Schumpeter, Equilibrium, and Growth

The following passage, from Art Diamond’s EH.Net review of Joseph A. Schumpeter: A Theory of Social and Economic Evolution by Esben Sloth Andersen, caught my eye.

Since Schumpeter was the premier advocate of economic dynamism, I have long wondered if his praise for Walras was sincere or ironic.  Andersen painstakingly shows that Schumpeter believed the economy moved from Walrasian circular flow to disequilibrium and then eventually back to a new Walrasian circular flow.  So Schumpeter sincerely believed that the development of an equilibrium economics based on Walras was a necessary complement to the evolutionary economics that Schumpeter himself developed.

It reminded me of Murray Rothbard’s neglected 1987 article, “Breaking Out of the Walrasian Box: The Cases of Schumpeter and Hansen” (Review of Austrian Economics, vol. 1, pp. 97-108). Rothbard offers exactly this interpretation of Schumpeter:

As a Walrasian, Schumpeter believed that general equilibrium is an overriding reality; and yet, since change, entrepreneurship, profits, and losses clearly exist in the real world, Schumpeter set himself the problem of integrating a theoretical explanation of such change into the Walrasian system. It was a formidable problem indeed, since Schumpeter, unlike the Austrians, could not dismiss general equilibrium as a long-run tendency that is never reached in the real world. For Schumpeter, general equilibrium had to be the overriding reality: the realistic starting point as well as the end point of his attempt to explain economic change.

In Schumpeter’s version of general equilibrium (unlike Mises’s evenly rotating economy), interest rates and gross savings are zero. Without any funds to maintain (let alone accumulate) capital, what can bring about economic change? The innovating entrepreneur, financed by bank credit expansion, as deus ex machina. Notes Rothbard:

To admire Schumpeter, as many economists have done, for his alleged realistic insight into economic history in seeing technological innovation as the source of development and the business cycle, is to miss the point entirely. For this conclusion is not an empirical insight on Schumpeter’s part; it is logically the only way that he can escape from the Walrasian (or neo-Walrasian) box of his own making; it is the only way for any economic change to take place in his system.

The idea that only inflationary bank credit can finance Schumpeterian innovation, emphasized by Rothbard, is almost entirely ignored in the vast neo-Schumpeterian literature. As Guido Hülsmann points out in Mises: Last Knight of Liberalism (pp. 173-74), Böhm-Bawerk immediately recognized this odd general-equilibrium construction as a fatal flaw in Schumpeter’s theory of economic development, writing that “Schumpeter commits a fateful mistake, which despite all the qualifications that he makes is a true mercantilistic mistake of superficial reasoning: When it comes to determining the possible scope of productive credit, he accords the essential role to money and means of payment, rather than to the economy’s supplies of real goods.”

Comments

  1. Excellent! That helps me a lot. I vaguely realized something similar when discussing the current situation with a “market monetarist.” He insisted that one person’s savings is another person’s loss of revenue. Which is true in circular flow economics and that leaves only monetary expansion as a possible means of growth.

    But if you simply break up homogenous capital into nothing more than consumer and producer goods then the savings get spent by producers instead of consumers, as Adam Smith understood. But that seems to be too hard a concept for mainstream economists to grasp.

  2. Minsky and Minskians have focused in on Schumpeter’s belief that economic growth requires credit expansion, Minsky integrating it into his business cycle theory. Apparently, the idea that growth can take place without a complimentary increase in the supply of fiduciary media is rarer than we thought.

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