Joseph Schumpeter (1883-1950) was born in Moravia, currently under the Czech Republic, to a family of industrialists. He was lucky to grow up in aristocratic surroundings and later head on to the prestigious Theresianum School in Vienna (Hoefle, 2017). During that era, it was obligatory for every Austrian economist to study law and politics beforehand. He regarded his teachers, the likes of Carl Menger and Friedrich von Mises, quite highly since they created a huge impact on how he would come to view economic issues. He had a storied academic career as well as being one of the youngest professors in Graz. While working in Britain, he always identified with the neoclassical school (McDaniel, 2005). He went on to become research professor for Columbia University the First World War interrupted his career but he later, 1919, became the Austrian finance minister in the country’s inaugural social democracy republic. He later moved to the private sector as head of a bank that collapsed due to the financial crisis of the time. He spent time as a lecturer in Bonn where he learned the mixed economy, the coexistence of family businesses and public corporations, as well as the nature of cartels. Later, in 1932, he moved to Harvard where he pioneered scientific economics and became one of the founders of econometrics (Hoefle, 2017).

He was one of the most advanced economics scholars of his generation, and this fact was shown by his versatility. His main fields of research included fiscal policy, money, economic governance systems, and business cycles. He had a sound grasp of the nuances of capitalism in a level comparable to greats like Max Weber (Hoefle, 2017). He conducted tireless researches on matters of political economics. Coupled with his cosmopolitan outlook, multilingual abilities, and writing skills, he has become one of the most important historiographies of economic ideas.

Schumpeter’s school of thought was of the idea that a capitalistic world could only function if there was a good symbiotic relationship between the historical, economic, social, and political aspects (Croitoru, 2012). All key aspects of a capitalistic society were approached separately since it was considered the most efficient way of accessing aspects of economic reality. According to him, economic phenomena could not be isolated from external factors. ‘The Theory of Economic Development’ presented Schumpeter’s earliest views on how to approach economic reality (Courvisanos and Mackenzie, 2011). His theory assigned phenomena like political upheavals, wars, and culture to a level of secondary significance. The importance of these important external elements was not effaced. Schumpeter focused the capitalistic economic development analysis only on the exclusive elements that constituted the process (McDaniel, 2005). He deals with events that occur in the sphere of economics within a society while external factors like politics and population are held constant. While Schumpeter’s theory on entrepreneurship is rooted in change, the terminology used is quite distinctive (McFarling, 2000). He notes that there are changes that come both from within and without the realm of the entrepreneur. Changes influenced by internal business decision were referred to as development while those caused by external forces were adaptations (Swedberg, 2007). The fundamental argument of his ideology found that the most significant part of entrepreneurship was innovation.

One of the most crucial elements of his analysis involved a clear distinction between endogenous and exogenous economic factors (Jones and Wadhwani, 2006). This perspective allows for the expert analysis of economic phenomena while retaining a safe distance with elements from other spheres of reality. In his approach, he elaborated the crucial role of entrepreneurs in a capitalistic society by viewing them as scientists rather that run-of-the-mill businesspeople. Business leaders had to keep thinking and researching to discover an innovative edge that would make them more competitive (Croitoru, 2012). Schumpeter’s theory of economic development was fixated on the issue of innovation (The Economist, 2007).

The evolution of Schumpeter’s ideas on entrepreneurship are clear in his several works. Practical business developments like the registration of limited companies influenced his thinking. He lived in Britain circa 1911, and had learned a lot from the first truly industrialized nation (Hämäläinen and Heiskala, 2007). He was also an avid studier of American industrial development at the time and found that both countries practiced partnerships or owner-manager setups. So, it lends credence to the fact that majority of the entrepreneurial examples studied by Schumpeter at the time were overwhelmingly individualistic. The Companies Act of 1885 allowed limited liability companies in Britain while they were already operational in America (McFarling, 2000). These had been lobbied by interested investors rather than business owners, which showed that individualism was still a major issue.

