MONEY and BANKING FULL GRAPHICS

 

 

SCHUMPETER  vs. MISHKIN

OLDRICH KYN

INOVATIONS - ENTREPRENEURSHIP - CREDIT in the Theory of  J.A. Schumpeter

in Hospodarske noviny, 34 / 1966

 

"To accomplish something new is not only objectively more difficult than to do something known and tried many times, but one would not feel like doing it even if there were no objective difficulties....In the mind of those who want to accomplish something new, the power of habit rises and tries to defeat the emerging plan.
The history of science is a great evidence of the fact that acceptance of the new scientific paradigm is for us unbelievably difficult. Thinking always returns to the old patterns.."

JOSEPH ALOIS SCHUMPETER

 

When Maurice Dobb gave a Lecture in Prague several years ago, [before 1966]  most of us were somewhat surprised that he regarded J. A. Schumpeter to be an economist more important for today than J. M. Keynes.

 We were surprised probably because at that time we knew very little about Schumpeter, and also because it happened just in the time of growing interest in the theory of Keynes and theories of growth. The process of eradication of  dogmatism, especially in the interpretation of the increased role of the state in contemporary capitalism, was in full swing.

During the preparation of the new economic system in Czechoslovakia, problems appeared that made Schumpeter's theory quite relevant.

It will not harm us to select from the long list of publications of this important contemporary economist, just his first book  „Theorie der Wirtshaftlichen Entwicklung“ (Theory of Economic Development) published in 1912. In spite of fifty years that passed since it's publication it can be more useful for the understanding of economic problems we face today than many economic publications that appeared here just five years ago.

A Concept of Economic Dynamics.

Schumpeter was one of the first non-Marxist economists who's central interest was economic dynamics. It was probably response to the static character of marginalist theory of his teachers.

The concepts of economic static and dynamics were introduced already earlier by J. B. Clark, who's interpretation was however quite different than Schumpeter's. According to Clark, static was the normal state of the economy, under which all economic regularities are taking their purest form. Dynamics was for him disturbances, fluctuations and deviations from the static state. He compared dynamics to the process of permanently shaking the container with a fluid. Waves appear on the surface, however, the fluid always tends to its static state.

 

For Schumpeter, dynamics is something completely different. Dynamics is not just 'spoiled static state', it has its own specific problems and regularities that cannot be explained within the static framework. The economy has an inbuilt engine that pushes it forward all the time, and what needs to be explained is the nature of endogenous powers causing that movement.  Schumpeter is not interested as much in the process of quantitative growth, as in the qualitative changes that he calls 'innovations'.

Innovations are the source of economic development, without them it becomes just a quantitative growth. Development is not in producing a little bit more of the product A and less of product B, but in a sudden appearance of the product C that is something new that was not here before. Innovations bring  sudden and discontinuous and unpredictable changes into the economy. This example is not to be interpreted as meaning that Schumpeter regarded for innovations only the inventions of new products. He included much wider spectrum of  processes. We shall return to this point later.

But neither static state is for Schumpeter a motionless situation. Even without innovations the economy must be continuously flowing; goods are produced, exchanged, and consumed, money circulate again and again. Schumpeter's static is not a standstill, but continuous flow of economic activities, that however, remain within traditional bounds.

 Goods are being produced then they disappear and are being produced again, but it is the same goods and they are produced using the same technologies under the same economic conditions. It is only cyclical repetition of something that was already here. Schumpeter calls this situation a "circular flow". It is in a way similar to the concept of simple reproduction of Marx, except that for Schumpeter is less important that quantities remain the same, he is stressing primarily that the style of economic activities is conservative and remains unchanged.

Innovations

 

Innovation have a decisive importance for economic development. They are generated on the production side and not on the side of consumption. In this respect Schumpeter is in opposition to the theory of Austrian school, according to which consumer decides by his choice what is going to be produced.

"But innovations do not  usually appear spontaneously and neither are they generated in the following way: new wants are first created by consumers and under their pressure production apparatus is adjusted. It is the producer who usually initiates economic change, and if necessary edifies consumers...so if in the theory of circular flow it is not only possible but it is simply necessary to regard wants of consumers as independent and in fact basic factor, then in the analysis of changes our point of view must be reversed." (Quotes are from the Polish edition: J. Schumpeter Teoria rozwoju gospodarczego, PWN, 1960)

It is worth to note that Schumpeter does not completely reject the leading role of consumer, he rejects only the idea that causes of the economic development are created by consumers. Economic development has its roots in production, not because production is repeated again and again, not even because more and more is produced, but because the way of producing changed. To produce means to combine factors of production, i.e. labor, means of production and natural resources, in a certain way. To change the way of producing means to change the combination of factors of production. "Development in our interpretation means to perform new combinations."

