Political Economy: Evolutionary Economics

1
Political Economy Evolutionary Economics

• Early contributions

2
Recap

• Modern evolutionary theory much richer than
  survival of the fittest
• Feedback between organism environment
• Positive as well as negative feedbacks
• Symbiosis as well as competition
• Interdependence of firms/sectors as well as raw
  competition
• Collective behaviour as well as individual
• Web of life/ Web of commerce
• Directed evolution
• Essential concepts variation environment/organis
  m feedback

3
Darwins influence

• Darwins Origin published 1869
• Influence substantial on Victorian mindset (from
  primogenesis to science to explain species)

• Some influence on economics, but generally
  developing under its own steam
• Marxs Das Kapital 1867 final, anti-capitalist
  Classical economics
• Collapse Classical school, development of
  neoclassical

4
The new economics circa 1870

• Dominant analytic techniques static
• Jevons marginal optimisation of utility
• Walras General Equilibrium
• Marshalls profit maximising firms
• Mathematical functions for maximising
  utility/profit
• Work out point at which change stops
• No evolution from the optimum
• Some recognition of superiority of
  dynamic/evolutionary approach

5
The new economics circa 1870

• Aware of importance of evolutionary dynamics
• If we wished to have a complete solution ... we
  should have to treat it as a problem of dynamics.
  But it would surely be absurd to attempt the more
  difficult question when the more easy one is yet
  so imperfectly within our power. (Jevons 1871
  1911 93)
• The Mecca of the economist lies in economic
  biology rather than in economic dynamics. But
  biological conceptions are more complex than
  those of mechanics a volume on Foundations must
  therefore give a relatively large place to
  mechanical analogies and frequent use is made of
  the term equilibrium, which suggests something
  of statical analogy (Marshall, Principles, 8th
  edition, p. 19)

6
And since then

• Clear expectation that theory would develop
  dynamical/evolutionary approach from static
  beginnings
• The main concern of economics is thus with human
  beings who are impelled, for good and evil, to
  change and progress. Fragmentary statical
  hypotheses are used as temporary auxiliaries to
  dynamicalor rather biologicalconceptions but
  the central idea of economics, even when its
  Foundations alone are under discussion, must be
  that of living force and movement. (Marshall
  22)
• But thats not what happened
• Hence Veblens Why? paper

Skip warning
7
Reading Veblen

• Yep, hes a verbose bastard
• But theres a certain poetry to his prose
• Read on and youll see gems of wisdom amongst the
  words

8
Why is economics not an evolutionary science?

• Veblen dominant tendency in economics is to
  uncover natural law
• This natural law is felt to exercise some sort
  of a coercive surveillance over the sequence of
  events, and to give a spiritual stability and
  consistence to the causal relation at any given
  juncture Any causal sequence which is
  apprehended to traverse the imputed propensity in
  events is a disturbing factor.
• A scientist, on the other hand
• is unwilling to depart from the test of causal
  relation or quantitative sequence. When he asks
  the question, Why? he insists on an answer in
  terms of cause and effect

9
Neoclassical economics as non-evolutionary

• Evolution based on variation and adaptive
  selection
• Economics uses ideals (General Equilibrium/Pareto
  Optimality) from which by definition their can
  be no adaptive improvement
• Economic theory is a projection of the accepted
  ideal of conduct. This ideal of conduct is made
  to serve as a canon of truth, to the extent that
  the investigator contents himself with an appeal
  to its legitimation for premises that run back of
  the facts with which he is immediately dealing,
  for the controlling principles that are
  conceived intangibly to underlie the process
  discussed, and for the tendencies that run
  beyond the situation as it lies before him.

10
Neoclassical economics as non-evolutionary

• Heavy criticism of role of equilibrium metaphor
  in which the concept of normality and propensity
  to an end has reached an extreme attenuation
• it is this facile recourse to inscrutable
  figures of speech as the ultimate terms of theory
  that has saved the economists from being
  dragooned into the ranks of modern science By
  their use the theorist is enabled serenely to
  enjoin himself from following out an elusive
  train of causal sequence. He is also enabled,
  without misgivings, to construct a theory of such
  an institution as money or wages or
  land-ownership without descending to a
  consideration of the living items concerned,
  except for convenient corroboration of his
  normalised scheme of symptoms.

