The Competitiveness of Nations

in a Global Knowledge-Based Economy

May 2003

AAP Homepage

Nathan Rosenberg

Exploring the Black Box:

Technology, economics and history

3 Joseph Schumpeter: radical economist

Cambridge University Press

Cambridge, U.K. 1994

pp. 47-61


I - Introduction

II - Stationary Capitalism as a Contradiction in Terms

III – Schumpeterian Competition

IV – The Growth and Limitations of Rationality

V – Consumer Taste

VI – Economics is History

HHC – titling and index added

I - Introduction

This chapter will deal with Schumpeter’s book, Capitalism, Socialism and Democracy, as the mature statement of the most radical scholar in the discipline of economics in the twentieth century.

Of course, I do not mean to suggest that Joseph Schumpeter held views on the organization of the economy, or society generally, that make it appropriate to label him as a radical in the political sense.  In his social and political views Schumpeter was anything but radical.  In fact, one could make a case - although I do not propose to do so - that Schumpeter was not merely conservative in his social views, but reactionary.  In his most private thoughts, as suggested by a recent biography, he seemed to possess an insatiable longing for the glorious later days of the Hapsburg monarchy.  Moreover, the most charitable characterization of his attitude toward Nazi Germany in the darkest days of the 1930s and the Second World War is that he was ambivalent.

The reason I propose to call Schumpeter a radical is that he urged the rejection of the most central and precious tenets of neo-classical theory.  Indeed, I want to insist that very little of the complex edifice of neo-classical economics, as it existed in the late 1930s and 1940s, survives the sweep of Schumpeter’s devastating assaults.  But in examining Schumpeter’s criticisms, it is not my primary intention to enlist his authority in an attack upon neo-classical economics.  Rather, I propose to show that the quintessential, later Schumpeter, the author of Capitalism, Socialism and Democracy, held views that were not only genuinely radical, but that are deserving of far more serious attention than they receive today, even, or perhaps especially,

This chapter was first presented at the meetings of the Schumpeter Society in Kyoto, in August, 1992. That meeting marked the fiftieth anniversary of the publication of Capitalism, Socialism, and Democracy.

47 Index

from scholars who think of themselves as working within the Schumpeterian tradition.  While this chapter focuses on Capitalism, Socialism, and Democracy, I draw upon Schumpeter’s other writings to round out the argument and interpretation that I am proposing.


II - Stationary Capitalism as a Contradiction in Terms

I begin by quoting from Schumpeter’s preface to the Japanese edition of The Theory of Economic Development, for in that preface Schumpeter sketches out what is probably the most precise and succinct statement of his own intellectual agenda that he ever committed to print.  That agenda focuses not only upon the understanding of how the economic system generates economic change, but also upon how that change occurs as a result of the working out of purely endogenous forces:

If my Japanese readers asked me before opening the book what it is that I was aiming at when I wrote it, more than a quarter of a century ago, I would answer that I was trying to construct a theoretic model of the process of economic change in time, or perhaps more clearly, to answer the question how the economic system generates the force which incessantly transforms it... I felt very strongly that there was a source of energy within the economic system which would of itself disrupt any equilibrium that might be attained.  If this is so, then there must be a purely economic theory of economic change which does not merely rely on external factors propelling the economic system from one equilibrium to another.  It is such a theory that I have tried to build. [1]

It should be noted that these words were published in 1937, when Schumpeter was, as we know, already at work on Capitalism, Socialism and Democracy.  In fact, I regard Capitalism, Socialism and Democracy as the fulfillment of precisely the intellectual agenda that Schumpeter articulated in the passage to his Japanese readers that I have just quoted.

Of course, an account of how and why economic change took place was precisely something that could not be provided within the “rigorously static” framework of neo-classical equilibrium analysis, as Schumpeter referred to it.  Schumpeter also observed that it was Walras’ view that economic theory was only capable of examining a “stationary process,” that is, “a process which actually does not change of its own initiative, but merely produces constant rates of real income as it flows along in time.”  As Schumpeter interprets Walras:

1. Joseph Schumpeter, Preface to Japanese edition of Theorie Der Wirtschaftlichen Eniwicklung, as translated by I. Nakayama and S. Tobata, Tokyo, Iwanami Shoten, 1937.  As reprinted in Essays of J.A. Schumpeter, ed. Richard V. Clemence, Addison-Wesley, Cambridge (MA), 1951, p. 158.