Schumpeter moved to America around 1939 when he was writing Business Cycles. The limited liability company had dominate the business landscape and there was a spike in issues of entrepreneurship and corporate innovation. His entrepreneurship theory underwent somewhat of a second incarnation with more emphasis placed on the creative destruction of innovative economic growth (Courvisanos and Mackenzie, 2011). Contrary to the initial view of the entrepreneur as individual figure who pools the factors of production, Schumpeter placed emphasis on innovation. Moving away from the individualistic ideology, he affirmed that entrepreneurs don’t have to be individual people. He stated that a country, or its agenda, can act in an entrepreneurial capacity after years of studying the happenings in the American economy. In the 18th and 19th centuries, inventors acted as entrepreneurs since they were behind the technological know-how and the companies were small in scope. However, modern times have taken the art of innovation into a task for entire departments that are funded by the organization.

Schumpeter’s Theory of Innovation  

Schumpeter’s theory was based on four fundamental features namely circular flow, the entrepreneur’s role, cyclical business processes, and end of capitalism.

Circular Flow

He assumes that businesses operate in a circular flow where same products are produced using similar means throughout the year. The economy is in a state of competitive equilibrium as supply and demand pieces are the same. There are no interest rates, savings, investment, unemployment, or profits. Schumpeter equates this self-reviving business cycle to the human blood circulation (McCraw, 2009).

Innovation as a terminology has been utilized since the late 1880s but all the precursors have not been as influential and articulate as Schumpeter (Dekkers et al., 2014). He assumed that consumer tastes were given since they did not undergo spontaneous transformation. In the process of economic development, the consumer’s role is viewed passively. He described development as a process as a historical process consisting of structural changes driven by innovativeness. According to him, there were five different types of innovation possible in a business:

  • Launching a new product or another version of an existing one.
  • Applying new methods of production or sales of a certain item.
  • Opening a new market where there was no prior representation (Nayab, 2011).
  • Acquiring a new, and efficient, source of raw materials.
  • A new structure within the industry such as the deconstruction of a monopoly.

Schumpeter argued that any entrepreneur seeking to generate profits must innovate (Śledzik, 2013). He considered innovation to be a critical determinant of economic dynamics as well as competitiveness. It would disrupt the economic structures and create new ones hence it was the key driver to effect change. The essence of any entrepreneurial advances lay not in the pooling of factors of production but in the creation of new combinations regarding processes, supplies, products and markets. Successful combinations would cause disruptions in the market equilibrium and act as a source of entrepreneurial profits.  

Role of entrepreneur as an innovator

Entrepreneurs were people who could venture into the unknown to explore new opportunities and ideas (McCraw, 2009). They occupy a central position in the innovation process because they are responsible for initiating and overseeing any development initiatives. According to him, there were crucial roles that entailed every entrepreneur:

  • To appreciate the possibilities of new innovations
  • To overcome common socio-psychological barriers that resist the introduction of new ideas
  • Opening up new channels by directing factors of production
  • Persuading the bankers to offer credit to the business
  • Inducing the importance of taking risks to other members of the organization
  • Creating a conducive environment for satisfaction of wants

Schumpeter gives a comprehensive explanation of the entrepreneur’s role which is considerably different from that of pure capitalists (McCraw, 2009). It was not mandatory for an entrepreneur to receive the profits made by an organization, but he was purely responsible for their generation. Therefore, they could be managers employed by the company owner to oversee the daily running of the business. Entrepreneurship was seen as a product of the social environment which compels them to innovate or get crushed by the fierce forces of competition. He found that there were three key factors that motivated entrepreneurs in their capacities (Śledzik, 2013):

  • The desire to make gains- business leaders will explore their desire to gain superiority over their counterparts in a sport like point of view. People want to outdo others in the running of businesses and generation of profits (McFarling, 2000).
  • The joy of creativity- some businesspeople will engage just to realize a creative edge by building something from nothing.
  • The desire to create an empire- some entrepreneurs are interested in the idea of amassing great wealth, power, and control. This ideology offers independence and a substantial level of authority on the individual.

The creation of new combinations, according to Schumpeter, was a source of the fundamental disruptive changes within markets, which is proof that capitalism is not stationary (Jones and Wadhwani, 2006).  

Individuals become complete entrepreneurs when they have the technical knowledge involved in production as well as control over all factors of production including credit (Cuervo, Ribeiro and Roig, 2007). He was particularly keen on the matter of profits in relation to the entrepreneurial duties. Schumpeter noted that businesspeople will innovate to earn profits, which are considered as the surplus of costs. According to him, the price of producing a product is equivalent to its price under a competitive equilibrium. It implies that there are no profits under this scenario. The equilibrium is only broken by an innovation, which causes a disruption, and the company reaps profits until it becomes outdated or other competitors catch up with the idea (Tzeng, 2009).