11
Neoclassical economics as non-evolutionary

• Economic vision of humans also unamenable to
  change
• People are conceived in hedonistic terms that
  is to say, in terms of a passive and
  substantially inert and immutably given human
  nature. The psychological and anthropological
  preconceptions of the economists have been those
  which were accepted by the psychological and
  social sciences some generations ago.
• And now, the greatest ever put-down of the
  neoclassical utility-maximising/budget
  constraint view of human behaviour

12
Neoclassical economics as non-evolutionary

• The hedonistic conception of man is that of a
  lightning calculator of pleasures and pains who
  oscillates like a homogeneous globule of desire
  of happiness under the impulse of stimuli that
  shift him about the area, but leave him intact.
  He has neither antecedent nor consequent. He is
  an isolated definitive human datum, in stable
  equilibrium except for the buffets of the
  impinging forces that displace him in one
  direction or another. Self-imposed in elemental
  space, he spins symmetrically about his own
  spiritual axis until the parallelogram of forces
  bears down upon him, whereupon he follows the
  line of the resultant. When the force of the
  impact is spent, he comes to rest, a
  self-contained globule of desire as before

versus the evolutionary view...
13
Neoclassical economics as non-evolutionary

• it is the characteristic of man to do something
  the desires under whose guidance the action takes
  place are elements of the existing frame of
  mind of the agent, and are the products of his
  hereditary traits and his past experience, and
  they afford the point of departure for the next
  step in the process. The economic life history of
  the individual is a cumulative process of
  adaptation of means to ends that cumulatively
  change as the process goes on, both the agent and
  his environment being at any point the outcome of
  the last process. His methods of life today are
  enforced upon him by his habits of life carried
  over from yesterday and by the circumstances left
  as the mechanical residue of the life of
  yesterday.

14
Neoclassical economics as non-evolutionary

• One difference (?) w.r.t. biological evolution
• Human action is purposeful (teleological from
  Greek Telos meaning end)
• Economic action is teleological, in the sense
  that men always and everywhere seek to do
  something. What, in specific detail, they seek,
  is not to be answered except by a scrutiny of the
  details of their activity but, so long as we
  have to do with their life as members of the
  economic community, there remains the generic
  fact that their life is an unfolding activity of
  a teleological kind.
• However, its ends arent necessarily those
  assumed by economists (utility maximisation,
  profit maximisation, optimal allocation of
  resources)

15
Neoclassical economics as non-evolutionary

• It may or may not be a teleological process in
  the sense that it tends or should tend to any end
  that is conceived to be worthy or adequate by the
  inquirer The question of a tendency in events
  can evidently not come up except on the ground of
  some preconception or prepossession on the part
  of the person looking for the tendency. In order
  to search for a tendency, we must be possessed of
  some notion of a definitive end to be sought The
  notion of a legitimate trend in a course of
  events is an extra evolutionary preconception,
  and lies outside the scope of an inquiry into the
  causal sequence in any process. The evolutionary
  point of view, therefore, leaves no place for a
  formulation of natural laws in terms of
  definitive normality

16
Neoclassical economics as non-evolutionary

• What should evolutionary economics be?
• the theory of a process of cultural growth as
  determined by the economic interest, a theory of
  a cumulative sequence of economic institutions
  stated in terms of the process itself.
• Why cant neoclassical economics achieve this?
• Evolutionary economics would attempt to trace
  the cumulative working out of the economic
  interest in the cultural sequence. It must be a
  theory of the economic life process a
  hedonistic psychology does not afford material
  for a theory of the development of human nature
  It is therefore not readily apprehended or
  appreciated in terms of a cumulative growth of
  habits of thought

17
Neoclassical economics as non-evolutionary

• Why has academic economics failed to become
  evolutionary?
• Because the taxonomic (equilibrium) approach
• is the easiest, gives the most gratifying
  immediate results, and best fits into the
  accepted body of knowledge of the range of facts
  in question The well worn paths are easy to
  follow and lead into good company. Advance along
  them visibly furthers the accredited work which
  the science has in hand. Divergence from the
  paths means tentative work, which is necessarily
  slow and fragmentary and of uncertain value.

18
Neoclassical economics as non-evolutionary

• Taxonomic? Foundations of neoclassical
  economics
• are certain very concise assumptions concerning
  human nature, and certain slightly less concise
  generalisations of physical fact These
  postulates afford the standard of normality
  whenever a departure from this normal course of
  things occurs, it is due to disturbing causes
  Such departures are constantly present in the
  facts but have no place in the body of the
  science The science is, therefore, a theory of
  the normal case, a discussion of the concrete
  facts of life in respect of their degree of
  approximation to the normal case. That is to say,
  it is a taxonomic science. (1919 163-164)

19
Neoclassical economics as non-evolutionary

• Economics has evolved into a dead end
• Like other men, the economist is a creature of
  habits and propensities given through the
  antecedents, hereditary and cultural, of which he
  is an outcome Methods of observation and of
  handling facts that are familiar through habitual
  use in the general range of knowledge, gradually
  assert themselves in any given special range of
  knowledge. They may be accepted slowly and with
  reluctance where their acceptance involves
  innovation but, if they have the continued
  backing of the general body of experience, it is
  only a question of time when they shall come into
  dominance in the special field.

