The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle

255 Pages·1983·1.4 MB·English

by  Joseph A. Schumpeter

New material this edition copyright © 1983 by Transaction Publishers, New Brunswick,
New Jersey. Original material copyright © 1934 by the President and Fellows of
Harvard College.
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Library of Congress Catalog Number: 79-67059
ISBN: 978-0-87855-698-4
Printed in the United States of America
Library of Congress Cataloging-in-Publication Data
Schumpeter, Joseph Alois, 1883-1950. The theory of economic development.
(Social science classis series)
Translation of: Theorie der wirtschaftlichen Entwicklung.
Reprint. Originally published: Cambridge, Mass.: Harvard University, 1934.
(Harvard economics studies v. 46) with new introd.
“Transaction ed.”—Introd.
Includes bibliographical references.
1. Economics. 2. Economic development. 3. Capitalism. I. Title. II. Series. III.
Series: Harvard economic srudies: v. 46.
HB175.S462 1983 330
ISBN 0-87855-698-2
79-67059
CONTENTS
TRANSLATOR’S NOTE
INTRODUCTION TO THE TRANSACTION EDITION
PREFACE TO THE ENGLISH EDITION
I. THE CIRCULAR FLOW OF ECONOMIC LIFE AS CONDITIONED BY
GIVEN CIRCUMSTANCES
II. THE FUNDAMENTAL PHENOMENON OF ECONOMIC DEVELOPMENT
III. CREDIT AND CAPITAL
IV. ENTREPRENEURIAL PROFIT
V. INTEREST ON CAPITAL
VI. THE BUSINESS CYCLE
TRANSLATOR’S NOTE
MY CHIEF aim has been to convey the meaning as accurately as possible, and to this
end I have not hesitated to use a clumsy phrase in cases where there was no current
English equivalent of the German word. After considerable reflection I decided upon
“circular flow” for “Kreislauf,” for reasons which it would take too long to relate. There
are inelegancies which have nothing to do with the technical side of translating. To
eradicate these would have meant rewriting the whole, and it did not seem expedient to
do so. Professor Schumpeter is so much at home in the English language that he would
inevitably have left his mark on the translation even if he had not given his time as
freely as he did to the more difficult points involved. For this reason, as well as for
those mentioned in the preface, the book is more than a translation.
The title of the German original is Theorie der wirtschaftlichen Entwicklung.
REDVERS OPIE
INTRODUCTION TO THE TRANSACTION EDITION
JOHN E. ELLIOTT
I
Joseph Alois Schumpeter, like his illustrious contemporary, British economist John
Maynard Keynes, was born in 1883, the year of death of Karl Marx. He died in 1950,
four years after Keynes. Thus, his adult life—and published works—roughly span the
first half of the twentieth century, as Marx’s did the middle decades of the nineteenth.
Schumpeter’s teacher, Eugen von Böhm-Bawerk, has sometimes been called the
“bourgeois Marx,” because of his focus upon the phenomenon of capital, the title of
Marx’s central lifework. The title better fits Schumpeter himself, who, many scholars
believe, provided the most comprehensive and provocative analysis since Marx of the
economic development and social transformation of industrializing capitalism. If Marx
was Schumpeter’s worthy opponent, Keynes was his contemporary rival and antagonist.
Schumpeter describes Marx as the greatest social scientist of the nineteenth century,
because of the passion and breadth of his vision of capitalist society and its future and
his uncanny ability to connect the economic, social, and political dimensions of his
analysis. The same kind of comment can be made about Schumpeter, whose analysis of
capitalist development and change similarly blends historical, economic, and
sociological elements, and whose studies of the capitalist order and its prospects
provide, with the notable exception of the writings of Thorstein Veblen, the only truly
comprehensive rival intellectual “system” to that of Keynes in the first half of the
twentieth century.
