Having been proven wrong by recent events on Hayekian claims on the inherent efficiencies of free markets, neo-liberalism now drops Hayek and parades Schumpeter and his creative destruction as the new banner of ideology as truth. The term has been used in recent days by Greensapan and a whole chorus of policy makers to expain the US economy as the remaining pocket of properity in the a world left in ruins by free market globalization.
Schumpeter conceptualizes long waves as disturbances in the equilibrium of an economic system, the exhaustion of these disturbances, and an eventual return to equilibrium. It is this repeated return to a state of equilibrium, and not the repeatability of the wave form, which gives long waves their cyclical character. Schumpeter designates this equilibrium state as "the circular flow of economic life" or the "stationary flow". This state refers to a condition comparable to simple reproduction and characterized by an absence of any change or development. But Schumpeter is also explicit that this "stationary flow" is only a theoretical norm, not a real state of affairs: it serves as a reference point from which to define phenomena such as overproduction, excess capacity, and unemployment.
"These terms, as commonly used, do not carry any precise meaning at all, and
the fact that they do not explains the inconclusiveness of much argument
that goes under these headings. As soon as we find such precise meanings
for them and to fit them for the task of identifying definite states of an
economic organism, the necessity of falling back on equilibrium relations
becomes apparent".
In actuality, economic systems never achieve equilibrium. At best, they move into what Schumpeter calls "neighborhoods of equilibrium...in which the system approaches a state which would, if reached, fulfill equilibrium conditions".
All economic systems have a fundamental tendency towards equilibrium within their separate given levels of free exchange and automatically move toward these neighborhoods after the disruptions caused by factors of change have exhausted themselves. For his theory of long waves, the most important characteristic of these neighborhoods of equilibrium is that economic conditions are relatively stable and this permits what he calls "tolerably reliable calculations" about the future. As a result, the risks associated with engaging in new activities are at their lowest.
In his general model, Schumpeter suggests that all cycles depart from these neighborhoods of equilibrium. When he introduces the notion of several simultaneous cycles, he relaxes the assumption that the shorter cycles begin from equilibrium in the strict sense of the term - "the sweep of the longer waves provides the neighborhood of equilibrium for the waves of the next lowest order." In other words, neighborhoods of equilibrium, in the strict sense, are only associated with long waves when "all cycles pass their normals".
Economic development is the result of many factors: external factors such as demand by government for new weapons and/or social justice; factors of gradual changes in socio-economic life and "the outstanding fact in the economic history of capitalist society" - innovation. For Schumpeter, innovation is the chief force in what he calls "economic evolution." Economic evolution is however discontinuous and takes the form of long waves because of a discontinuity in the introduction of major innovations into the economic system.
While the importance of innovation in Schumpeter's thought is well known, less attention has been paid to what Schumpeter meant by innovation. It appears that Schumpeter's concept of innovation is both `broader' and `narrower' than is generally assumed by what are considered his most direct disciples, Neo-Schumpeterians or innovation theorists. Schumpeter's concept is broader because, unlike innovation theorists, he does not restrict the concept of innovation to the patenting or commercialization of new inventions. In addition to these activities, Schumpeter includes other activities such as "new combinations" in organization, commerce, and the market, e.g., the opening of new markets, the discovery of new sources of raw material and supplies, and improved handling and transport of materials and goods, as well as the creation of new business organizations such as department stores, cartels and monopolies. The aspect is dearly embraced by neo-liberalism with regard to finance caoitalism and globalization.