20
Veblens alternative cumulative causation

• The sciences which are in any peculiar sense
  modern take as an (unavowed) postulate the fact
  of consecutive change. Their inquiry always
  centers upons some manner of process a sequence,
  or complex, of consecutive change in which the
  nexus of the sequence, that by virtue of which
  the change inquired into is consecutive, is the
  relation of cause and effect. (1919 32)
• This is post-Darwinian versus pre-Darwinian
  science as taxonomic (classification rather
  than causation) which still continues in
  economics
• The scientists of that era looked to a final
  term, a consummation of the changes which
  provoked their inquiry. (1919 36)

21
Veblens alternative cumulative causation

• Pre-Darwinian thought considers how things had
  been in the presumed primordial stable
  equilibrium out of which they, putatively, had
  come, and how they should be as the outcome of
  the play of forces which intervened between this
  primordial and the definitive stable equilibrium
  (1919 37)
• Anyone for comparative statics?
• In post-Darwinian science, the interval of
  instability and transition has come to take the
  first place of the inquiry Questions of a
  primordial beginning and a definitive outcome
  have fallen into abeyance (1919 37)
• This makes true science fundamentally dynamic,
  not static

22
Veblens alternative cumulative causation

• They occupy themselves with dynamic relations
  and sequences. The question which they ask is
  always, What takes place next and why? (1919
  84)
• Versus economics where the pure theory deals
  not with the dynamics, but with the statics of
  the case The process is rated in terms of the
  equilibrium to which it tends or should tend, and
  not conversely. (1919 165)
• Professor Marshalls work remains an inquiry
  directed to the determination of the conditions
  of an equilibrium It is not an inquiry into
  institutional development it is the movement of
  a consummately conceived and self-balanced
  mechanism, not that of a cumulatively unfolding
  process or an institutional adaptation to
  cumulatively unfolding exigencies. (1919 173)

23
Veblens alternative cumulative causation

• J.B. Clarke, originator of marginal productivity
  theorys view of dynamics is The more
  dynamic the society, the nearer it is to the
  static model until in an ideally dynamic
  society, with a frictionless competitive system
  the static state would be attained (1919 190)
• Economics of the line represented by Mr Clarke
  has never entered this field of cumulative
  change. It does not approach questions of
  genesis, growth, variation, process hedonistic
  economics does not, and cannot, deal with
  phenomena of growth (1919 192)

24
Veblens alternative cumulative causation

• Pessimism that post-Darwinian thinking will ever
  dominate economicsan inability to break away
  from final ends type thinking
• Even the evolutionary process of cumulative
  causation as conceived by the adepts of these
  sciences is infused with a preternatural,
  beneficent trend trend so that evolutionary is
  conceived to mean amelioration or improvement
  Whether such a shifting of the point of view in
  these sciences shall ever be effected is still an
  open question (1919 55)

25
Veblens contribution

• Cogent criticism of neoclassical theory
• Conviction that truly evolutionary economics
  cannot be built upon neoclassical foundations
  but
• No developed technical means to embody
  evolutionary thinking in economics
• Strong contrast with Schumpeter
• Acceptance of neoclassical economics as
  description of static state
• Analysis of change/instability complements, not
  contradicts statics
• But actual application of dynamic evolutionary
  thought overturns static results
• Processes of growth and disturbance coexist with
  processes of movement towards equilibrium

26
Schumpeter

• what is missing in the static apparatus and what
  accounts for the dissatisfaction with it and for
  the attempts to force such phenomena into its
  cracking frameinstead of, as we think it natural
  to do, recognising and explaining this as a
  distinct process going along with the one handled
  by the static theory.' (1928 379/65)
• But at the same time, instability
• Fundamental to capitalism
• A good thing leads to change growth
• Explains cyclical nature of capitalism