He would have said (and, as a matter of fact, he did say it to me the only time that I had the opportunity to converse with him) that of course economic life is essentially passive and merely adapts itself to the natural and social influences which may be acting on it, so that the theory of a stationary process constitutes really the whole of theoretical economics and that as economic theorists we cannot say much about the factors that account for historical change, but must simply register them. [2]

The critical point here is that Schumpeter directly rejects the view of Walras that economic theory must be confined to the study of the stationary process, and that it cannot go farther than demonstrating how departures from equilibrium, such as might be generated by a growth in population or in savings, merely set into motion forces that restore the system to an equilibrium path.  In proposing to develop a theory showing how a stationary process can be disturbed by internal as well as external forces, Schumpeter is suggesting that the essence of capitalism lies not in equilibrating forces but in the inevitable tendency of that system to depart from equilibrium - in a word, to disequilibrate.  Equilibrium analysis fails to capture the essence of capitalist reality.  Lest there should be any doubt about Schumpeter’s position on this critical matter, we cite his own forceful formulation: “Whereas a stationary feudal economy would still be a feudal economy, and a stationary socialist economy would still be a socialist economy, stationary capitalism is a contradiction in terms.” [3]

Although Schumpeter did in fact make important use of Walrasian general equilibrium in his analysis of the circular flow in a stationary state, he used the concept precisely as a means of demonstrating how capitalist economies would behave if they were deprived of their essential feature: that is, innovative activities that are the primary generator of economic change.

It is important to understand this methodological use that Schumpeter makes of the neo-classical analysis of a stationary economic process.  As Schumpeter stated: “In appraising the performance of competitive enterprise, the question whether it would or would not tend to maximize production in a perfectly equilibrated stationary condition of the economic process is... almost, though not quite, irrelevant.” [4]

The reason it is not completely irrelevant is that the model of a stationary competitive process helps us to understand the behavior of an economy that possesses no internal forces generating economic change.  Thus, the model of a Walrasian circular flow constitutes Schumpeter’s starting point in understanding the essential elements of capitalist reality because it shows

2. Ibid., pp. 2-3.

3. Joseph Schumpeter, “Capitalism in the Postwar World,” in Essays of J.A. Schumpeter, ed. Clemence, p. 174.

4. Joseph Schumpeter, Capitalism, Socialism and Democracy, second edition, George Allen & Unwin, Ltd., London, 1943, p. 77.

49 Index

how that system would behave in the absence of its most distinctive feature - innovation.  It is an invaluable abstraction precisely because it makes it possible to trace out with greater precision the impact of innovative activity.  This is the role served by the Walrasian conception of the circular flow in Schumpeter’s analysis of business cycles as well as growth.

Of course, one can always adopt the position that Schumpeter and neo-classical economics address very different questions, and that the theoretical analysis of each is valid in its particular intellectual context.  Newton’s law of gravity, after all, was not invalidated by Mendeleev’s periodic table of the elements.  Each theory was devised to account for different classes of phenomena.  They do not contradict each other and they may, therefore, be simultaneously valid - or invalid.

I believe that there is something to be said in support of such a position.  But I am not at all confident that the Schumpeter of part II of Capitalism, Socialism and Democracy would have been satisfied with it.  Schumpeter’s position seems to be that, if you want to understand what capitalism is all about as an economic system, the fundamental question is how it generates economic change rather than how it restores stability.  Not all theoretical frameworks are equally useful in analyzing the essential feature of modern capitalism.  And again, the essential feature, in Schumpeter’s view, is economic change.  This is because the capitalist form of economic organization has a built-in logic that dominates the behavior of that economic system.  Thus, economists who purport to have something to say that is pertinent to the contemporary operation of capitalism have the obligation to deal with certain distinctive patterns of capitalist behavior and to explain their consequences.  The behavior of capitalism is totally dominated by the continual working out of its inner logic, the essence of which is economic change resulting from the impact of the innovation process.