Schumpeter's concept of innovation is `narrower' because he stresses that innovation per se, i.e., simply as new ideas or new combinations, is not a force in economic development. Rather the true force in economic development is the consequences of these innovation: 1. ) the construction of new plants and the rebuilding of old plants "requiring, non-negligible time and outlay," 2) new firms which are founded for the purpose of capitalizing on specific innovations, and (3) the rise to leadership of new men (Schumpeter 1964, 68-71). These consequences make innovations a force in economic evolution and innovations which do not produce these consequences, which do not, in other words, produce other changes in the "stationary flow" would not and could not be a force in the economic development of a society. Economic evolution begins when an entrepreneur of exceptional ability - "the conductor"- introduces, in the above sense, an innovation. This enables the individual to make monopolistic profits and stimulates the borrowing of capital in order to increase the investment. The activity of the first entrepreneur also smoothes the path for other entrepreneurs to introduce innovations in associated or related fields. This "swarming of entrepreneurs" is financed through credit creation, which Schumpeter calls, "the monetary complement of innovation." Credit permits these firms to `bid away' factors of production from older non-innovating firms. This produces a rise in prices and a general economic expansion which characterizes the first phase of Schumpeter's four phase model, Prosperity. This describes globaliztion of the last 2 decades. Prosperity peaks, i.e., reaches its upper turning point, for several reasons. Unable to compete with successful new firms, older non-innovating firms and unsuccessful new firms suffer losses. New investments are halted because the economy is disrupted and it becomes impossible to make reliable calculations about the future. The possibilities offered by the current cluster of innovations are exhausted. Interest rates rise. The subsequent downturn is the second phase of the cycle - Recession. The decline of Recession continues however, past equilibrium in a secondary wave which Schumpeter attributes to "errors, excess of optimism and pessimism. ... Reckless, fraudulent and otherwise unsuccessful enterprises created in the optimism of expansion cannot stand the test administered by Recession" (Schumpeter 1964). They are liquidated. These liquidations, in turn, undermine the debt structure which begins to "crumble" and this causes a "panic." Deposits shrink and credit tightens even further. Firms which would have been able to withstand the contraction had it not resulted in panic are liquidated in what Schumpeter calls `abnormal' liquidations and among other enterprises there is "a shrinkage of operations that reduces them, quite erratically, below their equilibrium levels". This is eseentially a description of the Asian financial crisis that began in July 1997 and that since has spread its "contagion" through Russia and Brazil, with the EU next and eventually the US. For Schumpeter, these abnormal liquidations and the `excess' shrinkage of enterprises mark the third phase of the cycle - Depression. Depression continues until all unsuccessful and excess investments are liquidated. Once this point is reached (and it is by no means automatic), a movement towards a new "neighborhood of equilibrium" is initiated. This movement is the fourth phase of the cycle - Revival. What throws Schumpeter's neat economic theory off is that before the revival phase, soico-political instability will occur to choke of the revival phase, as is likely to occur in SE Asian and Russia. Schumpeter emphasizes that every cycle is "a historical individual and not merely an arbitrary unit created by the observer". Hence, the periodization of long waves can only be from the neighborhood of equilibrium preceding Prosperity to the neighborhood of equilibrium following Revival. This is an important clue to Schumpeter's understanding of causality and stands in marked contrast to innovation theorists who search for the `causes' of the next prosperity in the unsettled times of depression.
For Schumpeter, long waves are formally similar but differ substantially in their result. Each long wave is a break with the past and the economic system which emerges in the Revival phase is qualitatively different from the economic system of the Prosperity phase of the same cycle. In other words, long waves are not merely passing distortions or `imperfections' in the economic system. Instead, the innovations which propel each long wave produce real qualitative changes in the economic system.
[The] historic and irreversible changes in the way of doing things we call
"innovation" and we define: innovations are changes in production functions
which cannot be decomposed into infinitesimal steps. Add as many mail
coaches as you please, you can never get a railroad by so doing...The kind of
wave-like movement, which we call the business cycle, is incident to
industrial change and would be impossible in an economic world displaying
nothing except unchanging repetition of the productive and consumptive
process.
Schumpeter therefore identifies three specific long waves and their corresponding innovations: the Industrial Revolution Kondratieff, 1787 to 1842, (cotton, textiles, iron, and steam power); the Bourgeois Kondratieff, 1842 to 1897, (railroads); and the Neo-Mercantilist Kondratieff, 1897 to ?, (electrification, motorization, and chemical industries).