27
Schumpeter

• In contrast to neoclassical belief in stability
  equilibrium, argues that
• the economic structure and the social and
  political structure which were based upon it,
  therefore also that civilisation or system of
  values, were inherently unstable there can be no
  such thing as a stable social system. Any system
  transforms itself simply by its mere working and
  if history teaches us nothing else it teaches
  that. (Lowell Lectures 342)
• Transformational Growth Creative Destruction
• Growth leads to social change
• Progress causes destruction of old means of
  production/social arrangements
• A dialectical vision of cyclesprosperity
  contains the seeds of its own destruction

28
Schumpeter

• While a new thing is being built and financed,
  expenditure is on a supernormal level When such
  a period of advance has gone on for a time, the
  products of these new constructions begin to
  pour out and these products compete with the
  products of the old methods. In fact, thats the
  way in which progress is accomplished in
  capitalism and the old eliminated. (349)
• Cycles out of phase expectations inevitable
• when everyone observes value and profits to
  increase, he is likely more or less to project
  this rate of increase into the future and to
  enter into commitments which will turn out to be
  ill-conceived and untenable as soon as that rate
  of increase is interrupted. (349 shades of
  Keynes here)

29
Schumpeters model overview

• Conventional interpretation of neoclassical
  economics
• Utility analysis of consumer behaviour
• Marginal productivity theory of income
  distribution
• Says Law in static equilibrium
• somewhere in the economic system a demand is
  ready awaiting every supply, and nowhere in the
  system are their commodities without complements
  the sellers of all commodities appear again as
  buyers in sufficient measure to acquire those
  goods which will maintain their consumption and
  their productive equipment in the next economic
  period' (1936 8)

30
Schumpeters model production

• Semi-Austrian roundaboutness theory of
  production
• All means of production reducible to land
• we finally come to the ultimate elements in
  production for our purposes labour and the gifts
  of nature or land But the remaining products,
  the produced means of production, are, on the
  one hand, only the embodiment of those two
  original production goods we have no reason
  why we should see in them an independent means of
  production. We resolve them into labour and
  land. (1936 16-17)
• Subject to Cambridge critique of aggregate
  capital (see my History of Economic Thought
  lectures on Debunking website)

31
Schumpeters model profits money

• No profits in static equilibrium
• Hence, in an exchange economy, the prices of all
  products must, under free competition, be equal
  to the prices of the services of labour and land
  contained in it... Consequently, net profit
  cannot exist, because the value and price of the
  original productive services will always absorb
  the value and price of the product (1936
  30-31)
• Money only a veil over barter in static
  equilibrium
• 'To employ a customary expression, we can say
  that money thus far represents only the cloak of
  economic things and nothing essential is
  overlooked in abstracting from it.' (1936 51)
• Money as gold equivalent no net credit

32
Schumpeters model profits

• Profits come from discontinuous disequilibrium
  forces, which statics cant explain
• static analysis can neither explain the
  occurrence of such discontinuous productive
  revolutions nor the phenomena which accompany
  them. It can only investigate the new equilibrium
  position after the changes have occurred.' (1936
  61-62)
• To explain change, an evolutionary approach
  needed

33
Schumpeters model

• Evolutionary basis to thinking
• the evolutionary idea is now discredited in our
  field with all the hasty generalisations in
  which the word evolution plays a part, many of
  us have lost patience. We must get away from such
  things then two facts still remain first the
  fact of historical change... and that These
  changes constitute neither a circular process nor
  pendulum movements about a centre. (1936 57-58)
• Economic evolution hence development is
• spontaneous and discontinuous change in the
  channels of the flow, disturbance of equilibrium,
  which forever alters and displaces the
  equilibrium state previously existing.' (1936 64)

34
Schumpeters model micro

• Development occurs when an entrepreneur seeking
  profit either
• Introduces a new good
• Introduces a new method of production
• Opens up a new market
• Introduces a new source of supply
• Reorganises an industry
• Assumes
• entrepreneurs not involved in existing firms
  (treats intra-firm innovation as negligible)
• Reorganisation of employment of existing
  resources rather than employment of previously
  unemployed (treats latter as negligible)

35
Schumpeters model micro

• To be able to develop, entrepreneur needs credit
• the possessor of wealth ... must resort to
  credit if he wishes to carry out a new
  combination, which cannot like an established
  business be financed from returns from previous
  production. To provide this credit is clearly the
  function of that category of individuals we call
  capitalists (1936 69) and The banker has
  himself become the capitalist par excellence
  (1936 74)
• Entrepreneur as agent of evolutionary change
• The carrying out of new combinations we call
  enterprise the individuals whose function it
  is to carry them out we call entrepreneurs.
  (1936 74)

36
Schumpeters model micro

• Schumpeters example the powerloom
• 1st major step in automation of industry
  replacing hand weaving with mechanised production
  of cloth
• Has taken many forms over the years
• From the original design

• And the original sweatshops

37
Schumpeters model micro

• To the more advanced

• And its sweatshop

• To todays high tech

• And

• And what tomorrow bioengineering? nanotech?