Equilibrium analysis, on the other hand, focuses upon adjustment mechanisms that are only peripheral, and not central, to the logic of capitalist organization and incentives.  Therefore a theoretical approach that neglects persistent disequilibrium, instability and growth is an approach that deals with processes that are, at best, phenomena of secondary importance, or only mere epiphenomena. [5]


III – Schumpeterian Competition

I do not propose to examine in any detail Schumpeter’s views on innovation, or the breadth of his definition of innovation, since these are

5. For a perceptive examination of the limits of equilibrium analysis in the context of innovation studies, see Richard R. Nelson, “Schumpeter and Contemporary Research on the Economics of Innovation,” unpublished manuscript, Columbia University, February 1992.


familiar to all readers of his major works.  I do, however, propose to underline the rather radical implications that Schumpeter himself drew from the primacy that he attached to innovation - implications that have received little attention.  The dynamic forces that are inherent in the capitalist structure lead Schumpeter to treat capitalism as a system whose essential feature is an evolutionary process and not the mechanisms that force the system to revert to an equilibrium after some external force has produced a small departure from that equilibrium.  For those who find the term “disequilibrium analysis” too paradoxical to be useful as a description of Schumpeter’s mode of economic analysis, I suggest the propriety of the term “evolutionary.”  My justification is a simple one: it is Schumpeter’s own frequently used term in Capitalism, Socialism and Democracy:

The essential point to grasp is that in dealing with capitalism we are dealing with an evolutionary process... Capitalism... is by nature a form or method of economic change and not only never is but never can be stationary.  And this evolutionary character of the capitalist process is not merely due to the fact that economic life goes on in a social and natural environment which changes and by its changes alters the data of economic action; this fact is important and these changes (wars, revolutions and so on) often condition industrial change, but they are not its prime movers.  Nor is this evolutionary character due to a quasi-automatic increase in population and capital or to the vagaries of monetary systems of which exactly the same thing holds true. [6]

I ask readers of Capitalism, Socialism and Democracy to ponder the far-reaching implications of this statement.  For it involves not only the recognition of the inherently dynamic nature of capitalism.  It involves also nothing less than the rejection of the competitive ideal itself, as that ideal is enshrined not only in economists’ models but also in decades of government regulation and, in the United States, in a full century of anti-trust legislation.  In this view, textbook competition is not an ideal state to be pursued.  The welfare implications of the competitive ideal reflect a mistaken preoccupation with the distinctly secondary issue of how the economy allocates an existing stock of resources; whereas the far more significant concern for Schumpeter is how successful an economic system is at generating growth - growth in a qualitative as well as a quantitative sense.  In my own reading, this deserves to be regarded as the central message of Capitalism, Socialism and Democracy.  Capitalists survive, if they survive at all, by learning to live in, and to participate in, a “perennial gale of creative destruction... the problem that is usually being visualized is how capitalism administers existing structures, whereas the relevant problem is how it creates and destroys them.” [7]  I call attention to the

5. Schumpeter, Capitalism, Socialism and Democracy, p. 82.  See also ibid., p. 58.

6. Ibid., p. 84.

51 Index

significant fact that Schumpeter attached so much importance to this last observation that he repeated it, almost verbatim, in the preface to the second edition of Capitalism, Socialism and Democracy.[8]

In my view, if one is looking for a distinctively “Schumpeterian hypothesis,” it lies in this definition of the essential nature of the competitive process.  Perhaps this should not be regarded as a hypothesis, since it is difficult to reduce it to a testable, potentially refutable form.  It is more in the nature of a conception or, better, to use a favorite Schumpeterian term, a “vision” of the essential nature of capitalism.  It is a vision in which it is a mistake to reduce monopoly to the purely restrictive and anti-social consequences that are normally ascribed to it, since monopoly power is often a temporary adjunct of the process of creative destruction.  The Schumpeter of Capitalism, Socialism and Democracy does indeed attach considerable significance to the growth in the absolute size of the firm in the course of the twentieth century.  At the same time, I would like to insist that a “Schumpeterian hypothesis,” which postulates a strong association between market power and innovation, is an extreme oversimplification of a much more sophisticated - and much more radical - view of the meaning of competition. [9]

Thus, Schumpeter is involved in an explicit rejection of the central neo-classical notion that atomistic competition offers unique welfare advantages.  In Capitalism, Socialism and Democracy he posits a novel conception of competition based upon innovation as a central element in a disequilibrium process that leads the economy to higher levels of income, output, and, presumably, well-being.  In the course of the twentieth century the large-scale firm, with its internal research capabilities, has become the dominant engine of technical progress.  This is a main theme of Capitalism, Socialism and Democracy, as opposed to his earlier book, The Theory of Economic Development.  Schumpeter’s argument is certainly closely tied to bigness and to the dismissal of the virtues of perfect competition.  It recognizes some degree of monopoly power as a passing phase of the innovation process.  But rejecting the virtues of perfect competition is not the same thing as saying that monopoly power is inherently favorable to innovation.

