The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle

Abstract

Schumpeter first reviews basic economic concepts that describe recurring economic processes of a commercially organized state in which private property, division of labor, and free competition prevail. These constitute what Schumpeter calls the of economic life, such as consumption, factors and means of production, labor, value, prices, cost, exchange, money as a circulating medium, and exchange value of money. The principal focus of book is advancing idea that change (economic development) is key to explaining features of a modern economy. Schumpeter emphasizes that his work deals with economic dynamics or economic development, not with theories of equilibrium or circular flow of a static economy, which have formed basis of traditional economics. Interest, profit, productive interest, and business fluctuations, capital, credit, and entrepreneurs can better be explained by reference to processes of development. A static economy would know no productive interest, which has its source in profits that arise from process of development (successful execution of new combinations). The principal changes in a dynamic economy are due to technical innovations in production process. Schumpeter elaborates on role of credit in economic development; credit expansion affects distribution of income and capital formation. Bank credit detaches productive resources from their place in to new productive combinations and innovations. Capitalism inherently depends upon economic progress, development, innovation, and expansive activity, which would be suppressed by inflexible monetary policy. The essence of development consists in introduction of innovations into system of production. This period of incorporation or adsorption is a period of readjustment, which is essence of depression. Both profits of booms and losses from depression are part of process of development. There is a distinction between processes of creating a new productive apparatus and process of merely operating it once it is created. Development is effected by entrepreneur, who guides diversion of factors of production into new combinations for better use; by recasting productive process, including introduction of new machinery, and producing products at less expense, entrepreneur creates a surplus, which he claims as profit. The entrepreneur requires capital, which is found in money market, and for which entrepreneur pays interest. The entrepreneur creates a model for others to follow, and appearance of numerous new entrepreneurs causes depressions as system struggles to achieve a new equilibrium. The entrepreneurial profit then vanishes in vortex of competition; stage is set for new combinations. Risk is not part of entrepreneurial function; risk falls on provider of capital. (TNM)

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