Joseph Schumpeter Research Paper

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Joseph A. Schumpeter is one of the best known and most flamboyant economists of the twentieth century. His main accomplishments are to have introduced the entrepreneur into economic theory through Theorie der wirtschaftlichen Entwicklung (1912) and to have produced a magnificent history of economic thought, History of Economic Analysis (posthumously published in 1954). Schumpeter’s interests were wide ranging, and his writings also include contributions to sociology and political science. His analysis of democracy, which can be found in his most popular work, Capitalism, Socialism, and Democracy (1942), is generally regarded as an important addition to the theory of democracy.

1. Early Life And Career

Joseph Alois Schumpeter was born on February 8, 1883 in the small town of Triesch in the Austro- Hungarian Empire (today Trest in Slovakia). His father was a cloth manufacturer and belonged to a family which had been prominent in the town for many generations; and his mother, who was the daughter of a medical doctor, came from a nearby village. Schumpeter’s father died when he was four years old, an event that was to have great consequences for the future course of his life. Some time later his mother moved to Graz and then to Vienna, where she got married to a retired officer from a well known, aristocratic family, Sigismund von Keler. Schumpeter was consequently born into a small-town bourgeois family but raised in an aristocratic one; and his personality as well as his work were to contain a curious mixture of values from both of these worlds.

After having graduated in 1901 from the preparatory school for the children of the elite in the Empire, Theresianum, Schumpeter enrolled at the University of Vienna. His goal from the very start was to become an economist. Around the turn of the century the University of Vienna had one of the best educations in economics in the world, thanks to Carl Menger and his two disciples Eugen von Bohm-Bawerk and Friedrich von Wieser. Schumpeter had the latter two as his teachers, and he also attended lectures in mathematics on his own. When Schumpeter received his doctorate in 1906, he was 23 years old and the youngest person to have earned this degree in the Empire.

After having traveled around for a few years and added to his life experience as well as to his knowledge of economics, Schumpeter returned in 1908 to Vienna to present his Habilitationsschrift. Its title was Das Wesen und der Hauptinhalt der theoretischen Nationalokonomie (1908; The Nature and Essence of Theoretical Economics), and it can be characterized as a work in economic methodology from an analytical perspective. In 1909 Schumpeter was appointed assistant professor at the University of Czernowitz and thereby became the youngest professor in Germanspeaking academia. It was also at Czernowitz that Schumpeter produced his second work, the famous Theorie der wirtschaftlichen Entwicklung (1912; 2nd edn. from 1926 trans. as The Theory of Economic Development). At the University of Graz, to which he moved as a full professor in 1911, Schumpeter produced a third major study, Epochen der Dogmenund Methodengeschichte (1914; trans. in 1954 as Economic Doctrine and Method ). Over a period of less than ten years Schumpeter had produced three important works, and one understands why he referred to the third decade in a scholar’s life as ‘the decade of sacred fertility.’

1.1 The Works From The Early Years

Das Wesen is today best known for being the place where the term ‘methodological individualism’ was coined. In its time, however, this work played an important role in introducing German students to analytical economics, which Gustav von Schmoller and other members of the Historical School had tried to ban from the universities in Germany. Das Wesen is well written and well argued, but Schumpeter would later regard it as a youthful error and did not allow a second edition to appear. The reason for Schumpeter’s verdict is not known, but it is probably connected to his vigorous argument in the book that economics must sever all links with the other social sciences.

While the emphasis in Das Wesen had been exclusively on statics, in his second book, Theorie der wirtschaflichen Entwicklung, it was on dynamics. Schumpeter very much admired Walras’ theory of general equilibrium, which he had tried to explicate in Das Wesen, but he was also disturbed by Walras’ failure to handle economic change. What was needed in economics, Schumpeter argued, was a theory according to which economic change grew out of the economic system itself and not, as in Walras, a theoretical scheme in which economic change was simply explained as a reaction to a disturbance from outside the economic system.

Schumpeter starts the argument in Theorie by presenting an economy where nothing new ever happens and which therefore can be analyzed with the help of static theory, that is all goods are promptly sold, no new goods are produced or wanted, and profits are zero. Schumpeter then contrasts this situation of a ‘circular flow’ with a situation in which the activities of the entrepreneur sets the whole economic system in motion, and which can only be explained with the help of a dynamic theory. The model that Schumpeter now presented in Theorie would later be repeated and embellished upon in many of his writings: the entrepreneur makes an innovation, which earns him a huge profit, this profit attracts a swarm of other, less innovative entrepreneurs and as a result of all these activities a wave of economic change begins to work its way through the economic system, a business cycle, in brief, has been set in motion. The theory of business cycles that one can find in Theorie is fairly rudimentary, and Schumpeter would later spend much time in improving upon it.