Thus it is not sufficient to argue that because perfect competition is impossible under modern industrial conditions - or because it always has been impossible - the large-scale establishment or unit of control must be accepted as a necessary evil inseparable from the economic progress which it is prevented from sabotaging by the forces inherent in its productive apparatus.  What we have got to accept is that it

8. Ibid., p. x.

9. See Nelson, “Schumpeter and Contemporary Research on the Economics of Innovation,” for an illuminating discussion of this issue.


has come to be the most powerful engine of that progress and in particular of the long-run expansion of total output not only in spite of, but to a considerable extend through, this strategy which looks so restrictive when viewed in the individual case and from the individual point of time.  In this respect, perfect competition is not only impossible but inferior, and has no title to being set up as a model of ideal efficiency. [10]

Indeed, the perennial gale of creative destruction is continually sweeping away entrenched monopoly power that appeared so secure until a new innovation consigned it to the scrapheap of history.  That is precisely why the perennial gale is such a critically important economic force.


IV – The Growth and Limitations of Rationality

But there is much more to Schumpeter the radical anti-neo-classicist than has been suggested so far.  This becomes apparent as soon as it is recognized that innovation, the central feature of capitalist reality, is not a product of a decision-making process that can be described or analyzed as “rational”:

the assumption that business behaviour is ideally rational and prompt, and also that in principle it is the same with all firms, works tolerably well only within the precincts of tried experience and familiar motive.  It breaks down as soon as we leave those precincts and allow the business community under study to be faced by - not simply new situations, which also occur as soon as external factors unexpectedly intrude but by - new possibilities of business action which are as yet untried and about which the most complete command of routine teaches nothing.  Those differences in the behaviour of different people which within those precincts account for secondary phenomena only, become essential in the sense that they now account for the outstanding features of reality and that a picture drawn on the Walras-Marshallian lines ceases to be true - even in the qualified sense in which it is true of stationary and growing processes: it misses those features, and becomes wrong in the endeavour to account by means of its own analysis for phenomena which the assumptions of that analysis exclude. [11]

It is, of course, difficult to imagine a more profound rejection of neo-classical economics than is embodied in Schumpeter’s forceful assertion that the most important feature of capitalist reality - innovation - is one to which rational decision-making has no direct application.  The nature of the innovation process, the drastic departure from existing routines, is inherently one that cannot be reduced to mere calculation, although subsequent imitation of the innovation, once accomplished, can be so reduced.  Innovation is the creation of knowledge that cannot, and therefore should

10. Schumpeter, Capitalism, Socialism and Democracy, p. 106.

11. Joseph Schumpeter, Business Cycles, 2 vols., McGraw-Hill Book Company, New York, 1939, vol. I, pp. 98-99.

53 Index

not, be “anticipated” by the theorist in a purely formal manner, as is done in the theory of decision-making under uncertainty.  In Schumpeter’s view, it would be entirely meaningless to speak of “the future state of the world,” as that state is not merely unknown, but also indefinable in empirical and historical terms.  Serious doubt is thus cast on what meaning, if any, can be possessed by intertemporal models of equilibrium under uncertainty, in which the essential nature of innovation is systematically neglected.

Thus, if rationality is reduced in the neo-classical world more and more to the tautology that people do the best they can, given the whole gamut of constraints they face - among the most important of which is the informational constraint - then accepting Schumpeter’s concept of innovation means that human actions are always second best in a way that ultimately cannot be subjected to further analysis.  For rational behavior, in Schumpeter’s view, is most significant in a world of routine and repetition of similar events. (Needless to say, the modern literature on rational expectations does not overcome Schumpeter’s strictures here.  The “rationality” of rational expectations is limited by currently available information, and thus the inherent uncertainty concerning the future is not eliminated).