In his first major work, the Theory of Economic Development, Schumpeter wrote:
Social facts are the result of human conduct, economic facts result from
economic conduct and the latter may be defined as conduct directed towards
the acquisition of goods ... through production and exchange. The field of
economic facts is first of all delimited by economic conduct.
Had he been alive now he might has added the Golbalization Kondratieff, 1971 (Bretton Wood death)-2000?
Schumpeter's emphasis on actors and conduct, as opposed to economic facts, has several important, yet unexplored, ramifications for his theory of long waves.
First and foremost, innovation, for Schumpeter, is not an "economic facts" but rather, a type of conduct. This explains the earlier observations about both the `breadth' and `narrowness' of Schumpeter's concept of innovation. Its breadth is due to the fact that, as a type of conduct, innovation can take many forms. Innovation is not merely the commercial exploitation of new inventions and technology but rather the conduct, i.e., the forms of activity and the modalities of action, which makes this possible. Moreover, because innovation is first and foremost a conduct and therefore not necessarily tied to any specific context or field of action (such as that defined by technology and new inventions), this conduct can occur in almost all arenas of social life. Its `narrowness' is due to the fact innovation can only have an impact on an economic system if it engenders other, related forms of conduct such as the construction or modernization of new plants, or the founding of new firms.
For Schumpeter, an adequate explanation of economic phenomena is not simply explaining one economic fact, namely the conduct of innovation, as the result of other economic factors. Instead, an adequate explanation consists
in finding a definite causal relation between two phenomena ... if the one
which plays the causal role is non-economic. If, on the other hand, the
causal factor is economic in nature, we must continue our explanatory effort
until we ground on the "non economic" bottom. Always we are concerned
with describing the general form of causal links that connect the economic
with the non-economic (Schumpeter).
Already it is apparent that for Schumpeter long waves can not, in the strict sense, be caused by the clustering of innovation - the clustering of innovation, an economic fact, does not represent the ""non-economic" bottom." The clustering of innovations, (actually, the clustering of innovative conduct) explains the dynamics of the cycle and its duration, but to explain this clustering it is necessary to move even further "backwards" into the non-economic. Hence, the `mere' clustering of innovations is not, in terms of Schumpeter's requirements for an adequate explanation of economic phenomena, the cause of the long wave.
For Schumpeter, causality must be sought at level of motives. Motives are the residual factor and an adequate explanation of the causes of economic phenomena must link economic conduct to motives. Thus, for Schumpeter, the real cause of long waves lies at the level of what motivates the entrepreneur to undertake his or her special and unique form of conduct, innovation. Although entrepreneurs possesses an ability to effect this conduct and this ability is continuously present, the conduct occurs discontinuously. Entrepreneurs are not, in other words, always `galvanized' to innovate. Thus, to explain what causes a clustering of innovations it is necessary to explain what galvanizes entrepreneur to his/her sui generis form of conduct. These factors can be accounted but the actual individual subjective meanings underlying the innovative activity of individual entrepreneurs, can not. In other words, entrepreneurs may innovate for reasons of love, hate, greed, revolution, etc., but these remain unknown. At most, links can be established between factors which spark or galvanize the entrepreneur and the consequences of this motivation, i.e., innovative conduct. The actual motives are the "non-economic" bottom and once the analysis has reached this level, causality has, for Schumpeter, been explained.
According to Schumpeter, entrepreneurs are galvanized into action under the following conditions: [1] the existence of new possibilities more advantageous from the private standpoint - a necessary condition; [2] limited access to these possibilities because of personal qualifications and external circumstances, and [3] an economic situation which allows tolerably reliable calculations. To the above, a further condition may be added to account for the swarming of entrepreneurs - (4) the smoothing of the way by the first entrepreneur.
