|MONEY and BANKING||LOW GRAPHICS|
Schumpeter vs. Mishkin
Schumpeter provides a provocative argument for the role of banks within the economy. According to Schumpeter, an economy has an endogenous locomotor which is innovation. Innovation is generally defined as “the new combinations of existing stock of the factors of production.” (Kyn 1) Those who realize and create these new combinations, and thus promote economic growth, are defined as entrepreneurs. This belief is in contrast to the widely held belief that the locomotor of the economy is the consumer. Rather than attribute entrepreneurship to purely economic reasons, Schumpeter introduces a psychological reason, the drive to break the status quo, while acknowledging the existence of the profit motive. Given the fact that innovation and its consequent economic development depend on a non-conservative mindset, the entrepreneur can be viewed as a trendsetter. Although the entrepreneur is the conductor of economic growth, he or she cannot promote growth alone. Often the entrepreneur does not have access to the factors of production. This is where banks come into play. Banks are the co-conductors of economic development, as they move capital from idle hands into the hands of the innovator/entrepreneur. They promote innovation by “ withdrawing the means of production from old combinations and allocating it to new combinations.” (Kyn 6). In summary banks use their intermediary role to help stimulate the economy. Mishkin, also expresses the view that the role of banks is one of an intermediary that matches up those with capital with productive investment opportunities. While Mishkin uses many examples of entrepreneurship, such as Carl the carpenter, his argument is more in line with traditional economic theory of supply and demand. Banks are the main avenue for the provision funds from those with a surplus to those with a shortage, as well as the main provider of productive investment opportunities to those who lack them. Unlike, Schumpeter, capital accumulation is an essential part of change in Mishkin’s analysis and subsequently, economic development. Whereas Schumpeter provides a psychological motive for innovation, Mishkin focuses on the profit motive, interest, as the cause of innovation. In Mishkin’s analysis, banks are vital to the economy because they determine money supply upon which many economic activities are dependent. Additionally banks promote efficiency and this is necessary for the economy to reach its full potential. (Mishkin 37)
Shumpeter’s theory primarily plays host to the idea that banks serve as a means of transferring funds between those with surplus assets to those who lack assets to make innovations happen. Mishkin expands upon Shumpeter’s idea herein marking the difference between the two. Although Miskin agrees that financial intermediaries serve the essential role of transferring assets to those parties that thereafter innovate, he also sees banks as a means of reducing transaction costs and significantly lowering many of the risks created by adverse selection. The two additional factors identified by Mishkin allow us to see banks in a whole different light. They are not only means of money for those who seek to innovate but rather serve the dual purpose of protecting the lender from undesired risk and further expanding the capabilities of the borrower. Shumpeter’s argument neglects many of the benefits both lenders and borrowers see in working with a bank (especially if one considers it from a modern perspective and takes into account modern financial regulation). Shumpeter and Mishkin also differ in the belief on the growing size of financial institutions. Shumpeter believes that this growth will eventually lead the capitalist system into a form of socialism. Mishkin on the other hand believes in these larger financial institutions as a means to prevent “financial panic” and “ensure the soundness of financial intermediaries” through several factors. These include barriers to entry and restrictions on the assets that banks can hold as well as the level of risk their activities can entail. Mishkins argument suggests that the size of these institutions actually makes them a safer bet from a lenders standpoint.
Schumpeter believed that the only way for a country’s economy to grow and expand is through economic development. That is the innovation of new combinations of factors of productions. (For example: New production techniques and new materials). These new developments are from the creative minds of entrepreneurs. Schumpeter believed that the role of Banks are that facilitators of spare credits (savings from consumers for instance) for entrepreneurs to carry out their social roles as innovators. Banks are the mediators or “middlemen” between those who have the ideas to create new combinations and those who have the resources.
Mishkin’s role of banks is one of the creator and provider for deposits. They play an important role in the creation of money supply. This is a view of economic growth through money creation, where the banks provide the facilities for loans, mortgages, etc. Banks are less willing to provide credit for new and untried ventures, as they are deemed risky. Government regulations and agencies also shy away from them as they want to protect the integrity of the financial system and not risk a breakdown.
Schumpeter’s role of banks plays an equal role with the entrepreneurs in the growth of the economy. They are more like an equal partner and not the only reason. The banks have a more dynamic role here, as they have to be willing to be daring and have the foresight to provide credits to those individuals with potential from those who do not. Mushkin’s roles of banks are the primary reason for the growth of the economy, as they have an important role in the creation of money supply. However it is a passive role, as the individuals who need the credits have to come to them.
According to Schumpeter, banks and credit have a key role in promoting innovation, which is the most important part of development. He says the bank’s main role is to get capital from those who don’t have innovative ideas and give it to entrepreneurs (those who have innovative ideas). It is the innovations that arise from this system that will actually lead to the development of an economy. Schumpeter points out that innovations that will allow for new combinations of production are more important than capital accumulation. Mishkin, on the other hand, does not speak of such innovations and he does not downplay accumulation as Schumpeter does. In fact, he believes it is the accumulation of capital that leads to economic development. He talks of the transfer of capital between those who have surplus funds and those who lack funds. He says that a bank, acting as a financial intermediary, can match lenders and borrowers, promote efficiency, and thereby lead to higher production levels. Additionally, he talks about the fact that people will be able to time their purchases better. However, he doesn’t make the connection between borrowers being innovative and lenders being the ones who don’t have ideas, nor does he say that a bank’s main role is to promote innovation. Instead, Mishkin believes a bank’s more important role is helping to determine the supply of money through decisions about excess reserve ratios and discount loans from the Fed.
According to both Schumpeter's and Mishkin's explanation of the function of banks, banks are intermediares between lenders and savers. In both characterization of their roles banks are neccessary for innovation and thus, economics development. Mishkin's idea of banks as intermediares supposes that there should be an accumulation savings in order to provide borrowers with the money. On the other hand, Schumpeter stresses that there is no need for accumulation savings for the economic development. He emphasizes that by creating credit from nothing will create inflation and thus, confiscated by banks means of production then relocate to somebody else's hands. Though, the Schumpeter's theory seems lucrative, he does not explain how exactly the process of confiscation and realocation of means of production will work and if it can be applied in the real life. The other thing that should be questioned is will this creation of credit from nothing will favour the economic development? Even though such creation of credit from nothing might favour innovation, the economy in general might suffer slowdown because of the inflation. Thus, as it was mentioned in your paper Schumpeter underestimated the importance of accumulation, that is why, on my opinion, his theory might not able to explain the economic development only by the existence of the banks. The other part of Mishkin's explanation of function of banks, which is lowering of tranction cost by them, has been left by Schumpeter, which again shows as it was mentioned in your paper his theory as one-sided. Lowering of transaction costs by the banks would bring the innovations up and thus, according to both Mishkin and Schumpeter will favour economic development.