Schumpeter and Creative Destruction:
The Process of Market Innovation in Capitalist Societies
Joseph Schumpeter was a 20th century Austrian economist who taught at Harvard for several years upon coming to the US. While much of his work was overshadowed by his contemporary Keynes, he made important contributions to macroeconomic theory by developing dynamic models of market change. His work described the nature of market innovation within capitalist societies and emphasized the role of less quantitative measures such as sociology as a major factor for economic development. Much of his inspiration was drawn from the economists Marx and Weber who favored dynamic sociological backgrounds, as well as Walrus from whom he borrowed the concept of the entrepreneur. Despite his emphasis on social factors, however, Schumpeter was one of the leading econometric economists of his day.
In 1942 Schumpeter published Capitalism, Socialism, and Democracy. In this work lies the theory of creative destruction, one of his most notable contributions. Originally a term coined by Marx, Schumpeter employed the “creative destruction” to mean the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one”. He wrote that the concerns of capitalism were less about how existing structures were administered and maintained and more about how these structures are destroyed and created. Entrepreneurs, he says, are the sole facilitators of innovation and invention that bring about these structural and market changes in economic systems.
Schumpeter placed much focus on equilibrium and the role of entrepreneurs to facilitate change within an economy. According to Schumpeter, an economy in equilibrium produces products for future consumers who are consuming their present products, and consumers consume products of past producers in a circular flow based on past experience. The expectations and cycles are essentially contained with no new production functions allowing for changes. The entrepreneur operates outside the system and introduces changes to the production function that allow for the creation of new wealth and destruction of the old- hence the term, creative destruction.
In Schumpeter’s analysis, entrepreneurs are the sole agents of change and responsible for the destruction and construction of new markets and wealth within a society. It is the sheer acts of will and leadership, rather than intellect, which characterize the entrepreneur and secure economic progress through successful innovation.
According to Schumpeter, capitalist societies did not operate in a the static circular flow, or equilibrium, proposed by Weber where the production function is invariant and preexisting factors of production are combined according to the technology at hand mechanically. Market activity is much more dynamic and changing. It is the Entrepreneurs who operate as a nonentity outside of this equilibrium and force new combinations of factors that disturb the circular flow as a means of innovative development. Rather than changing the quantity of factors to change the quantity of products produced, this disturbance creates market disequilibrium as their innovative contributions change the form of the production function. This change in production function form introduces new and higher quality commodities which destroys old wealth and creates new wealth.
William Dare 