Much of Schumpeter’s analysis in Theorie is today forgotten and few economists are today interested in the way that Schumpeter explains interest, capital and profit by relating these to the activities of the entrepreneur. Some parts of Theorie, however, are still very much alive and often referred to in studies of entrepreneurship. In one of these Schumpeter discusses the nature of an innovation, and explains how it differs from an invention; while an invention is something radically new, an innovation consists of an attempt to turn something—for example, an invention—into a money-making enterprise. In another famous passage Schumpeter discusses the five main forms of innovations:

(1) The introduction of a new good … or of a new quality of a good. (2) The introduction of a new method of production … (3) The opening of a new market … (4) The conquest of a new source of supply of raw materials or halfmanufactured goods … (5) The carrying out of the new organization of any industry, like the creation of a monopoly position … or the breaking up of a monopoly position.

Schumpeter’s description of what drives an entrepreneur is also often referred to, as is his general definition of entrepreneurship: ‘the carrying out of new combinations.’

Schumpeter’s third work from these early years is a brief history of economics, commissioned by Max Weber (1914–20) for a handbook in political economy (Grundriss der Sozialokonomik). Its main thesis is that economics came into being when analytical precision, of the type that one can find in philosophy, came into contact with an interest in practical affairs, of the type that is common among businessmen; and to Schumpeter this meeting took place in the works of the Physiocrats. Epochen der Dogmenund Methodengeschichte was later overshadowed by the much longer History of Economic Analysis, but while the latter work tends to be used exclusively as a reference work, Schumpeter’s study from 1914 can be read straight through and is also more easy to appreciate.

1.2 Difficult Mid-Years

By the mid-1910s Schumpeter had established himself as one of the most brilliant economists in his generation, and like other well-known economists in the Austro-Hungarian Empire he hoped for a prominent political position, such as finance minister or economic adviser to the Emperor. During World War I Schumpeter wrote a series of memoranda, which were circulated among the elite of the Empire, and through which he hoped to establish himself as a candidate for political office. The various measures that Schumpeter suggested in these memoranda are of little interest today, for example, that the Empire must not enter into a customs union with its powerful neighbor, Germany. What is of considerably more interest, however, is that they provide an insight into Schumpeter’s political views when he was in his early 30s. Schumpeter’s political profile at this time can be described in the following way: he was a royalist, deeply conservative, and an admirer of tory democracy of the British kind.

Schumpeter’s attempt during World War I to gain a political position failed, but his fortune changed after the Empire had fallen apart and the state of Austria came into being. In early 1919 Schumpeter was appointed finance minister in a joint Social Democratic and Catholic Conservative government in Austria, led by Karl Renner. Already by the fall of 1919, however, Schumpeter was forced to resign, mainly because the Social Democrats felt that he had betrayed them and could not be trusted. The Social Democrats in particular thought that Schumpeter had gone behind their backs and stopped their attempts to nationalize parts of Austria’s industry. Schumpeter always denied this, and in retrospect it is difficult to establish the truth. What is clear, however, is that the Austrian Social Democrats advocated a democratic and peaceful form of socialism, while Schumpeter detested all forms of socialism.

Loath to go back to his position at the University of Graz, Schumpeter spent the early part of the 1920s working for a small bank in Vienna, the Biedermann Bank. Schumpeter did not take part in the everyday activities of the bank but mainly worked as an independent investor. These activities ended badly, however, and by the mid-1920s Schumpeter was forced to leave the Biedermann Bank and had by this time accumulated a considerable personal debt. For many years to come, Schumpeter would give speeches and write articles in order to pay back his debts. Adding to these economic misfortunes was the death in 1926 of his beloved wife Anna (‘Annie’) Reisinger, a 20 years younger working class girl to whom Schumpeter had only been married for a year. From this time on, Schumpeter’s friends would later say, there was a streak of pessimism and resignation in his personality.

In 1925 Schumpeter was appointed professor of public finance at the University of Bonn, and it is clear that he was both pleased and relieved to be back in academia. While his ambition, no doubt, extended to politics and business, he always felt an academic at heart. The great creativity that Schumpeter had shown in the 1910s was, however, not to return in the 1920s, and Annie’s death was no doubt an important reason for this. Schumpeter’s major project during the 1920s was a book in the theory of money, but this work was never completed to his satisfaction Schumpeter 1970). Schumpeter did, however, write several interesting articles during these years, some of which are still worth reading. One of these is ‘The Instability of Capitalism’ (1928), in which Schumpeter suggests that capitalism is undermining itself and will eventually turn into socialism. Another worthwhile article is ‘Gusta vs. Schmoller und die Probleme on heute’ (1926), in which Schumpeter argues that economics has to be a broad science, encompassing not only economic theory but also economic history, economic sociology and statistics. Schumpeter’s term for this type of general economics is ‘Sozialokonomik.’