According to Schumpeter there are 5 cases of new combinations: 1.production of new types of goods, or change of properties of the existing goods; 2. introduction of the new method of production, that may be based on the new scientific discovery; 3. opening of a new market; 4. use of the new sources of  of raw materials and intermediate goods; 5. new organization of production.

 These all are innovation according to Schumpeter. Technical progress is certainly also an innovation, but the concept of innovation is broader than technical progress. We will not violate Schumpeter's theory if under the 5. we include also socio-economic changes in the economic system.

And now we are coming to a very important point: it looks as if Schumpeter participated in our current discussion about 'living beyond our means'. He argues against the view that development requires in the first place accumulation i.e. larger and larger amassing of means of production

"The new combination usually have to extract means of production from some old combinations...we can say that this happens always.  Implementation of new combinations means, therefore, only a different way of utilization of existing stock of means of production....Development means primarily  the alternative ways of use of existing supplies, it means that the new products are produced whether these supplies grow or not." (Underlined by O.K.)

This statement of Schumpeter must not be exaggerated as if he completely denied any usefulness of accumulation. What is true is that he rejected the primary importance of accumulation for development. The primary role have innovations, i.e. the new combinations of existing stock of factors of production.

Entrepreneurship

Innovations do not fall from heaven, they do not appear on their own. Somebody had to decide and somebody had to implement the new combination of factors of production. Schumpeter calls that person, which brings innovation an entrepreneur. In Schumpeter's conception an entrepreneur is not any director, chairman or manager, but only those of them who promotes innovations. An entrepreneur in this sense can  even be a person that would normally not be given that title.

The determining characteristics of an entrepreneur is entrepreneurship, i.e. realization of changes, promotion of innovations. Entrepreneurship is not some kind of occupation, it is a social function and not a social category. Anybody is an entrepreneur only while he is promoting innovation, therefore, entrepreneurs (in Schumpeterian sense) do not constitute any social groups.

Entrepreneurs represent a special type, but it is primarily the type of behavior; the type of people only if certain type of behavior requires a special type of people.

"The type of behavior, we are talking about, is specific in two ways. First of all because its goal is to accomplish something different, and because it means to do something different than is usually done. Second, the type of behavior in consideration is itself something else, it means doing something else that requires not just different degree of abilities, but completely different kind of abilities then those that are needed for realization of the circular flow."

Economic activity in the circular flow is customary, it requires only habit and routine, but otherwise it can be done by anybody. The circular flow requires endless repetition of the same kind of activity because only that way one gets practice and routine. It also generates conservative tendencies.

Development requires the opposite, overcoming conservatism, desire for change, attempts to do something in a completely new way, even though it is not exactly known whether and how it will reach the goal. Development is in conflict with routine. But "beyond the border of routine many cannot proceed at all and a majority can proceed only within some limits."

 

Because of these difficulties entrepreneurs must have certain specific predispositions, that are quite rare in population. They must be able to overcome the resistance of the environment and also their own prejudices, they must not be afraid of taking risk, swim against the current, work with unknown variables.

Two obstacles-internal and external - hinder the exploitation of the mentioned predispositions. The internal obstacles have their origin in the very process of thinking. Everybody has a natural propensity for conservatism in thinking, everybody gets used to certain persistent mental procedures and conclusions, that is very difficult to overcome.

"The nature of persistent mental patterns, ..rests in the fact  that they became subconscious, that they provide results automatically, and that even the critique does not harm them, and it does not matter whether they are in conflict with facts or not."

The external obstacles are created by resistance of social environment. "This reaction can appear primarily in obstacles of legal or political nature. But if we abstract from these obstacles, than every time some member of a social group leaves aside the established patterns of behavior, he will meet rejection of various extent depending whether the given social group is accustomed to changes in behavior or not....The opposition is stronger at primitive stage of culture than in more advanced stages, but it exist all the time."

The remaining question is: what are the motives that lead the entrepreneur to innovative activity? Schumpeter thinks that psychology is needed to explain those motives. He thinks that entrepreneurship cannot be explained by economic reasons, and that the psychology of the entrepreneur is non-hedonistic. The satisfaction of wants - according to him - can be considered the main motive only in circular flow. The motives of the entrepreneur are rather breaking old traditions, desire to fight and conquer, to demonstrate own success and superiority over others.

That does not mean at all that Schumpeter rejected the profit motive. Just the opposite is true, the profit motive is according to him and essential prerequisite for the existence of entrepreneurship.

