of continuity.

(ibid.: 8–9)

What is important to notice here is that, even if the fundamental variables change spontaneously (in response to exogenous factors), no qualitative breakdown of the logic of the circular flow follows: agents simply react to this modification by a process of trial and error. Their present choices are backwardlooking in the sense that they are determined by past experience. Economic growth is the result of successive quantitative changes smoothly crystallised into routinised behaviour:

[A]ll knowledge and habit once acquired becomes as firmly rooted in ourselves as a railway embankment in the earth. It does not require to be continually renewed and consciously reproduced, but sinks into the strata of subconsciousness. It is normally transmitted almost without frictions by inheritance, teaching, upbringing, pressure of the environment. Everything we think, feel, or do often enough becomes automatic and our conscious life is unburdened of it.

(ibid.: 84)

The circular flow is not, however, identical with general equilibrium theory. It constitutes a more general framework which takes the Walrasian equilibrium as a central point of reference and elaborates on it. As will be argued, it is, however, also compatible with early Austrian analysis.

If the framework of the circular flow allows us to grasp the essential mechanisms of a stationary economy, it cannot provide any insights into the very different phenomenon of economic evolution which concerns a qualitatively different – endogenous – set of dynamics; changes of the fundamental variables are here the result of the economic process itself:

The position of the ideal state of equilibrium in the economic system, never attained, continually ‘striven after’ (of course not consciously), changes, because the data change … If the change occurs in the non-social data (natural conditions) or in non-economic social data (here belongs the effects of war, changes in commercial, social, or economic policy), or in consumers’ tastes, then to this extent no fundamental overhaul of the theoretical tools seems to be required. These tools only fail … where economic life itself changes its own data by fits and starts.

(ibid.: 62)

The dynamics of the circular flow results from changes in the exogenous circumstances which determine the optimal equilibrium position on which the economic process converges (though unconsciously as far as individuals are concerned); evolutionary dynamics results from endogenous shocks, self-generated by the normal working of the economy. But what then is the ‘source of energy within the economic system which would of itself disrupt any equilibrium that might be attained’?⁷ A new type of individual rationality enters the scene, to wit ‘energetic rationality’. ‘Energetic rationality’ corresponds to a forward-looking form of behaviour, something more akin to creation, ‘[to] doing something different from other conduct’ (ibid.: 81 fn. 2). More precisely, in order to define this alternative type of rationality and, therefore, to grasp the essence of economic evolution, three new factors need to be introduced into the analysis which are absent from the stationary economy: creative actions materialise through innovations; creation is impossible without the support of the institution of credit; the initiator of change is the entrepreneur.

As is well known, the concept of innovation is defined in very broad terms as a new combination of factors leading to the production of a new product, the implementation of a new method of production, the creation of a new market, the reorganisation of sectors of the economy or to the utilisation of new raw materials. However, not all inventions are actually implemented. Most face a selection process by banks deciding on the allocation of finance to specific new combinations that have become available. Credit is the standard source of funding for the implementation of new combinations (ibid.: 104), because innovations disrupt the normal working of the circular flow in which all means of production are employed, no profits are made and, thus, no savings can be accumulated. If an entrepreneur uses his savings to finance an innovation, this means that past evolution has allowed him to accumulate savings. Even so, bank credit remains by far the most common and also the logically prior form of finance: ‘And [credit] is the source from which new combinations are often financed, and from which they would have to be financed always, if results of previous development did not actually exist at any moment’ (ibid.: 73).

The entrepreneur’s main role is precisely that of obtaining financial resources and employing them in the implementation of new combinations. In this, Schumpeter does not follow the traditional definition of the entrepreneur as a risk-bearer. Nor does he accept the idea that the entrepreneur is simply the recipient of profits, for profit is only the consequence of the entrepreneur’s innovative role. Entrepreneurs are agents guided by energetic rationality, whose plan of action does not originate in the (unconscious and routinised) search for ways to satisfy their needs but from novel intuitions about future developments. In deciding to switch from a mechanically adaptive response to existing conditions to an attitude which impels them to act upon these conditions, entrepreneurs represent the disruptive force in the circular flow: ‘Carrying out a new plan [energetic rationality] and acting according to a customary one [hedonist rationality] are things as different as making a road and walking along it’ (ibid.: 85).

Given that Schumpeter, the historian of thought, bases his appraisal of Menger and the early Austrians on the qualitative distinction between the circular flow and economic evolution, a closer examination of the essence of this distinction is in place here. As we have pointed out above, the concept of economic evolution is, of course, directly linked to the introduction of the concepts of innovation, credit and entrepreneurship. However, given that we are, in the first place, engaged in an exercise of logical reconstruction, what is required is a more radical criterion to locate authors either in the logic of the circular flow or in that of economic evolution. What we need is a criterion that may help us understand why, despite their undisputed originality, it is possible to subsume Austrians along with marginalists under the logic of the circular flow. The criterion we have in mind concerns the idea of consumer sovereignty. In the circular flow, the production structure continually adapts to consumers’ needs. Individual needs are the ultimate cause of all economic phenomena, and individual behaviour is governed by the drive for need satisfaction. Given external conditions and individual needs are the two decisive factors that cooperate in determining the result of the economic process: ‘Production follows needs; it is so to speak pulled after them’ (ibid.: 12).

The logic of economic evolution requires a fundamental alteration of the role of consumer sovereignty: an innovation is not a better way to satisfy a given need. Rather, it anticipates a change of tastes and preferences. An innovation is not a hedonistic response – an adaptation to the existing structure of preferences – but a real activity which prompts adaptation on the side of the consumer:

Yet innovations in the economic system do not as a rule take place in such a way that first new wants arise spontaneously in consumers and then the productive apparatus swings round through their pressure. We do not deny the presence of this nexus. It is, however, the producer who as a rule initiates economic change, and consumers are educated by him if necessary.

(ibid.: 65)

To sum up, in the circular flow the production structure adapts to consumers’ needs, whereas in the course of economic evolution needs are endogenously modified by the creative actions of entrepreneurs on the supply side.

The Austrians and the logic of the circular flow

We can now return to Schumpeter’s ...