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Schumpeter Creative Destruction


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Schumpeter Creative Destruction

  1. 1. Schumpeter’s Business Cycles as Business History. Business History Review 80 (Summer 2006): 231–261. © 2006 by The President and Fellows of Harvard College.
  2. 2. Quiz: &quot; According to Schumpeter...&quot; <ul><li>What is a 'business cycle'? </li></ul><ul><li>Provide one example of innovation from industry </li></ul><ul><li>Why do companies react “adaptively” to change? </li></ul><ul><li>Mention two types of innovation </li></ul><ul><li>Why are power groups in society likely to resist new changes? </li></ul><ul><li>What is the main motivator behind innovation? </li></ul><ul><li>Explain the relation between innovation, competition, and profit: </li></ul><ul><li>What is the role of marketing in innovation? </li></ul><ul><li>What is the difference between invention and innovation? </li></ul><ul><li>Explain why &quot;stabilized capitalism is a contradiction in terms&quot;? </li></ul>
  3. 3. <ul><li>&quot;Business Cycles, Business History&quot; is a three-country study of the United States, Britain, and Germany, covering the whole capitalist epoch. </li></ul><ul><li>It laid a solid foundation for &quot;Capitalism, Socialism and Democracy&quot; (1942), one of the seminal nonfiction works of the twentieth century. </li></ul><ul><li>&quot;Cycles&quot; refers to the economic ebb and flow that defines capitalism: fitting historical patterns of business booms and busts into predictable wave periods of standard lengths </li></ul>
  4. 4. <ul><li>Schumpeter focuses on companies in five industries that led economic development: </li></ul><ul><ul><li>cotton textiles, </li></ul></ul><ul><ul><li>railroads, </li></ul></ul><ul><ul><li>steel, </li></ul></ul><ul><ul><li>automobiles, </li></ul></ul><ul><ul><li>and electric power </li></ul></ul><ul><li>He also emphasizes three institutional innovations crucial to the rise of capitalism: </li></ul><ul><ul><li>the factory, </li></ul></ul><ul><ul><li>the corporation, </li></ul></ul><ul><ul><li>and the modern financial system. </li></ul></ul>
  5. 5. <ul><li>A general theory of capitalist evolution: </li></ul><ul><li>Recurring “Innovation” propels the economy, which exists in a state of constant tumult. New Men” or “Entrepreneurs,” operating within “New Firms,” drive innovation. </li></ul><ul><li>All companies react “adaptively” to change, but creative “responses” come only from innovative acts by entrepreneurs. Their innovations can take many forms: for example, “the case of a new commodity,” “a new form of organization such as a merger,” and “the opening up of new markets.” </li></ul><ul><li>Innovating firms do not arise evenly throughout the economy. Instead, groups of these firms emerge just after an organizational or technological breakthrough in a particular industry. </li></ul><ul><li>Meanwhile, powerful elements of society resist major innovations, because they tend to wreak havoc on existing arrangements. </li></ul>
  6. 6. <ul><li>As a result, “the history of capitalism is studded with violent bursts and catastrophes.” It is no gentle process of adjustment but something “more like a series of explosions.” </li></ul><ul><li>The building of a railroad where none had existed, for example, “upsets all conditions of location, all cost calculations, all production functions within its radius of influence.” </li></ul><ul><li>Innovation, then, is very much a double-bladed sword. </li></ul>
  7. 7. <ul><li>Schumpeter identifies entrepreneurial profit as the prime motivator—“the premium put upon successful innovation.” </li></ul><ul><li>When other participants in the same industry see the new level of high profit, they quickly try to imitate the innovation. </li></ul><ul><li>The entrepreneur tries to preserve his high profit for as long as possible, through patents, further innovation, secret processes, and advertising—each move an act of “aggression directed against actual and would-be competitors.” </li></ul>
  8. 8. <ul><li>Every entrepreneur’s high profit is temporary, because competitors will copy the innovation, causing market prices to fall. </li></ul>
  9. 9. <ul><li>A major theme of Business Cycles is the extreme difficulty of changing traditional ways of doing things. </li></ul><ul><li>Schumpeter emphasized that the destructive part of creative destruction has always been quite real, and he stressed that those whose interests are being destroyed will fight hard to preserve their culture and status. </li></ul>
  10. 10. <ul><li>Besides innovating in production, entrepreneurs often had to change habits of consumption. Industrialists had to convince reluctant customers that they actually needed the new goods. </li></ul><ul><li>Schumpeter places heavy emphasis on the role of marketing in mass consumption and in economic growth itself. “It was not enough to produce satisfactory soap,” he writes, “it was also necessary to induce people to wash—a social function of advertisement that is often inadequately appreciated.” </li></ul>
  11. 11. <ul><li>Undeniable needs such as food, clothing, and shelter do not, by themselves, “set the capitalist engine into motion.” </li></ul><ul><li>“ Needs, whatever they may be, are never more than conditioning factors, and in many cases mere products of entrepreneurial action.” </li></ul>
  12. 12. <ul><li>&quot;The Luddites were a social movement of British textile artisans in the nineteenth century who protested – often by destroying mechanised looms – against the changes produced by the Industrial Revolution, which they felt were leaving them without work and changing their way of life. </li></ul><ul><li>In modern usage, &quot;Luddite&quot; is a term describing those opposed to industrialisation, automation, computerisation or new technologies in general.&quot; </li></ul>