Joseph Schumpeter, the Austrian economist of world acclaim, taught at Harvard University for nearly twenty years. Born in Moravia in 1883, he raised the specialized scope of economics to interdisciplinary, political, historical and social dimensions. His theories, characterized by his open-minded approach and his desire to integrate a variety of impulses from different cultural milieus, scientific areas and disciplines, are even more relevant today, as Eastern Europe begins to experiment with capitalism. Schumpeter recognized the vital importance of entrepreneurs in business. He emphasized the entrepreneur's role in stimulating investment and innovation, which determine the rise and ebb of prosperity. The distinction between statics and dynamics was essential to his account of capitalism - certain periods approximating to equilibrium, and other exhibiting considerable change. His analysis of business cycles started from this point and distinguished the types and behaviour of cycles. The posthumous History... shows a prodigious grasp of the literature of economics. In this, as in his major book Capitalism, Socialism and Democracy, he relates economic phenomena and ideas to a wider context of social analysis. The latter, whilst rejecting the Marxian analysis, still envisages capitalism as moving by its own internal forces towards Schumpeter's vision of a socialist society. He held a permanent faculty appointment at Harvard University in 1932. Schumpeter's theories emphasized the role of the entrepreneur in stimulating investment and innovation, thereby causing creative destruction. Creative destruction occurs when innovation makes old ideas and technologies obsolete. Schumpeter also predicted that capitalism would be undermined eventually by its own success because it would create a class of intellectuals who would attack it. Are they on this list? Laissez faire came to be perceived as promoting monopoly rather than competition and as contributing to boom-and-bust economic cycles, and by the mid-20th cent. the principle of state noninterference in economic affairs had generally been discarded. Nevertheless, laissez faire, with its emphasis shifted from the value of competition to that of profit and individual initiative, remains a bulwark of conservative political thought, influential in the 1980s in such government administrations as that of REAGAN/THATCHER. What is amzing and disappointing is that Clinton/Rubin/Greenspan are also buying into it wholesale and in the process, pushing the world into an enduring economic abyss.
Henry C.K. Liu
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WITH THE DISMEMBERMENT of
the Soviet empire, the retreat of
socialism and the spread of global
capitalism, Karl Marx is out.
Joseph Schumpeter, so often
praised in Forbes but for long
ignored by the rest of the media,
is now in. Published in the year
of Schumpeter's death (1950), his
Capitalism, Socialism and
Democracy unfolds like a play.
Act I describes and extols the
dynamism of capitalism. "Unlike
other economic systems, the
capitalist system is geared to
incessant change...," he wrote.
"This process of Creative
Destruction is the essential fact
about capitalism." It keeps the
system healthy by weeding out
the weak businesses, nourishing
the strong ones and thereby
raising living standards by
promoting efficiency and
innovation. The capitalist society
Schumpeter projects is not a
comfortable or easy place, but it
is the best means for lifting the
masses of the people out of
poverty.
In Act II, Schumpeter introduces
portents of tragedy when he
argues that capitalism's success
sows the seeds of its own
destruction. Societies become so
rich that they can support a
growing class of chatterers who,
feeling slighted by the success of
the entrepreneur and dismayed
by the growing satisfaction of the
masses, seek to undermine the
system. What the entrepreneur
creates, Schumpeter warns,
left-leaning intellectuals can
destroy.
In Western Europe, alas,
Schumpeter's Act II seems to be
unfolding on schedule. The
chatterers, their message
reinforced by the inevitable
turmoil caused by Schumpeter's
"creative destruction," are having
their way. France, a country that
has resisted capitalism and
embraced the welfare state more
aggressively than most other
European countries, has
stagnated since the mid-1970s.
The portion of the working-age
population that is employed has
dropped from 65% to 59%. And
the private sector's share of total
employment has steadily
withered from 56% in the
mid-1970s to only 49% today. In
consequence, France is on the
brink of bankruptcy and
international irrelevance. The
other welfare states of Western
Europe aren't far behind.
President Chirac and
Chancellor Kohl
refused to be fitted out
with jeans, cowboy hats
and boots.
If his fellow liberals in Europe
haven't gotten the message,
however, the ever opportunistic
Bill Clinton has. At the June G-7
Summit in Denver, Clinton said,
"America's economy is the
healthiest in a generation and
the strongest in the world." His
aides passed out charts depicting
vigorous U.S. growth and job
creation, compared with the
dismal performances in Europe.