To illustrate what economists can accomplish with the help of sociology, Schumpeter wrote an article on social classes (1927), which is still often referred to. Schumpeter starts out by drawing a sharp line between the way that the concept of class is used in economics and in sociology. In economics, Schumpeter says, class is basically used as a category (e.g., wage-earner nonwage-earner), while in sociology class is seen as a piece of living reality. An attempt was also made by Schumpeter to link his theory of the entrepreneur to the idea of class.

In mentioning Schumpeter’s articles on social classes, something must also be said about two of his other famous studies in sociology: ‘The Fiscal Crisis of the Tax State’ (1918) and ‘The Sociology of Imperialisms’ (1918–19). The former study can be described as a pioneer effort in the sociology of taxation, which focuses on the situation in Austria just after World War I but which also attempts to formulate some general propositions about the relationship between taxation and society. Schumpeter, for example, suggests that if the citizens demand more and more subventions from the state, but are unwilling to pay for these through ever higher taxes, the state will collapse. In the article on imperialism, Schumpeter argues that imperialism grows out of a social situation which is not to be found in capitalism; and whatever imperialist forms that still exist represent an atavism and a leftover from feudal society. Schumpeter’s famous definition of imperialism is as follows: ‘imperialism is the objectless disposition on the part of the state to unlimited forcible expansion.’

2. The Years In The United States

By 1930 Schumpeter was still depressed about his life and quite unhappy about his career; he had found no one to replace his wife on an emotional level and he felt that he deserved a better professional position than Bonn. When Werner Sombart’s chair at the University of Berlin became vacant, Schumpeter had high hopes that he would get it. When this did not happen, however, he instead accepted an offer from Harvard University; and in 1932 he moved to Cambridge, Massachusetts for good. Schumpeter was slowly to regain his emotional composure, and also his capacity to work, in the United States. In 1937 he got married to economist Elizabeth Boody, who regarded it as her duty in life to take care of Schumpeter and manage his worldly affairs. With the support of his wife, Schumpeter produced three major works: Business Cycles (1939), Capitalism, Socialism and Democracy (1942), and History of Economic Analysis (published posthumously in 1954).

2.1 The Works From The American Period

Of these three works, the one for which Schumpeter had the highest hopes was definitely Business Cycles (1939), which appeared exactly 25 years after his last book in Europe. This work is more than 1100 pages long and it traces business cycles in Great Britain, the United States and Germany during the years 1787– 1938. Schumpeter had hoped that Business Cycles would get the kind of reception that Keynes’ General Theory got, and he was deeply disappointed by the lack of interest that his colleagues and other economists showed. The impression one gets from histories of economic thought, however, is that Business Cycles is rarely read today, mainly because few people are persuaded by Schumpeter’s theory that business cycles are set off by innovations and that their motion can be best described as a giant Kondratieff cycle, modified by Juglar and Kitchin cycles; Schumpeter’s handling of statistics is also considered poor. To a large extent this critique is true, although it should also be noted that a number of themes and issues in this and other of Schumpeter’s works are increasingly being referred to in evolutionary economics.

After many years of excruciatingly hard work on Business Cycles, Schumpeter decided that he needed an easier task to work on than the recasting of economic theory that was on his agenda since the time in Bonn. In the late 1930s Schumpeter therefore began working on what he saw as a minor study of socialism. This minor study, however, quickly grew in size, and when it finally appeared in 1942—under the title Capitalism, Socialism, and Democracy—it was nearly 400 pages long. Of all of Schumpeter’s works (1942), this book was to become the most popular one, especially in the United States where it is still considered a standard work in political science. Capitalism, Socialism, and Democracy has also been translated into more languages than any other work by Schumpeter, and it is still in print.

Capitalism, Socialism, and Democracy contains an interesting history of socialist parties (part V), a fine discussion of the nature of socialism (part III), and an excellent discussion of the work of Karl Marx (part I). What has made this work into a social science classic, however, are its two remaining parts with their discussion of capitalism (part II) and the nature of democracy (part IV). Capitalism, Schumpeter says, can be characterized as a process of continuous economic change, through which new enterprises and industries are continuously being created and old ones continuously being destroyed. Schumpeter’s famous term for this process is ‘creative destruction.’ Perfect competition of the type that economists talk about, he also says, is a myth; and monopolies, contrary to common belief and economists’ dogma, are often good for the economy. Without monopolies, for example, very expensive forms of research and investments would seldom be undertaken.