  13. 13. <ul><li>&quot;The making of the invention and the carrying out of the corresponding innovation are, economically and sociologically, two entirely different things.” Often the two interact, but they are never the same&quot; </li></ul>
  14. 14. <ul><li>Richard Arkwright was an inventor, but—much more critically—an innovating entrepreneur: &quot;Doing the thing, the actual setting up of new production functions is a distinct phenomenon.&quot; </li></ul>
  15. 15. <ul><li>&quot;Schumpeter notes that most of the technological problems were worked out in France and Germany during the 1890s and early 1900s. But the real automotive innovations occurred in the United States.&quot; </li></ul><ul><ul><li>1908: Model T Ford—a “great new thing,” as Schumpeter describes it—designed not for the rich but for the masses. By 1925, after only twenty-two years in business, Ford had sold twelve million Model T’s </li></ul></ul><ul><ul><li>General Motors’ introduction of installment buying created an immense amount of credit by turning consumers into significant borrowers... General Motors’ innovations in financing—as well as in styling, marketing, and organization—were as significant to the industry as Ford’s assembly line had been in production </li></ul></ul>
  16. 16. <ul><li>“ Capitalist evolution spells disturbance,” Schumpeter emphasizes </li></ul><ul><li>“ Capitalism is essentially a process of (endogenous) economic change.” The key that starts the engine and keeps it running is innovation: “Without innovations, no entrepreneurs; without entrepreneurial achievement, no capitalist returns and no capitalist propulsion. </li></ul><ul><li>The atmosphere of industrial revolutions—of ‘progress’—is the only one in which capitalism can survive.” Hence there must be constant change, generated from within. </li></ul><ul><li>“ In this sense,” Schumpeter concludes, “stabilized capitalism is a contradiction in terms.” </li></ul>
  17. 18. <ul><li>&quot;The great majority of changes in commodities consumed has been forced by producers on consumers who, more often than not, have resisted the change and have had to be educated up by elaborate psychotechnics of advertising.&quot; </li></ul><ul><ul><li>&quot;Railroads have not emerged because any consumers took the initiative in displaying an effective demand for their service in preference to the services of mail coaches. Nor did the consumers display any such initiative wish to have electric lamps or rayon stockings, or to travel by motorcar or airplane, or to listen to radios, or to chew gum.&quot; </li></ul></ul>
  18. 19. <ul><li>&quot;It is easy to adduce instances of initiative change of consumers' tastes and even to group them around familiar types.&quot; </li></ul><ul><ul><li>&quot;In every social circle, we observe leaders of fashion, specialists in creating new forms and habits of private life. &quot; </li></ul></ul>
  19. 20. <ul><li>&quot;We shall designate by the term Growth changes in population and in the sum total of savings... </li></ul><ul><li>That term is to emphasize not only that variation in both those variables is continuous in the mathematical sense but also that it occurs at a rate which changes but slowly and is per se incapable of producing those fluctuations in industry and trade which interest us here. </li></ul><ul><li>This does not mean that it cannot cause any fluctuations : it obviously can. Nor do we mean, that this factor of change is irrelevant to those fluctuations which are our subject, or that it is quantitatively insignificant.&quot; </li></ul>
  20. 21. <ul><li>Changes in the methods of supplying commodities: </li></ul><ul><li>A range of events including the introduction of new commodities which may even serve as the standard case. </li></ul><ul><li>Technological change in the production of commodities already in use, the opening up of new markets or of new sources of supply, Taylorization of work, improved handling of material, the setting up of new business organizations such as department stores—in short, any &quot;doing things differently&quot; in the realm of economic life. </li></ul>
  21. 22. <ul><li>&quot;It is entirely immaterial whether an innovation implies scientific novelty or not. Although most innovations can be traced to some conquest in the realm of either theoretical or practical knowledge, there are many which cannot. </li></ul><ul><li>Innovation is possible without anything we should identify as invention and invention does not necessarily induce innovation, but produces of itself no economically relevant effect at all.&quot; </li></ul>
  22. 23. <ul><li>&quot;the making of the invention and the carrying out of the corresponding innovation are two entirely different things. They often have been performed by the same person ; but this is merely a chance coincidence which does not affect the validity of the distinction. </li></ul><ul><li>Personal aptitudes—primarily intellectual in the case of the inventor, primarily volitional in the case of the businessman who turns the invention into an innovation—and the methods by which the one and the other work, belong to different spheres. </li></ul><ul><li>The social process which produces inventions and the social process which produces innovations do not stand in any invariant relation to each other and such relation as they display is much more complex than appears at first sight.&quot; </li></ul>
  23. 24. <ul><li>&quot; Of course, in reality, all three factors—changes in tastes, growth, and innovation—interact and mutually condition each other, and observed historic changes are the result of them all. But we can satisfy ourselves of their logical independence by visualizing societies in which internal change is merely caused by autonomous change in consumers' tastes or merely by growth or merely by innovation.&quot; </li></ul>
  24. 25. <ul><li>&quot;Innovation is the outstanding fact in the economic history of capitalist society or in what is purely economic in that history, and also that it is largely responsible for most of what we would at first sight attribute to other factors.&quot; </li></ul>