38
Schumpeters model micro

• If anyone in sees the possibility of
  powerlooms,... borrows from a bank and creates
  his business... If a worker is now in a
  position to produce six times as much as a
  hand-worker in a day, given three conditions
  the business must yield a surplus over costs
• First, the price of the product must not fall
  to such an extent that the greater product per
  worker brings no greater receipts now
• Secondly, the costs of the powerloom per day must
  remain below the daily wages of the five
  workers dispensed with
• The third condition the prices of labor and
  land rise because of the new demand. ...
  therefore the businessman, must add an
  appropriate amount, so that yet a third item must
  be deducted.
• Only if receipts exceed outlays after allowing
  for all three sets of changes is there a surplus
  over costs. (129-130)

39
Schumpeters model micro

• Net profit emanates from development
• he has, if everything has gone according to
  expectations, enriched the social stream with
  goods whose total price is greater than the
  credit received and than the total price of the
  goods directly and indirectly used up by him...
  Furthermore, the entrepreneur can now repay his
  debt (amount credited plus interest) at his bank,
  and normally still retain a credit balance
  (entrepreneurial profit) that is withdrawn from
  the purchasing power of the circular flow.
  (110-111)

40
Schumpeters model micro finance

• Net credit (credit in excess of asset backing)
  arises from development
• money, and other means of payment perform an
  essential function, processes in terms of means
  of payment are not merely reflexes of processes
  in terms of goods (95) in real life total
  credit must be greater than it could be if there
  were only fully covered credit (101)
• Disruption to equilibrium, net entrepreneurial
  profit, net credit, leading ultimately to a new
  equilibrium

41
Schumpeters model micro

• But now comes the second part of the drama. The
  spell is broken and new businesses are
  continually arising under the impulse of the
  alluring profit. A complete reorganisation of the
  industry occurs, with its increases in
  production, its competitive struggle, its
  supercession of obsolete businesses, its possible
  dismissal of workers, and so forth the final
  result must be a new equilibrium position
  Consequently, the surplus of the entrepreneur in
  question and his immediate followers disappears
  Nevertheless, the surplus is realised And their
  profit, the surplus, to which no liability
  corresponds, is an entrepreneurial profit.
  (131-132)
• This process occurs in cycles

42
Schumpeters model the business cycle

• Cycles occur because the new combinations are
  not, as one would expect according to general
  principles of probability, evenly distributed
  through time but appear, if at all,
  discontinuously in groups or swarms. (223)
• Three circumstances increase the effect of the
  swarm-like appearance of new enterprises
• the vast majority of new combinations will not
  grow out of the old firms but compete with
  them
• the fact that entrepreneurial demand appears en
  masse starts a secondary boom
• errors must play a considerable role at the
  beginning of the boom and during the course of
  the depression. (225-227)

43
Schumpeters model the business cycle

• Why do entrepreneurs appear, not continuously
  but in clusters? Exclusively because the
  appearance of one or a few entrepreneurs
  facilitates the appearance of others, and these
  the appearance of more, in ever-increasing
  numbers. (228)
• Reality also discloses that every normal boom
  starts in one or a few branches of industry But
  the pioneers remove the obstacles for the others
  not only in the branch of production in which
  they first appear, but, owing to the nature of
  these obstacles, ipso facto in other branches
  too Hence the first leaders are effective beyond
  their immediate sphere of action (229)

44
Schumpeters model the business cycle

• Boom leads to bust
• During boom, financing of new innovations expands
  net credit, general business activity, increases
  wages rents
• Once innovations produced
• new/cheaper goods undercut existing enterprises
• Repayment of net credit (with entrepreneurial
  profit deducted) contracts credit system
• Both deflate prices, causing financial distress
• The average time which must elapse before the
  new products appear fundamentally explains the
  length of the boom. This appearance of the new
  products causes the fall in prices, which on its
  part terminates the boom, may lead to a crisis,
  must lead to a depression, and starts all the
  rest. (233)