But this is not the end of Schumpeter’s rather complex treatment of the role of rationality.  If one considers rationality in the long historical context, Schumpeter mounts an argument in Capitalism, Socialism and Democracy the essential element of which is that capitalism, considered as a civilization, has continuously enlarged the social space within which rationalistic attitudes and habits of thought come to prevail. [12]  In chapter 11, “The Civilization of Capitalism,” Schumpeter argues that capitalism has expanded the sphere within which “rational cost-profit calculations” could be carried out.  Moreover,

primarily a product of the evolution of economic rationality, the cost-profit calculus in turn reacts upon that rationality; by crystallizing and defining numerically, it powerfully propels the logic of enterprise.  And thus defined and quantified for the economic sector, this type of logic or attitude or method then starts upon its conqueror’s career, subjugating - rationalizing - man’s tools and philosophies, his medical practice, his picture of the cosmos, his outlook on life, everything in fact including his concepts of beauty and justice and his spiritual ambitions. [13]

This aspect of Schumpeter’s argument - what he himself might have described as his own “economic sociology” - is, in my opinion, analytically brilliant, breathtaking in its sweep and, historically, substantially correct.  I regret that it is impossible here to examine his argument in detail.  I remind

12. Contrast this view with Babbage’s treatment of rationality and the “Mental Division of Labour” in the previous chapter.

13. Schumpeter, Capitalism, Socialism and Democracy, pp. 123-124.


you of it now because it is the linch pin of Schumpeter’s argument that capitalism will eventually “self-destruct.”  The self-destruction is inevitable because, in his view, the historical expansion of rationality brings in its wake two crucial consequences.

The first is that rationality challenges and unfrocks beliefs and institutions that cannot survive the searching and corrosive glare of a (presumably narrow) rationality:  “When the habit of rational analysis of, and rational behavior in, the daily tasks of life has gone far enough, it turns back upon the mass of collective ideas and criticizes and to some extent ‘rationalizes’ them by way of such questions as why there should be kings and popes or subordination or tithes or property.” [14]

The second consequence is that, as capitalism expands the sphere to which rationality applies, it learns eventually how to supplant the entrepreneur, the human “carrier” of innovation, with institutions that do away with the social leadership of the entrepreneur himself.  The entrepreneurial function itself becomes rationalized - or bureaucratized - with the growth of the large firm.  “For... it is now much easier than it has been in the past to do things that lie outside familiar routine - innovation itself has been reduced to routine.  Technological progress is increasingly becoming the business of teams of trained specialists who turn out what is required and make it work in predictable ways.” [15]

Of course, the growth of large-scale enterprise and the “obsolescence of the entrepreneurial function” led Schumpeter, through the rich argument of his economic and political sociology, to his conclusion that capitalism cannot survive.  The ideology and social myths that once sustained it cannot survive its tendency to “automatize progress” [16] and thus to reveal its new-found ability to do without the leadership and vitality once provided by the entrepreneur and the bourgeoisie.

My own view - with the easy wisdom of fifty years of retrospection - is that Schumpeter much overstated the extent to which technological progress would become automatized.  I believe that this, in turn, is partly due to his intensive focus upon the earliest stages in the innovation process, and to his failure to consider the degree to which commercial success is dependent upon subsequent stages in the carrying out of an innovation.  But, regrettably, these issues cannot be explored here.  What is essential to my examination of Schumpeter the radical is the observation that, both in the past and in the future, it is Schumpeter’s view that a rational approach to the innovation process is incompatible with capitalist institutions.  So long as the function was carried out by the individual entrepreneur, it was an act based upon intuition and charismatic leadership; when capitalist

14. Ibid., p. 122.

15. Ibid., p. 132.

16 Ibid., p. 134.

55 Index

institutions eventually, at some future date, succeed in subjecting innovation to a rationalized routine, those institutions will, ipso facto, lose their lustre and social justification, and be replaced by a socialized state.

Thus, in a world where capitalist institutions continue to prevail, innovation calls upon a decision-making process that goes beyond rational calculation.  When capitalist development eventually leads to the institutionalization of innovation, the organizational basis of the economy will, Schumpeter believes, be transformed into some form of socialism.  In neither case, ironically, does Schumpeter concede a significant role for the neo-classical analysis of rational behavior.


