Joseph Schumpeter Business Cycles

Economist Joseph Schumpeter Business Cycles

Schumpeter's emphasis on the entrepreneur as the active agent for change in a com­petitive economy provides a bridge between the microeconomics of the firm and the macroeconomics of government policy. Within a Schumpeterian framework, the transmission mechanism through which tax and spending policies affect economic behavior is the ultimate impact that such policies have on individual incentives. Once again, the entrepreneur is the focal point. Citing the experience of the U.S. economy in the 1920s, Schumpeter raised the issue of whether taxes significantly affect the profit motive and economic progress. The United States inaugurated a federal income tax in 1913, so the issue was a timely one in the 1920s. Schumpeter evaluated the effects of a progressive income tax on the entrepreneurial function:

Any tax on net earnings will tend to shift the balance of choice between "to do or not to do" a given thing. If a prospective net gain of a million is just sufficient to over-balance risks and other disutilities, then that prospective million minus a tax will not be so, and this is as true of a single transaction as it is of series of transactions and of the expansion of an old or the foun­dation of a new firm. Business management and enterprise ... will for its maintenance depend, at least in the long run, on the actual delivery, in case of success, of the prizes which that scheme of life holds out, and, therefore, taxes beyond a percentage that greatly varies as to time and place must blunt the profit motive (Business Cycles, pp. 291-292).

True to his Austrian training, Schumpeter always kept an eye on the competitive process, that maelstrom of economic activity that is composed of individual deci­sions based on reigning economic incentives. Schumpeter retained the Austrian per­spective on macroeconomics, namely that it concerns aggregates, which in turn rep­resent collective outcomes of individual decisions. The causation runs from the individual to the collective, however, as Menger taught, never the other way around. There may be numerous institutional forces promoting or discouraging economic growth, but a key one, in Schumpeter's judgment, lies in a "do no harm" fiscal policy that includes low and/or declining rates of taxation. In the vernacular of politics, Schumpeter was an early "supply sider."

Schumpeter's influence on the theory of economic development has been enor­mous, even among those economists who reject the theory outright. And among econ­omists, especially those lacking historical perspective, the term "entrepreneur" has become virtually synonomous with the name of Schumpeter. As theories of economic change go, Schumpeter's analysis occupies the middle ground between Marshall and Max Weber. Marshall's theory adapted incrementally to shifts in preference and pro­duction functions, the result being a continuous improvement in moral qualities, tastes, and economic techniques. Its shortcoming was that it did not explain business cycles, a deficiency that Marshall's student Keynes set about to remedy. Marshall's approach also implied a theory of unilinear progress, which Schumpeter's theory de­nies. Weber's theory developed its own set of moral imperatives and used them to explain rapid social and economic transitions that punctuate long periods of histor­ical continuity. Schumpeter postulated the continuous occurrence of innovations and waves of adaptation simply because entrepreneurs are always present and are a force for change.

Ultimately, the appeal of Schumpeter's theory of economic development derives from its simplicity and its power, characteristics evident in the Schumpeterian phrase: "The carrying out of new combinations we call 'enterprise'; the individual whose function it is to carry them out we call 'entrepreneurs' " (Economic Development, p. 74). Yet despite the importance of Schumpeter's contribution to economic devel­opment, his dynamic approach and his holistic vision of economic activity have failed to dominate economic analysis. Conventional economics still works mainly by in­tellectual specialization and division of labor.