45
Schumpeter and cycles

• I explain the phenomenon of business
  fluctuations solely by an objective chain of
  causation which runs its course automatically,
  that is by the effect of the appearance of new
  enterprises upon the conditions of the existing
  ones. (Schumpeter 213)
• Necessarily non-equilibrium because
  discontinuous
• does this proceed in unbroken continuity, is
  it similar to the gradual organic growth of a
  tree? Experience answers in the negative. It is a
  fact that the economic system does not move along
  continually and smoothly. Counter-movements,
  setbacks, incidents of the most various kinds,
  occur which obstruct the path of development
  there are breakdowns in the economic value system
  which interrupt it. (216)

46
Schumpeter and cycles

• Breakdowns could be randomly distributed through
  time
• There would then be no trade cycle, only
  deviations from trend
• But Schumpeter argues that new combinations are
  not, as one would expect according to general
  principles of probability, evenly distributed
  through timein such a way that equal intervals
  of time could be chosen, in each of which the
  carrying out of one new combination would
  fallbut appear, if at all, discontinuously in
  groups or swarms. (223)
• This discontinuous appearance is necessary for a
  true cycle to emerge, since

47
Schumpeter and cycles

• If the new enterprises in our sense were to
  appear independently of one another, there would
  be no boom and no depression as special,
  distinguishable, striking, regularly recurring
  phenomena. For their appearance would then be, in
  general, continuous. (224)
• Three reasons for the clumped nature of new
  innovations associated booms
• new combinations will not grow out of the old
  firms or immediately take their place, but appear
  side by side, and compete, with them. (226)
• Credit extended to new entrepreneurs causes a
  very substantial increase in purchasing power all
  over the business sphere. This starts a secondary
  boom, which spreads over the whole economic
  system and is the vehicle of the phenomenon of
  general prosperity

48
Schumpeter and cycles

• This general prosperity allows everyone to
  profit, not just entrepreneurs
• Only because new purchasing power goes in bulk
  from the hands of entrepreneurs to the owners of
  material means of production, to all producers of
  goods for "reproductive consumption", and to the
  workers, and then oozes into every economic
  channel, are all existing consumption goods
  finally sold at ever-rising prices. Retailers
  thereupon place bigger orders, manufacturers
  extend operations, and for this purpose
  increasingly more unfavorable and often already
  abandoned means of production come into use
  again. And only on this account do production and
  trade everywhere temporarily yield a profit, just
  as in a period of inflation (226)

49
Schumpeter and cycles

• The combination of these factors
• notable innovations in production
• new credit-financed demand as they are brought
  into existence
• general prosperity from the extended credit
• Means that other entrepreneurs (good and bad!)
  find it easier to also get funding
• Why do entrepreneurs appear, not continuously,
  but in clusters? Exclusively because the
  appearance of one or a few entrepreneurs
  facilitates the appearance of others, and these
  the appearance of more, in ever-increasing
  numbers. (228)
• With danger that success of good entrepreneurs
  helps bad ones to get funding

50
Schumpeter and cycles

• Every normal boom starts in one or a few
  branches of industry (railway building,
  electrical, and so forth), and derives its
  character from the innovations in the industry
  where it begins. But the pioneers remove the
  obstacles for the others not only in the branch
  of production in which they first appear, but,
  owing to the nature of these obstacles, ipso
  facto in other branches too. Many things may be
  copied by the latter the example as such also
  acts upon them and many achievements directly
  serve other branches too, , quite apart from
  the circumstances of secondary importance which
  soon appearrising prices and so on. Hence the
  first leaders are effective beyond their
  immediate sphere of action and so the group of
  entrepreneurs increases still further and the
  economic system is drawn more rapidly and more
  completely than would otherwise be the case into
  the process of technological and commercial
  reorganisation which constitutes the meaning of
  periods of boom. (229)

51
Schumpeter and cycles

• the swarm-like appearance of new combinations
  easily and necessarily explains the fundamental
  features of periods of boom. It explains why
  increasing capital investment is the very first
  symptom of the coming boom, why industries
  producing means of production are the first to
  show supernormal stimulation It explains the
  appearance of new purchasing power in bulk,
  thereby the characteristic rise in prices during
  booms, which obviously no reference to increased
  need or increased costs alone can explain.
  Further, it explains the decline of unemployment
  and the rise of wages, the rise in the interest
  rate, the increase in freight, the increasing
  strain on bank balances and bank reserves, and so
  forth, and, as we have said, the release of
  secondary wavesthe spread of prosperity over the
  whole economic system. (230)