Schumpeter’s theory of monopolies has led to a large number of studies of innovation. By ‘the Schumpeterian hypothesis’ two propositions are meant: that large firms are more innovative than small firms, and that innovation tends to be more frequent in monopolistic industries than in competitive ones. Each of these hypotheses can in their turn be broken down into further hypotheses. Many decades later the results of all of these studies are still inconclusive, and there is no consensus if monopolistic forms of enterprise further or obstruct innovation (for an overview of research on the Schumpeterian hypothesis, see Kamien and Schwartz 1982).

Schumpeter’s overall theory in Capitalism, Socialism, and Democracy—the idea that capitalism is on its way to disappear and be replaced by socialism—has, on the other hand, led to little concrete research. One reason for this is probably that many readers of Schumpeter’s book have felt that his argument is very general in nature and at times also quite idiosyncratic. Schumpeter argues, for example, that capitalism tends to breed intellectuals, and that these are hostile to capitalism; that the bourgeois class is becoming unable to appreciate property; and that the general will of the bourgeoisie is rapidly eroding. ‘Can capitalism survive?’ Schumpeter asks rhetorically, and then gives the following answer, ‘No. I do not think it can.’ Schumpeter’s conclusion about the inevitable fall of capitalism has often been sharply criticized (e.g., Heertje 1981). His more general attempt to tackle the question of how social and economic institutions are needed for an economic system to work properly has, however, remained unexplored. There also exists a certain tendency to cite catchy phrases from Schumpeter’s work without paying attention to their organic place in his arguments.

What has always been much appreciated in Capitalism, Socialism, and Democracy is Schumpeter’s theory of democracy. Schumpeter starts out by criticizing what he calls ‘the classical doctrine of democracy,’ which he characterizes in the following way: ‘the democratic method is that institutional arrangement for arriving at political decisions which realizes the common good by making the people itself decide issues through the election of individuals who are to assemble in order to carry out its will.’ What is wrong with this theory, he argues, is that there is no way of establishing what the common good is. There is also the additional fact that politicians do not have interests of their own, according to this theory; their function is exclusively to translate the desires of the people into reality.

To the classical type of democracy Schumpeter counterposes his own theory of democracy, which he defines in the following manner: ‘the democratic method is that institutional arrangement for arriving at political decisions in which individuals acquire the power to decide by means of a competitive struggle for the people’s vote.’ Some critics have argued that Schumpeter’s theory is elitist in nature, since democracy is reduced to voting for a political leader at regular intervals. This may well be true, and Schumpeter’s theory of democracy no doubt coexists in his work with contempt for the masses. Regardless of this critique, however, Schumpeter’s theory is generally regarded as being considerably more realistic than the classical doctrine of democracy.

World War II was a very trying time for Schumpeter since he felt emotionally tied to German speaking Europe, even though he by now was a US citizen. Schumpeter did not support the Nazis but like many conservatives felt that Communism constituted a more dangerous enemy than Hitler. Schumpeter’s intense hatred of Roosevelt, whom he suspected of being a socialist, also put him on a collision course with the academic community in Cambridge during World War II. In his diary Schumpeter expressed his ambivalence towards Hitler, Jews, Roosevelt and many other things; and in his everyday life he more and more withdrew into solitude and scholarship. The War, in brief, was a very difficult and demoralizing time for Schumpeter.

From the early 1940s Schumpeter started to work feverishly on a giant history of economic thought that was to occupy him till his death some ten years later. He did not succeed in completing History of Economic Analysis, which was instead put together by Elizabeth Boody Schumpeter after several years of work. History of Economic Analysis is many times longer than Schumpeter’s history of economics from 1914, and it is also considerably more sophisticated in its approach. Schumpeter’s ambition with this work, it should first of all be noted, was not only to write the history of economic theory, but also to say something about economic sociology, economic history, and economic statistics, the four ‘fundamental fields’ of economics or Sozialokonomik. It should also be mentioned that History of Economic Analysis begins with a very interesting methodological discussion of the nature of economics. This is then followed by a brilliant, though occasionally willful discussion of economics from classical Greece to the years after World War I. The section on twentieth century economics was unfortunately never completed, but it is clear that Schumpeter was very discontent with the failure of his contemporaries to create a truly dynamic economic theory.

Schumpeter died in his sleep on January 8, 1950 and the cause was put down as cerebral hemorrhage. Some of his friends thought that the real reason was overwork, while his diary shows that he had been tired of life for a long time. Schumpeter’s private notes also show that behind the image of brilliant lecturer and iconoclastic author, which Schumpeter liked to project, there was a person who felt deeply unhappy with the way that his life had evolved and with his failure to produce a theory that would revolutionize economic thought. ‘With a fraction of my ideas,’ he wrote in dismay a few years before his death, ‘a new economics could have been founded.’


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