Breaking the circular flow of businesses by an innovation requires the participation of other quarters as Schumpeter elaborated. He started his model by assuming a company that innovates and comes up with a new product for the sake of making a profit. The research and development of a new item requires substantial financing. This is where Schumpeter brought in the banking system and its important role for any entrepreneur (McFarling, 2000). Companies will borrow money at an interest from the banks to finance their innovation ideas. Once a product or service becomes successful, the company make huge profits but fellow competitors take note of this and either imitate or enhance the product and the profits return to zero.

Business Cycle

The economic process operates under capitalism according to Schumpeter. His historical, analytical, and statistical approach identifies that business cycles are a result of both economic and nob-economic factors. Adapting to the new conditions is a recipe for business crises which are mainly solved by accessing bank credit. It increases the disposable income, and hence purchasing power, of the consumers leading to increased demand (Shionoya, 2007). The shortage of product to offer the market forces companies to seek capital to increase their investments to satisfy the market. The surplus demand also alerts competitors who invest in the market in a period known as a boom. New products in the market will often signal death for the old ones. These products are replaced and hence their demand falls. Companies lower the prices to stimulate demand, leading to generation of losses (Bezemer, 2014). Businesses are paying their loans while investment is on the decline and prices are falling. Profits also fall to zero as uncertainty sets in the market. The boom ends and a depression sets in, indicating the upswings and downswings according to Schumpeter.  

End of Capitalism

Just like Karl Marx, Schumpeter believes in the self-destructive nature of capitalism. He visualizes the disintegration of capitalism, which will be caused by its success, into socialism (Hospers, 2005).

Key Assumptions

According to Schumpeter, innovators are not necessarily the entrepreneurs. The latter include the people who channel any new innovations into a productive outcome within the organization. This line of reasoning hence implies that a business owners are considered entrepreneurs only when they are effecting new combinations. Entrepreneurs leave the static equilibrium by launching new methods or products and rendering the others obsolete in a process called creative destruction (Dekkers et al., 2014).

The main features of this theory make a number of assumptions which include:

  • All economic activities follow a familiarly repetitive routine. All companies in the industry use the same methods of production.
  • All the producers know the quantity of goods demanded in an economy and hence will adjust their output accordingly. There is perfect knowledge in the market which allows every business to plan its inventory efficiently (Dekkers et al., 2014).
  • There is no wastage of resources since the economy utilizes the optimal level of output generation.
  • The firms are in a state of competitive equilibrium and are of optimal size.
  • The prices of the goods are equivalent to the average cost of production.
  • The only way to break this retrogressive cycle occurs when companies differentiate themselves via innovating. The theory centers on entrepreneurial innovation as the only way of breaking out of the static equilibrium.
  • There is sufficient availability of capital in the market (Hospers, 2005). It assumes that the banks will always have money to lend to new innovations. This state calls for robust and well-developed banking systems to be the norm, a situation which is mostly found in developed economies.
  • Existence of a high level of technology to enhance innovation. Entrepreneurs make use of technology to come up with new products or methods, and Schumpeter assumes that it is readily available.
  • Entrepreneurs are responsible for introducing all significant changes within the economy (Cantner, Dinopoulos and Lanzillotti, 2005).

Influence on Modern Business and Management

Schumpeter’s ideas shave left a lasting impact in economics, which is an indication of the importance of his ideologies (Cantner, Dinopoulos and Lanzillotti, 2005). He said that innovation was the only way to make entrepreneurship a successful endeavor. Today we see many corporations investing massive sums in the research department in an effort to create new products and improve their competitiveness. Every business is keen on consistent innovation to keep up with customer preferences and open up new markets in consistency with Schumpeter’s ideas. Dynamic economies have access to a wide pool of entrepreneurs a result (Braunerhjelm, 2010).

He identified the three core motivators of entrepreneurs around the world. They are still associated with many businesspeople today. Entrepreneurship is driven by those three main reasons. Those who do it for recognition and to achieve a creative effort should receive congratulatory messages to encourage the performance. They should also receive a level of autonomy, in cases where they are not the capitalists, to exercise their vision. Globally, we see corporations are keen on keeping the management motivated at all times using vacation packages, promotions, and increased delegation among others to keep them motivated (Hoefle, 2017).


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