V – Consumer Taste

Schumpeter’s radical anti-neo-classical stance extends even to the issue of what it is that constitutes the explicanda of economic analysis.  It is normal practice for neo-classical economists to take tastes and technology as exogenously given, and to seek to examine issues of resource allocation by explicit reference to changes in incomes and relative prices. [17]

Thus, Schumpeter’s assault upon neo-classical economics includes even his deliberate violation of the sanctum sanctorum of the neo-classical citadel: the commitments to the exogeneity of consumer preferences and the associated virtues of consumer sovereignty.  His belief that the central problem of the economist is to account for economic change over time undoubtedly played an important role in sharpening his perception of the forces influencing consumer preferences:

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; they are, as it were, taught to want new things, or things which differ in some respect or other from those which they have been in the habit of using.  Therefore, while it is permissible and even necessary to consider consumers’ wants as an independent and indeed the fundamental force in a theory of the circular flow, we must take a different attitude as soon as we analyse change. [18]

Schumpeter made the same essential point later on in Business Cycles:

We will, throughout, act on the assumption that consumers’ initiative in changing their tastes - i.e., in changing that set of our data which general theory comprises in

17. See George Stigler and Gary Becker, “De Gustibus non est Disputandum,” American Economic Review, 67 (1977), pp. 76-90.

18. Joseph Schumpeter, The Theory of Economic Development, Harvard University Press, Cambridge (MA), 1949, p. 65 Schumpeter’s italics. (first published in German in 1911).


the concepts of “utility functions” or “indifference varieties” - is negligible and that all change in consumers’ tastes is incident to, and brought about by, producers’ actions.  This requires both justification and qualification.

The fact on which we stand is, of course, common knowledge.  Railroads have not emerged because any consumers took the initiative in displaying an effective demand for their service in preference to the services of mail coaches.  Nor did the consumers display any such initiative wish to have electric lamps or rayon stockings, or to travel by motorcar or airplane, or to listen to radios, or to chew gum.  There is obviously no lack of realism in the proposition that the great majority of changes in commodities consumed has been forced by producers on consumers who, more often than not, have resisted the change and have had to be educated up by elaborate psychotechnics of advertising. [19]

Although modern economists have, of course, investigated the consequences of endogenous preferences for welfare judgments, most have considered it better, for reasons of division of labor with other disciplines, in particular psychology, to neglect the investigation of why and how tastes change. [20]  But Schumpeter asserted that innovation, the fundamental driving force of the historical evolution of capitalism, would mould tastes as well as technology in unexpected ways.  The implications, both for the development of the economic and social systems, as well as for microeconomic welfare judgments were, as Schumpeter recognized, potentially radical.  Just before his death in 1950 he severely criticized economists for the uncritical belief that so many seem to harbor in the virtues of consumers’ choice:

First of all, whether we like it or not, we are witnessing a momentous experiment in malleability of tastes - is not this worth analyzing?  Second, ever since the physiocrats (and before), economists have professed unbounded respect for the consumers’ choice - is it not time to investigate what the bases for this respect are and how far the traditional and, in part, advertisement-shaped tastes of people are subject to the qualification that they might prefer other things than those which they want at present as soon as they have acquired familiarity with these other things?  In matters of education, health, and housing there is already practical unanimity about this - but might the principle not be carried much further?  Third, economic theory accepts existing tastes as data, no matter whether it postulates utility functions or indifference varieties or simply preference directions, and these data are made the starting point of price theory.  Hence, they must be considered as independent of prices.  But considerable and persistent changes in prices obviously do react upon tastes.  What, then, is to become of our theory and the whole of microeconomics?  It is investigations of this kind, that might break new ground, which I miss. [21]

19. Schumpeter, Business Cycles, vol. I, p. 73.

20. See, for example, Milton Friedman, Price Theory, Aldine Publishing Company, New York, 1976, p. 13.

21. Joseph Schumpeter, “English Economists and the State-Managed Economy,” Journal of Political Economy (1949), pp. 380-381.  Schumpeter’s italics.

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The earlier discussion of Schumpeter’s analysis of innovation has already anticipated his unwillingness to treat technological change, as well as consumers’ tastes, as an exogenous phenomenon.  But it is necessary to distinguish between the earlier Schumpeter of The Theory of Economic Development (1911) and the later Schumpeter of Capitalism, Socialism and Democracy (1942).  In his earlier book, Schumpeter looked upon invention as an exogenous activity and upon innovation as endogenous.  Whereas inventors conducted their activities off the economic stage and contributed their artifacts to a pool of invention, the timing of the entrepreneurial decision to draw from this pool was decisively shaped by economic forces.  But the later Schumpeter saw both invention and innovation as generated by economic forces inside the large firm with its own internal research capabilities.  The reason for the change in Schumpeter’s views during this period is not far to seek: the economic world, the object of Schumpeter’s studies, had changed substantially during the period between the publication of the two books.  Schumpeter’s altered views were an acknowledgment of empirical changes that had occurred during his own professional lifetime.

