Joseph Schumpeter: Unraveling Economic Cycles and the Role of Technological Innovations

Joseph Aloïs Schumpeter, economist and economic historian, was born on February 8, 1883 in Triesch, Moravia (part of the former Austro-Hungarian Empire). He died on January 8, 1950 in Taconic, Connecticut, United States, following a cerebral hemorrhage.

He is known to have been one of the founders of a certain economic evolutionism, his theories being based essentially on technological innovations.

Joseph Schumpeter is interested in the analysis of economic history and the link between economics and sociology. His theories represent fine analyzes of the economy of his time and the complexity of economic theories.

Schumpeter takes as a sociological unit the character of the entrepreneur, and as historical landmarks the great innovations. From this, he builds an analysis of economic cycles and their fluctuations in history based on his historical and sociological benchmarks.

The study of economic cycles and technological innovations are the two main contributions of his theories. At the beginning of the 20th century, it was a significant step forward in theoretical economics to show that we could create new tools for analyzing the history of the economy, by adding variables to the tool well known that is the balance of
walk.

On the sidelines of classical theories, Schumpeter still managed to make an important place for himself in American intellectual circles. From 1927 he taught at Harvard and from 1937 he chaired the American Economic Association.

Equilibrium and the “neighborhood of equilibrium”

Schumpeter takes classical economic equilibrium as his first tool of analysis. Indeed, he uses the latter to show that it can be used to make rough analyzes of economic situations and their causes.

In particular, the first phase of his analysis of economic cycles is based on economic equilibrium as theorized by economists of the classical school.

On the other hand, to make finer analyzes it is necessary to detach a little from this balance.

This is why he often uses the notion of “neighborhood of balance“, referring to a situation where one tends towards balance without really reaching it (due to the abstract nature of this balance ). This concept of “neighborhood of balance” is very useful to him in order to anchor his theory a little more in social reality. His goal being to confront economics and sociology, the idea of pure balance would be too far removed from the society in which he lives to be credible.

The entrepreneur – sociological anchoring

The entity of the entrepreneur is the way that Schumpeter found to bring his economic theories closer to the propositions of sociology. Indeed, classical economics offers a calculating economic agent and inevitably appealing to one and the same rationality.

Maximizing the gains while minimizing the risks, here is the only calculation that the agent of the classical economy performs.

To stand out from this, Schumpeter proposes the character of the entrepreneur. This makes it possible to apprehend a state of mind specific to important agents of the economy possessing at least two characteristics: the power of command within any entity and access to credit.

The entrepreneur is a leader in the field of the economy: he makes the decisions and above all he applies them. Thus, he must focus on the near future and act quickly. It is therefore impossible and unproductive for him to take into account all the parameters as the decision-maker of classical economics would do.

Schumpeter’s entrepreneur still differs from the decision-maker of classical economics in that his goal is not the maximization of his own earnings. Indeed, the state of mind of the entrepreneur is different: he is a dreamer.

He wishes to create and prosper in spite of others, he is more interested in the “territory” than in wealth. The goal of the entrepreneur is to build an empire, not to accumulate as much money as possible.

Innovation “clusters” – historical roots

After the definition of a sociological unit, we must move on to historical anchoring. Following several other economists, Schumpeter is interested in the evolution of the economy in history, its crises as well as its boom years.

In order to set benchmarks from which to begin his analysis, Schumpeter identifies “clusters of innovations“, that is to say given periods in which innovations have borne fruit have spawned others. .

The term cluster refers to all the innovations arising from the first.

For example, the creation of the Internet network is an innovation that has enabled thousands of other innovations. Taken together, these represent a cluster of innovations.

To push the analysis as far as possible, it would be necessary to make a detailed study of all the implications (social, political, historical, religious, etc.) that a single innovation could have had. To do this with the example of the Internet, we would still have to wait a while

in order to be able to integrate all the consequences – more or less distant in space-time – of this innovation, which represents a colossal work of analysis. That is why

Schumpeter stops at “clusters of innovations” already allowing an analysis of certain key periods in the history of the economy.

Business cycle models and different analyzes

Schumpeter devoted himself to the study of economic cycles throughout history. The latter takes place in two main stages, for two different analyses. The first is an analysis that can be described as crude, which uses a model of classical economics: equilibrium. For a very long-term study, Schumpeter defends this equilibrium model because it represents the average trend of the economy throughout history, its average curve.

Indeed, in an analysis that can be described as “macro”, Schumpeter identifies two visible trends: the first consists of the “cluster of innovations” and the prosperity that follows; and the second of the end of growth caused by the cluster and
of the recession as a consequence of it.

The idea of a cycle obviously comes from the fact that after a recession inevitably comes the time for a new cluster of innovation.

The second analysis of the cycles is a little finer and is based on what Schumpeter calls “the neighborhood of equilibrium”. In a situation like this, the economy tends to balance but never really achieves it.

Thanks to this additional postulate, Schumpeter can identify two more tendencies in the study of cycles. There is always prosperity and recession, and are added, after these two phases, phases of depression and recovery.

These two phases represent the link between the cycles. After the recession comes a phase of depression which pushes for technological innovation and the latter makes it possible to enter a phase of recovery – characterized by attempts at innovation – preceding the next phase of prosperity.

The analysis of these cycles is relevant from the point of view of the analysis of the history of the economy, but Schumpeter sees a problem when one wants to use the cycles to predict what will happen: there is too many unknown variables to be able to predict the future.

In addition, social factors must be taken into account, since agents are able to change their rationality at any time, as in the example of the entrepreneur. This is also what makes Josef Schumpeter a contemporary economist: he thinks about economics beyond classical theories and highlights the fact that these are practical for a certain level of analysis, but they have their limits. , as well as the theory of business cycles.

Conclusion

In conclusion, Joseph Schumpeter’s contributions have illuminated the intricate dance between economic cycles and technological innovations. His concept of “creative destruction” underscores the dynamic nature of capitalism, where innovations lead to the dismantling of old structures and the emergence of new opportunities.

Through his theories, Schumpeter has underscored the critical role of entrepreneurs and their ability to harness technological advancements to propel economic progress. As the world navigates the uncharted waters of the digital era, Schumpeter’s insights continue to serve as guiding beacons, reminding us of the enduring interplay between innovation and economic evolution.

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