The Theory of Economic Development,1 the work which comprises this book, vividly
illustrates one of Schumpeter’s cherished interpretations concerning intellectual
creativity. In Schumpeter’s view, the foundations of significant creative achievements,
notably theoretical ones, are almost always laid in the third decade of a scholar’s life,
“that decade of sacred fertility.”2 Subsequent scholarly work, he believed, typically
builds on these foundations and fleshes out the details and applications of one’s early
creative insight. As Schumpeter put it in his review essay on Keynes, every
comprehensive theory of society “consists of two complementary but essentially
distinct elements. There is, first, the theorist’s view about the basic features of that state
of society, about what is and what is not important in order to understand its life at a
given time. Let us call this his vision. And there is, second, the theorist’s technique, an
apparatus by which he conceptualizes his vision and which turns the latter into concrete
propositions or ‘theories.’”3
Whatever the general merits of this view, it fits closely the circumstances of
Schumpeter’s life and scholarly work. In the third decade of his life, Schumpeter
vividly illustrated his hypothesis by a remarkable burst of creative energy, the
establishment of an international reputation, and the laying of the foundations for his
life’s work. Schumpeter “was never a beginner but, a precocious genius; he entered the
scientific arena a full-fledged master.”4 By the age of thirty-one, he had published
twenty papers, fifty book reviews, and three major works. His first, The Essence and
Principal Contents of Economic Theory (1908),5 outlined the basic elements of an
exchange economy, at least from the perspective of pure economics, with precision and
clarity. The second, The Theory of Economic Development (1911), was the now-classic
work which made Schumpeter world-famous. It provided both his “vision” of the
capitalist process and the central theoretical structure which underpinned his subsequent
analysis of socioeconomic change. The last, Epochs in the History of Doctrine and
Method (1914),6 gave a brief but brilliant exposition of the history and methodology of
economics. Arthur Spietlioff aptly summaries the unusual character of Schumpeter’s
early work by asking, “What is more unheard of, a twenty-five-year-old and a twenty-
seven-year-old who stirs at the foundations of the discipline, or a thirty-year-old who
writes its history?”7
Schumpeter’s colorful personality, eventful life, and early recognition complemented
his creativity. From the age of 10, when his mother, widowed several years earlier,
married a lieutenant-general in the Austro-Hungarian army, Schumpeter grew up in the
aristocratic atmosphere of pre-World War I Vienna. Between 1893 and 1901, he was
provided by his step-father with a thorough and classical education at the Theresianum,
an exclusive school for sons of the Viennese aristocracy. After leaving the Theresianum,
he attended the University of Vienna as a student in the Faculty of Law, specializing in
law and economics, and received the doctor of law degree in 1906, at twenty-three.
Three years later, after practicing law in Cairo and managing the finances of an
Egyptian princess, Schumpeter was appointed full professor at the University of
Czernowitz, located in an eastern province of the Austro-Hungarian Empire. At twenty-
six, the youngest full professor in the university, Schumpeter was a bit of an enfant
terrible as well as a Wunderkind. Disdainful of what he perceived as the provinciality of
most of his colleagues, he liked to shock them by wearing his riding boots at faculty
meetings and formal dress even when dining alone with his wife.8 In 1911, with the
help of his teacher and benefactor Böhm-Bawerk, Schumpeter was appointed to the
faculty at the University of Graz. At twenty-eight, he was, as at Czernowitz, the
youngest full professor in the university. This, combined with the solid negative vote of
the faculty (who had recommended, Gottfried Haberler comments, some “local
nonentity”)9 against his appointment, and his practice of spending much of his time in
the national capital, did little to endear Schumpeter to his academic colleagues. At
thirty, he accepted a visiting professorship at Columbia University, where he was
awarded an honorary degree in 1914.
Between 1914 and 1925, there was a nonacademic interlude which included a short
and unsuccessful, stint as Austrian finance minister, followed by a presidency of a
private bank in Vienna. Schumpeter returned to academic life in 1926 with a
professorship at the University of Bonn. In the early 1930s, after a triumphal tour of
Japan—where reception of his writings on capitalist development had created a minor
sensation—he accepted a professorship at Harvard University and remained there until
his death, in 1950. One of the more charming stories about Schumpeter during his
Harvard period concerns his often-cited comment, in classes, that as a young man in
Vienna he had three burning ambitions. One was to be the greatest lover of women in
Vienna. The second was to be the greatest horseman in all Europe. The third was to be
the greatest economist of his age. Alas, Schumpeter then would say, he had achieved
only two of his three youthful ambitions.
II
Understanding Schumpeter’s central work, The Theory of Economic Development, is
enhanced by placing it in a broader intellectual and historical context and relating it to
his other writings. There have been three great periods of creativity in the development
of economic thought. The first, ranging from roughly the late eighteenth century to the
middle decades of the nineteenth, was the era of classical politcal economy. This period
was associated with such classic names as Adam Smith, Thomas Malthus, David
Ricardo, and John Stuart Mill. To this list, we should add Karl Marx, who both
extended and critically evaluated classical economic thought. These men established
economics as a systematic, social scientific discipline. Although their methods and
some of their ideas seemed crude, even misdirected, to later generations of economists,
theirs was a kind of golden age in the early development of economics. Most of them
were concerned with the grand themes of economic growth and development, the
relation of socioeconomic change to the distribution of income and power among social
classes, and to the principles of production and value underlying market exchange, as
well as to the more mundane issues of how a competitive, private enterprise economy
goes about allocating its resources and marketing its products. Several were
philosophers as well as social scientists, and most perceived the discipline in
sufficiently broad terms as to connect economic behavior to its social and political
context.