However, the profit motive of the entrepreneur - he thinks - is non-hedonistic. (Let us recall that in Schumpeter's conception there is not an equal sign between the notions entrepreneur an capitalist. That means that Schumpeter's conception is compatible with the existence of capitalists for whom profit motive has primarily hedonistic character, i.e. who desire profit for rich consumption and ....) Entrepreneur does not seek profit only to satisfy his wants better, to reach more pleasure from richer consumption.

The entrepreneur seeks profit " primarily because monetary profit gives precise and from the views of others independent measure of conquest and leadership in the capitalist world....It would be very difficult to substitute something else for profit as a fuel of industrial development, even if we rejected its importance for creating investment fund..."

The role of credit and banks

For entrepreneur to be able to fulfill his social role, i.e. to promote new combinations of factors of production, somebody must give means of production in his hands. He may inherit it, but somebody who inherited capital does not become automatically an entrepreneur in Schumpeter's sense. On the other hand there may exist people who have entrepreneurial abilities but do not have capital.

And here appears the very important role of banks and credit. Banks have importance for the economic development because they drain capital (and means of production with it) from the hands of less capable proprietors and with the help of credit provide them to entrepreneurs - innovators. The banks by using  credit accomplish that withdrawal of the means of production from old combinations and allocate it to the new combinations.

 

And so we are back at the problem of accumulation. "Conventional theory sees the problem in the existence of means of production  needed for new or rather all processes of production and in connection with that accumulation becomes a special function or service.  As far as we are concerned, we completely deny that such a problem exists.....Such a problem does not exist in circular flow....but neither it exist when new combinations are realized....Instead of that we see completely different problem: the problem of draining means of production (already in use somewhere) from the circular flow and allocation of them to new combinations."

This function, as we said before, is performed by a bank with the use of credit. Credit, however can be provided from the means obtained by accumulation savings. To stress specifically that development does not depend on accumulation, Schumpeter describes a case of economic development without any accumulation. Even in that case banks can create additional credit, but they make it  'from nothing', by purely nominal creation. According to standard views it seems that such a credit that is not backed by real capital, cannot lead to real economic growth, but only to monetary inflation. Schumpeter does not agree with that. Of course, at first there will be increase of money that will lead to inflation, but what will happen afterwards? The decline of purchasing power of money will cause decline of real purchases of means of production by the agents of circular flow.

By inflation the bank confiscated a part of means of production, which then allocates - using credit- to innovators. Creation of the credit 'from nothing' did not create more means of production but it reallocated existing means of production from somebody's hands to somebody else's hands. If the means go from incompetent hands to hands of entrepreneurs than from 'nothing' is created 'something' - innovation that gives impulse to economic growth is  made possible.

"And so the banker is a mediator between those who want to realize new combinations and those who have the means of production. In principle the banker is a factor of development, but only if the social process is not controlled  by some central power. He makes possible application of new combinations, he designates some people - as if in lieu of the society -  by their realization. He is an arbiter of the market economy."

Entrepreneurs with profit motive and bankers using credit are according to Schumpeter the most important characteristics making the capitalist economy dynamic. They are prerequisites of permanent flow of innovations that leads to economic development.

It is known that Schumpeter's view of  future was considerably pessimistic. Although he was not a socialist he was convinced that capitalism will be necessarily replaced by socialism. He was not very optimistic about this historical necessity because according to his view socialism cannot be sufficiently dynamic. He believed that under socialism the main promoters of the economic development - i.e. entrepreneurship and profit motive -  will disappear, and also banks and credit will loose they role in promoting innovations. He related the weakening of development factors with concentration of production and centralization of economic control, which are taking place already under capitalism.

However that would bring us to his much later but also very interesting book "Capitalism, Socialism and Democracy".

Schumpeter's theory is certainly somewhat one-sided. But every theory must be more or less one-sided. It is also clear that Schumpeter undervalued the importance of accumulation, but on the other hand he was apparently right in regarding innovations as more important factor of development than accumulation. After all we could say that the 'primary role of innovations' is the Marxian dictum about the role of 'powers of production' for economic development only expressed in different language. It seems that our recent experiences confirmed the validity of Schumpeter's analysis of the role of entrepreneurship, profit motive, banks and credit. The main error of Schumpeter was his denial of the possibility of the existence of these factors under socialism.

Socialist entrepreneurship should be one of the key attributes of the new system of management and the profit motive was not only theoretically rehabilitated but also used in practice, if only in the form of gross income incentives. Perhaps we should pay somewhat larger attention to the role of  banks and credit. It appears that neither of these factors is dependent on the specifically capitalist forms of ownership and distribution and therefore there is no reason to assume that impulses of economic development under socialism cannot be as strong or even stronger than under capitalism.

 

 

 

 

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