52
Schumpeter and cycles

• So a boom is a positive feedback process
• Financing of one invention makes it easier for
  other inventions to be financed
• One success in one industry sector makes it
  easier for others in the same sector to succeed
• Spillover of finance into rest of economy makes
  new businesses and old ones profitable
• Conventional economics dominated by presumption
  of negative feedback
• Increase in price reduces demand
• Rise of profits encourages new entrants who
  reduce profits, etc.
• In fact many real-world processes involve
  positive feedback, with one other essential
  real-world feature

53
Schumpeter and cycles
Nonlinear relations

• Positive feedback process sets of further process
  that later strengthens negative feedbacks
• Interaction over time of ive -ive feedbacks
  produces continuous cycle system never settles
  down to equilibrium
• Schumpeters cycle not ended by convergence to
  equilibrium but by build-up of negative feedback
  forces

54
Schumpeter and cycles

• the new entrepreneur's demand for means of
  production, which is based upon new purchasing
  powerthe well known "race for means of
  production" in a period of prosperitydrives up
  the prices of these. (232)
• the new products come on the market after a few
  years or sooner and compete with the old
• At the beginning of the boom costs rise in the
  old businesses later their receipts are reduced,
  first in those businesses with which the
  innovation competes, but then in all old
  businesses, in so far as consumers' demand
  changes in favor of the innovation

55
Schumpeter and cycles

• The average time which must elapse before the
  new products appearthough of course actually
  dependent upon many other elementsfundamentally
  explains the length of the boom. This appearance
  of the new products causes the fall in prices,
  which on its part terminates the boom, may lead
  to a crisis, must lead to a depression, and
  starts all the rest (233)
• the appearance of the results of the new
  enterprises leads to a credit deflation, because
  entrepreneurs are now in the positionand have
  every incentiveto pay off their debts and since
  no other borrowers step into their place this
  leads to a disappearance of the recently created
  purchasing power just when its complement in
  goods emerges (233)

56
Schumpeter and cycles

• Cycle seen as necessary aspect of capitalism,
  rather than something to be eradicated
• But does have negative aspects as well as
  positive
• the boom creates out of itself an objective
  situation, which makes an end of the boom,
  leads easily to a crisis, necessarily to a
  depression, and hence to a temporary position of
  relative steadiness and absence of development.
• The depression as such we may call the "normal"
  process of resorption and liquidation the course
  of events characterised by the outbreak of a
  crisispanic, breakdown of the credit system,
  epidemics of bankruptcies, and its further
  consequenceswe may call the "abnormal process of
  liquidation." (236)

57
Schumpeter and cycles

• A recession/depression a necessary outcome of a
  boom
• With the fall in the demand for means of
  production, the rate of interestif the
  coefficient of risk is removedand the volume of
  employment also fall. With the fall in money
  incomes, which is causally traceable to the
  deflation, even though it is increased by
  bankruptcies and so forth, the demand for all
  other commodities finally falls, and the process
  has then penetrated the whole economic system.
  The picture of the depression is complete. (237)
• Schumpeter anticipates leads and lags identified
  by US data by Kydland Prescott (1990)

58
Schumpeter and cycles

• The reduction in the demand for labor should be
  a very early symptom of the change, but just as
  wages do not rise immediately in prosperity
  because as a rule there are unemployed workers,
  so wages and the amount of employment do not
  usually fall as promptly as one would expect
  because a series of well known obstacles stands
  in the way. The business world tries to defend
  itself against a fall in prices, and where
  competition is not completely "free"as is
  practically nowhere the caseand when the banks
  lend their support, it resists with temporary
  success, so that the maximum price level is often
  later than the turning point. (238)
• Crisis often appears to be one of over-production

59
Schumpeter and cycles

• Subjectively, the turning point appears to
  producers, especially if they resist the
  unavoidable fall in prices, as an outbreak of
  hitherto latent overproduction, and the
  depression as its consequence. The unsaleableness
  of commodities already produced, still more of
  those producible, at prices which cover costs
  calls forth the well known further phenomenon of
  the tightness of money, possibly insolvency,
  which is so typical that every theory of the
  business cycle must be in a position to explain
  it. (239)
• Schumpeters explanation accords with KPs data
  and common experience of booms/slumps (think
  Sydneys property market 2003-2005)
• But acceptance of neoclassical economics leads
  him astray on final state

60
Schumpeter and cycles

• the depression leads to a new equilibrium
  position. (242)
• In fact, downturn involves over-compensation
  system goes below equilibrium whereas was above
  it during boom
• Equilibrium itself shifts path-dependent
  change
• Try to imagine todays capitalism without the
  Internet
• Modern Schumpeterians (e.g., Ed Nell) refer to
  process of growth as Transformational change
• But depressed period not as socially bad as
  normally perceived