The second great creative period in economic thought occurred in the latter decades
of the nineteenth century. Although this period, like the classical era before it, had its
predecessors, its generally acknowledged founding figures were an Englishman, a
Frenchman, and an Austrian—Stanley Jevons, Léon Walras, and Carl Menger. Each of
these three independently published a major treatise embodying a significant shift in the
scope, content, and methodology of economics during the early 1870s.10 Under the
essentially separate, though with time reinforcing, leadership of this trio, the focus of
economics shifted from the broad themes of economic development and distribution of
income among social classes to the narrower and more manageable issues of the
allocation of resources and the associated distribution of income among individuals.
The time frame changed from the dynamic to the explicitly static, and the discipline
became self-consciously positive rather than normative, symbolized by the shift from
the broader phrase “political economy” to the narrower term “economics.” Although
Menger and his “Austrian school” colleagues, Böhm-Bawerk and Friedrich A. von
Wieser, eschewed mathematics, on the perceived ground that it was inappropriate for
piercing the basic qualitative factors underlying economic quantities, Jevons, Walras,
and their successors emphasized the need for a quantitative approach to their subject
and to the contributions of mathematics to development of a more exact formulation of
economic theories.
The new economics of the 1870s was sometimes called the “marginal utility” school.
During the first generation of the new approach, emphasis was placed on the noun
“utility” rather than the adjective “marginal,” to contrast the new focus upon subjective
factors of utility and demand in determination of market exchange values with the
earlier classical stress upon cost of production and supply. By the late nineteenth
century, focus had shifted to the adjective, as the “marginalist way of thinking” in terms
of incremental benefits and costs of alternative individual decisions spread to the
interpretation of various aspects of economic life, illustrated, for example, by the
marginal productivity theory of income distribution developed by the American
marginalist John Bates Clark. According to Clark’s analysis, in static, competitive
equilibrium, the price of any agent or factor of production such as “labor” or “land”
would equal its marginal contribution to the total product produced, and the total
product would be exhausted by payments to all individuals contributing to production in
accord with their marginal productivities.
Focus upon either component in the phrase “marginal utility,” however, probably
exaggerates the extent of differentiation from classical political economy. Important
elements of continuity included essential similarities concerning underlying
assumptions, notably concerning motivations, institutions, and technology. Economic
orthodoxy of the late nineteenth century, like that of its classical predecessors, tended to
suppose rational, calculating “economic men,” interested in promoting individual
economic gain through market exchange. Markets were presumed to be essentially
competitive, dominated by large numbers of small-scale enterprises. Technologies were
assumed to permit atomistic competition. Indeed, the main constraint upon the size of
enterprises was perceived to be “diminishing returns” to existing production units and
“diseconomies to scale” to expansion in overall enterprise i.e., rather than problems in
profitably marketing larger output. Another important element of continuity was the
general acceptance of “Say’s law,” named in honor of early nineteenth-century French
economist Jean Baptiste Say. This theorem postulated a tendency toward stable
equilibrium at full employment and utilization of resources in the economy as a whole
resulting spontaneously from the generally beneficial functioning of the competitive
market exchange processes of supply and demand.
Continuity with the classical political economy was substantially greater in the
writings of the “neoclassical” Cambridge economist Alfred Marshall than was true for
Jevons, Walras, and Menger. Marshall’s Principles of Economics, which went through
eight editions, dominated economics teaching in the English-speaking world for several
decades after its initial publication in 1890. Marshall was as thoroughgoing a
marginalist as were the founders of the marginal utility school. Like them, he also
independently incorporated a strategic role for utility and demand considerations in his
analysis of exchange value, notably in relatively shorter periods of time. He also shared
with them the view that “equilibrium” would involve not only the most satisfactory
position for each individual in the economic system, but the elimination of any above-
normal profits, that is, any profits above those necessary to reward the owner of an
enterprise for the contributions of his own productive resources. Unlike them, however,