This did not go down well.
President Chirac and Chancellor
Kohl refused to be fitted out with
jeans, cowboy hats and boots for
one of the Denver banquets.
They were damned if they were
going to be seeming to endorse
America's "Wild West" capitalism.
If the rest of the world is moving
toward capitalism, they want to
stop the world so they can get
off.
Lest we become complacent
about the final triumph of
capitalism, we should pay
attention to Western Europe's
stubborn resistance to
Schumpeterian doctrine. The
summer 1997 issue of the
respected journal Foreign Policy
contained a piece titled "The
Crash of Civilization: the Limits of
the Market and Democracy." It
was penned by none other than
Jacques Attali, the Pico della
Mirandola of French intellectuals
and celebrated adviser to French
politicos.
Attali waxed eloquent about the
alleged dark side of capitalism.
What Schumpeter calls creative
destruction, Attali calls
dehumanizing.Listen to this:
Unless the U.S. "begins to
recognize the shortcomings of the
market economy and democracy,
Western Civilization will gradually
disintegrate and eventually
self-destruct." Right here in the
U.S., George Soros, that
speculator with intellectual
pretensions, has been uttering a
similar message.
Some of this Attali-Soros
chattering can be chalked up to
old-fashioned America-bashing.
But be careful: Joseph
Schumpeter predicted that the
anticapitalist chattering
classes—who, let us not forget,
dominate the media—would bring
the system down, despite its very
obvious successes. He might yet
be right—at least in Western
Europe. This process is what
the famous economic historian Joseph Schumpeter called
the "creative destruction" that characterizes a
market-driven, capitalist economic system. Like everyone
else in the technology area, I have always been on the
lookout for the next new innovation that would fuel the
growth of the company that could bring it to market. What I
didn't appreciate, until I stumbled across this thread and
followed the comments for several months, is that the flip
side of most long opportunities was the opportunity to
short--Schumpeter's creative destruction at work. This is
obviously old hat to traders--witness Roger's comment that
he didn't care whether the market went up or down, so
long as he could continue to trade. But to an economist,
watching--and participating--in creative destruction
provides new insights into the functioning of markets
generally. Many thanks to all for the thread!
Capitalism's creative ability, Schumpeter argued, is only half of its success story. Just as capitalism builds up new modes of production, so too does it perform the less popular but equally necessary task of eliminating and disbanding obsolete industries. Schumpeter termed this the "creative destruction" of the free market:
The opening up of new markets, foreign or domestic, and the organizational development from the craft shop and factory to such concerns as U.S. Steel illustrate the same process of industrial mutation - if I may use that biological term - that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.
Schumpeter therefore has a compelling explanation for why economic progress under capitalism has been so dramatic. Most historical economic systems, from feudalism to mercantilism to socialism, cement economic power in the hands of a self-satisfied orthodoxy. Statist economies deliberately shield producers from change; the surest path to success is to gain the favor of the government, rather than the favor of a clientele. In contrast, laissez-faire capitalism strips established interests of governmental protection, and throws the economic contest wide open. While this theoretical ideal has never been fully implemented, the facts strongly support Schumpeter's interpretation; in relatively unregulated economies, industry leaders frequently lose their dominance while competitors forge ahead. Thus, after Henry Ford virtually created the modern automobile industry, he was displaced by General Motors; some years later, American auto-makers desperately sought governmental protection from Japanese competitors that suddenly threatened their entrenched position. While other firms hold their lead, the danger of falling behind remains real: Microsoft retains its leading position in computer software, but the company must struggle merely to avoid falling behind.
"creative destruction" refers to the way that economic advances make
existeng economic capital ideas absolescent: thay are partially destroyed (in
value term). Existing models have only considered how additions to economic
knowledge make existing knowledge less valuable. This paper recognises
that both knowledge and capital obsolesce and considers the effect on both.
By that definition, socialism will apply creative destruction to capitalism.