61
Schumpeter and cycles

• the period of depression does something else,
  which indeed comes less to the fore than those
  phenomena to which it owes its name it fulfils
  what the boom promised. And this effect is
  lasting, while the phenomena felt to be
  unpleasant are temporary. The stream of goods is
  enriched, production is partly reorganised, costs
  of production are diminished,' and what at first
  appears as entrepreneurial profit finally
  increases the permanent real incomes of other
  classes. (245)
• Think again of the Internet bubble

62
Schumpeter and cycles

• a period of depression brings to and takes from
  different categories of individuals
• From entrepreneurs and all their followers,
  especially from those who fortuitously or
  speculatively enjoy the fruits of the rise in
  prices during the boom, it takes away the
  possibility of profit
• Workers do well out of the boom In the boom
  wages must rise. For the new demand, is,
  directly and indirectly, chiefly a demand for
  labor. Therefore employment must first increase
  and with it the sum total of wages of labor, then
  the rate of pay and with it the income of the
  individual worker. It is from this rise in wages
  that the increased demand for consumption goods
  proceeds which results in the rise in the general
  price level (248)

63
Schumpeter and cycles

• In the depression, however
• the purchasing power of the unit of wages rises.
  On the other hand the money expression of the
  effective demand for labor falls in consequence
  of the automatic deflation which the boom starts.
  In so far as only this occurs, the effective real
  demand for labor could remain undisturbed. The
  real income of labor would then still be higher,
  not only than in the previous approximate
  equilibrium position, but also than in the boom
  (249)
• Though it will still cause unemployment

64
Schumpeter and cycles

• the essentially temporary character of which
  does not alter the fact that it is a great and
  under certain circumstances annihilating
  misfortune for those concerned, and that the fear
  of it - simply because of the incalculableness of
  its occurrence -contributes substantially to the
  atmosphere of depression. This unemployment is
  typical of periods of depression and the source
  of panic offers of labor, thus resulting in the
  loss of much ground previously gained by
  trade-union action and sometimes, though not
  necessarily, in a severe pressure on wages, the
  effect of which may be greater than might be
  thought from the number unemployed. (250)
• Though again there is new employment in new
  industries

65
Schumpeter and cycles

• the economic nature of depression lies in the
  diffusion of the achievements of the boom over
  the whole economic system and that only
  temporary reactions, which are only in part
  necessary to the system, overshadow this
  fundamental feature and produce the atmosphere
  expressed in the word depression as well as the
  repercussion which even those indices exhibit
  which do not appertain to the sphere of money,
  credit, and prices
• Next week extending Schumpeter to sphere of
  money, credit, and prices Minskys Financial
  Instability Hypothesis

66
Discordant fathers

• Two different foundations for evolutionary
  economics
• Veblen
• Evolutionary view incompatible with neoclassical
  statics
• Evolutionary perspective needed for everything
  from consumer behaviour up
• But no systematic alternative developed
• Schumpeter
• Evolution can be pasted onto neoclassical statics
• Statics suitable for consumer behaviour, circular
  flow
• Evolution needed for growth development
• Attempt at systematic analysis coherent verbal
  model results at odds with neoclassical statics

67
Discordant children

• Main branch of evolutionary economics combines
• Veblens scepticism re statics
• Non-neoclassical theory of value
• Simons satisficing vs neoclassical optimising
• Markup pricing vs marginal cost pricing
• Schumpeters creative destruction and focus
  upon
• Business cycle dynamics
• Role of entrepreneur
• Evolution of technology
• Some evolutionary approaches not considered
• Evolutionary game theory
• Austrian economics (Hayek/Mises/Rothbard)

68
References

• Schumpeter, J.A.
• (1928). The instability of capitalism, Economic
  Journal 361-386, reprinted in Essays of J.A.
  Schumpeter, Addison-Weslay, Cambridge MA 47-72.
• (1936). The Theory of Economic Development,
  Harvard University Press, Cambridge MA.
• Veblen, T.
• (1904). The Theory of Business Enterprise,
  Augustus M. Kelley, New York, 1965.
• (1919). The Place of Science in Modern
  Civilisation, B.W. Heubsch, New York.
• The evolution of the scientific point of view,
  32-55. (1908)
• The preconceptions of economic science, I, II
  III, 82-113, 114-147, 148-179. (1899, 1899, 1900)
• Professor Clarkes economics, 180-230. (1908)
• The limitations of marginal utility, 231-251.
  (1909)