Schumpeter’s insistence upon the role of endogenous forces applies, not only to technology, but also to science itself.  The rationalizing influence of the capitalistic mentality and institutions created “the growth of rational science” as well as its “long list of applications.” [22]  Significantly, Schumpeter cites as examples not only “Airplanes, refrigerators, television and that sort of thing...” but also the “modern hospital.”  Although one might be surprised at the appearance here of an institution that is not commonly operated on a profitmaking basis, Schumpeter’s explanation is illuminating.  It is

fundamentally because capitalist rationality supplied the habits of mind that evolved the methods used in these hospitals.  And the victories, not yet completely won but in the offing, over cancer, syphilis and tuberculosis will be as much capitalist achievements as motorcars or pipe lines or Bessemer steel have been.  In the case of medicine, there is a capitalist profession behind the methods, capitalist both because to a large extent it works in a business spirit and because it is an emulsion of the industrial and commercial bourgeoisie.  But even if that were not so, modern medicine and hygiene would still be by-products of the capitalist process just as is modern education. [23]

Thus, Schumpeter insisted that both science and technology, normally so far from the world of phenomena examined by neo-classical economics, are in reality highly endogenous to the economic world, subject to the gravitational pull of economic forces.  In one of the last articles published during his own lifetime, Schumpeter identified his views with those of Marx

22. Schumpeter, Capitalism, Socialism and Democracy, p. 125.

23. Ibid., pp. 125-126.


on the role played by western capitalism in accounting for progress in both science and technology.  Schumpeter observed that Marx had, in the Communist Manifesto, “launched out on a panegyric upon bourgeois achievement that has no equal in economic literature.”  After quoting a relevant portion of the text, he says:

No reputable “bourgeois” economist of that or any other time - certainly not A. Smith or J.S. Mill - ever said as much as this.  Observe, in particular, the emphasis upon the creative role of the business class that the majority of the most “bourgeois” economists so persistently overlooked and of the business class as such, whereas most of us would, on the one hand, also insert into the picture non-bourgeois contributions to the bourgeois success - the contributions of non-bourgeois bureaucracies, for instance - and, on the other hand, commit the mistake (for such I believe it is) to list as independent factors science and technology, whereas Marx’s sociology enabled him to see that these as well as “progress” in such fields as education and hygiene were just as much the products of the bourgeois culture - hence, ultimately, of the business class - as was the business performance itself. [24]

Did Schumpeter then believe, along with Marx, in the economic interpretation of history?  I suggest that he did, with certain qualifications.  However, the qualifications that Schumpeter imposed upon the economic interpretation of history were of a sort that, if anything, actually strengthened its usefulness as a device for explaining economic change.  It is important here to recall that the first four chapters of Capitalism, Socialism and Democracy are devoted entirely to an examination of Marx’s views on a range of subjects.  Schumpeter offered a sympathetic and approving treatment of the economic interpretation of history; moreover, almost all of his own writing fits conveniently into that interpretation.  But Schumpeter also compresses the economic interpretation into just two propositions:

1. The forms or conditions of production are the fundamental determinants of social structures which in turn breed attitudes, actions and civilizations.

2. The forms of production themselves have a logic of their own; that is to say, they change according to necessities inherent in them so as to produce their successors merely by their own working. [25]

Schumpeter asserts that “Both propositions undoubtedly contain a large amount of truth and are, as we shall find at several turns of our way, invaluable working hypotheses.” [26]  His main qualification, if that is what it really is, is his insistence upon the importance of lags, that is, social forms that persist after they have lost their economic rationale.  It is far from clear that Marx would have disagreed with such a qualification, since Marx was much too sophisticated a historian to believe that economic changes

24. Joseph Schumpeter, “The Communist Manifesto in Sociology and Economics,” Journal of Political Economy (1949), p.293.  See also Capitalism. Socialism and Democracy, chapter 1.

