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The Theory of Economic

Development: An Inquiry into

Profits, Capital, Credit, Interest,

and the Business Cycle (1912/1934)

Joseph A. Schumpeter (Author)

Product Details:

Paperback: 244 pages

Publisher: Transaction Publishers

(January 1, 1982)

Language: English

ISBN-10: 0878556982

ISBN-13: 978-0878556984

Schumpeter’s explanation of economic progress

This book provides a useful corrective to some of the shortcomings of the so-called Austrian theory of Capital and the Business Cycle. Schumpeter, who studied under the great Austrian economists Bohm-Bawerk, was too much of an independent thinker to be part of an economic movement or school. The Theory of Economic Development is his declaration of independence from Austrian capital theory. In the book, he introduces a theory of development and the business cycle that shocked his more orthodox colleagues. Economic development, Schumpeter argues, involves transferring capital from old businesses using established methods of production to businesses using new, innovative methods. Schumpeter’s special insight comes in trying to explain how the transfer of capital from the old to the new takes place. Schumpeter argued that it takes place through credit expansion. Through the fractional reserve system, banks are able to create credit, quite literally out of thin air. This money is lent to businesses specializing in new methods of production, who then bid up the price of production goods and consumer goods in their effort to pay for the production goods they require. Thus a form of inflationary spoliation takes place at the expense of established businesses and consumers. Although Schumpeter does not draw the spoliation inference from his theory, it is nonetheless there in the text for all who can see. Credit expansion is a form of spoliation, a form of robbery hardly distinguishable from counterfeiting. But what is unique about the capitalist engine of production is how it uses spoliation in the service of progress. And not merely spoliation through credit expansion, but spoliation through protectionism, stock manipulation, corporate welfare, cartels and monopolies, and outright fraud and manipulation. Schumpeter’s book sheds light on just one aspect of this spoliation, and from this stems the book’s vital importance to economic theory.

Dynamics and Progress

The Theory of Economic Development represents a high point in the history of economic science. Schumpeter had a clear understanding of the difference between static and dynamic issues in economics, and an appropriate appreciation of the latter. This book also shows how advanced Schumpeter’s thinking was. On page 10 Schumpeter appears to anticipate the modern definition of economics- 20 years before Robbins wrote his Nature and Significance of Economic Science (was this in the original edition, or just in my 1934 reprint?). Chapter one sorts out Say’s Law of Markets in detail, and explains its static nature. Chapter two explains economic development in correct dynamic terms (unlike the pseudo-dynamics of Neoclassical growth theory). Schumpeter is able to explain dynamics because he examines entrepreneurship (and vice versa). Schumpeter also leaves room for real institutions, especially financial markets.

Schumpeter was interested in matters of great consequence and thought about them deeply. There is simply no comparison between Schumpeter’s insightful analysis and the tedious and purely imaginary intellectual constructs of Solow influenced math modelers. There is a clear difference between Schumpeter’s analysis and the intellectual gymnastics of modern mathurbationists. Schumpeter was a true professional.

I was somewhat surprised by the extent to which Schumpeter’s ideas fit with the ideas of Mises, Kirzner, and Lachmann. Schumpeter is often seen as an Austrian born Walrasian instead of as an Austrian economist in the Menger-Mises-Hayek tradition. There are clear Austrian influences on Schumpeter’s thinking, though he was not a Mises clone. I was already impressed with Capitalism, Socialism, and Democracy. Schumpeter was a true genius, and an economist on par with Ricardo and Hayek. Read this book to learn some development economics, and a little intellectual history too.

On the Economic Causes of Business Cycles

In this important book Schumpeter explains the ECONOMIC origins of business cycles. In a convincing way Schumpeter argues that business cycles are inevitable in a developing economy.

This does not mean that there are no other causes of business fluctuations such as changes in commercial policy, wars, inflationary government finance or panics. But these constitute non-economic data and cannot be explained by economic theory.

Conventional macroeconomic theory tends to explain business cycles by some kind of error and focus on correcting this error either by active policy or by advocating a hands-off policy. In this view business cycles have no function.

In a stationary, non-developing economy (i.e. absence of innovations) there would be very little uncertainty. If you and your competitors have been selling essentially the same product in the same market year in year out and if this were to apply to all products and services would there be any economic risk (fires, epidemics and tax increases are non-economic data) left ? Were there any true economic causes, i.e. causes that economics can explain, of business cycles in the Dark Ages ?

There is still something to be said for Keynesian theory (although not for policy) in that uncertainty does influence investment decisions and that because of uncertainty in a monetary economy some hoarding of purchasing power does occur. But these are mere symptoms of underlying endogenous business cycles caused by the inflationary investment booms – “animal spirits” if you like – invoked by the swarms of innovating firms, e.g. the internet bubble, and the deflationary busts that follow when the old firms die off and yesterday’s innovators become part of the stationary cycle. Schumpeter explains the origins of economic uncertainty.

What Schumpeter teaches us is that booms and recessions are necessary phenomena in developing economies, that can’t be removed or corrected if we are not to thwart the creation of new wealth by innovation. Recessions are the price we pay for long term economic growth. However, recessions can lead to unnecessary panics that cause unnecessary harm to the economy. Here governments or central banks are able to, and should in my view, correct.

The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle (1912/1934)

Joseph A. Schumpeter (Author)

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