Schumpeter’s Theory of Economic Development

Question

What are the elements involved in Schumpeter’s theory of economic development?

Answer

Introduction

There are four characteristics of Schumpeter’s theory of economic development.

(1) Circular Flow

First, there is a circular flow of existing trading activities (Thanawala 1994). Economic activity flows around a society, under stable circumstances, with aggregate demand and supply in equilibrium.

(2) Innovation and The Entrepreneur

The circular flow is disrupted by the introduction of innovative products. The entrepreneur uses their knowledge to develop new products (Sledzig 2013). Such entrepreneurs require finance to be able to fund their innovations. However, once their innovations are successful they can earn profits. The search for profits will encourage other businesses to enter the market, and lead to the further funding of innovative products. This will continue to disrupt the original stable market.

(3) The Business Cycle

Products which become outdated will suffer falls in demand. Businesses which fail to maintain their competitive advantage will close and there will be economic recession in geographical areas where outdated firms are clustered. Outmoded businesses will suffer from what Schumpeter described as ‘creative destruction’ (Anderton 2008). However, successful firms can exploit bank credit to increase the scale of the businesses and become monopolies (Hagedoorn 1994).

(4) Criticism of Capitalism

It was argued that creative destruction would damage the capitalist society on which it is based. Schumpeter believed that capitalism could “turn upon itself” and its own “social practices and institutions” (McCaffrey 2009:12).

Schumpeter also suggested that the development of large firms would lead to a reduction in entrepreneurial control. Firms would become less entrepreneurial as they became more bureaucratised (McCaffrey 2009).

References

Anderton, A., (2008), Economics: Fourth Edition, Causeway Press: Harlow

Hagedoorn, J. (1994), Schumpeter: an appraisal of his theory of innovation and entrepreneurship. Available at http://collections.unu.edu/eserv/UNU:1001/rm1994-020.pdf. Accessed at 06/11/2016

McCaffrey, M. (2009), Entrepreneurship, economic evolution, and the end of capitalism: Reconsidering Schumpeter’s thesis. The Quarterly Journal of Austrian Economics 12, Number 4 (2009): 3–21. Available at https://www.researchgate.net/publication/239590657_Entrepreneurship_economic_evolution_and_the_end_of_capitalism_Reconsidering_Schumpeter’s_thesis. Accessed at 06/112016

Śledzik, K. (2013), Schumpeter’s View on Innovation and Entrepreneurship, University of Gdańsk – Faculty of Management, April 29, 2013, in Management Trends in Theory and Practice, (ed.) Stefan Hittmar, Faculty of Management Science and Informatics, University of Zilina & Institute of Management by University of Zilina, 201. Available at https://www.academia.edu/5396861/SCHUMPETER_S_VIEW_ON_INNOVATION_AND_ENTREPRENEURSHIP. Accessed at 06/11/2016

Thanawala, K. (1994), Schumpeter’s Theory Of Economic Development and Development Economics, Review of Social Economy, Volume 52, Issue 4