25. Schumpeter, Capitalism, Socialism and Democracy, pp. 11—12.

26. Ibid., p. 12.

59 Index

generated the “appropriate” social changes instantaneously.  Schumpeter, in making the qualification about lags, adds that Marx, although perhaps not fully appreciating their implications, would not have taken the simplistic position involved in denying them a role:

Social structures, types and attitudes are coins that do not readily melt.  Once they are formed they persist, possibly for centuries, and since different structures and types display different degrees of this ability to survive, we almost always find that actual group and national behaviour more or less departs from what we should expect it to be if we tried to infer it from the dominant forms of the productive process.  Though this applies quite generally, it is most clearly seen when a highly durable structure transfers itself bodily from one country to another.  The social situation created in Sicily by the Norman conquest will illustrate my meaning.  Such facts Marx did not overlook but he hardly realized all their implications. [27]


VI – Economics is History

Whether or not one concludes, as I do, that Schumpeter believed in a form of the economic interpretation of history, he clearly was strongly committed to the view that economic phenomena, in order to be meaningfully examined, must be studied in an historical context.  Since I have spent a significant portion of my own professional life studying economic behavior in historical contexts, I am naturally pleased to be able to invoke the authority of Schumpeter in support of such an approach.  At the same time, I believe that this interpretation of Schumpeter is more than a merely self-serving exercise on my part.

The fact is that most of what Schumpeter wrote qualifies as history, both economic and intellectual.  Not only Capitalism, Socialism and Democracy but, in addition, Business Cycles and his posthumous History of Economic Analysis are historical works.  His commitment to the historical approach was deeply rooted in his thought.  Schumpeter had a profound appreciation of the path-dependent nature of economic phenomena and therefore of economic analysis itself. [28]  More than this.  The very subject matter of economics, in Schumpeter’s view, is history.  Economics is about economic change as it has occurred over historical time.  That is why he insists upon the importance of studying capitalism as an evolutionary process.  It is also why he assigns such a limited importance to the study of stationary economic processes.  And these things have a great deal to do with Schumpeter’s highest regard for some of Marx’s contributions to economic analysis:

27. Ibid., pp. 12-13.

28. For a more precise definition of path dependence and further analysis of the relationship between modern economic theory and historical analysis, see chapter 1 in this book.


There is... one thing of fundamental importance for the methodology of economics which he actually achieved.  Economists always have either themselves done work in economic history or else used the historical work of others.  But the facts of economic history were assigned to a separate compartment.  They entered theory, if at all, merely in the role of illustrations, or possibly of verifications of results.  They mixed with it only mechanically.  Now Marx’s mixture is a chemical one; that is to say, he introduced them into the very argument that produces the results.  He was the first economist of top rank to see and to teach systematically how economic theory may be turned into historical analysis and how the historical narrative may be turned into histoire raisonnée. [29]

This passage, it seems to me, is also the best explanation for Schumpeter’s frequent expression of admiration for, and intellectual indebtedness to Marx.

I can think of no better way of closing this chapter than by reminding you of certain views that Schumpeter expressed in chapter 2 of his History of Economic Analysis.  After stating that a “scientific” economist is to be identified by the demonstrated command over three techniques - history, statistics, and theory - he goes on to say:

Of these fundamental fields, economic history - which issues into and includes present-day facts - is by far the most important.  I wish to state right now that if, starting my work in economics afresh, I were told that I could study only one of the three but could have my choice, it would be economic history that I should choose.  And this on three grounds.  First, the subject matter of economics is essentially a unique process in historic time.  Nobody can hope to understand the economic phenomena of any, including the present, epoch who has not an adequate command of historical facts and an adequate amount of historical sense or of what may be described as historical experience.  Second, the historical report cannot be purely economic but must inevitably reflect also “institutional” facts that are not purely economic; therefore it affords the best method for understanding how economic and non-economic facts are related to one another and how the various social sciences should be related to one another.  Third, it is, I believe, the fact that most of the fundamental errors currently committed in economic analysis are due to a lack of historical experience more often than to any other shortcoming of the economist’s equipment. [30]

It is sad to have to conclude with the observation that some knowledge of history is still not regarded as essential to competent economic analysis.  Indeed, judging by the curricula of the graduate programs in American universities today, the very idea would appear to be distinctly perverse and alien.  In this, as in so many other respects, Schumpeter the radical economist still has a great deal to teach us.

29. Ibid., p. 44.

30. Joseph Schumpeter, History of Economic Analysis, Oxford University Press, New York, 1954, pp. 12-13. Schumpeter’s italics.



The Competitiveness of Nations

in a Global Knowledge-Based Economy

May 2003

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