INDUSTRYAND INNOVATION

VOLUME 9                        MARCH 2002                    NUMBER 1

SPECIAL ISSUE:

 Schumpter's"Lost" Seventh Chapter

CONTENTS

CONTRIBUTORS

           Ulrich Witt is Professor of Economics at theUniversity of Jena, Germany, and Director of the Evolutionary Economics Unit atthe Max Planck Institute for Research into Economic Systems in Jena. Hisresearch interests lie in the study of adaptive economic behavior and itsbiological and psychological foundations, long-term economic development andgrowth, economic institutions and institutional change, and the methodologicaland conceptual problems of evolutionary thought. He has published ten booksrelated to the agenda of evolutionary economics and some 50 articles in leadingjournals and scholarly volumes, many of them reprinted in reference volumes. Hecan be contacted at: witt@mpiew-jena.mpg.de

Erik S.Reinert holds an MBA from HarvardUniversity and a Ph.D. in Economics from Cornell University. In the 1980’s heworked with Telesis, a US consulting firm, and as an entrepreneur and managingdirector of a multinational manufacturing firm based in Italy. Going back toNorway and academia in the 1990’s, he worked at the University of Oslo and atNorsk Investorforum, a private sector think-thank, and as an advisor to theEuropean Union. He presently works with The Other Canon Foundation, a smallfoundation devoted to research in economics (www.othercanon.org),and as an advisor to The Norwegian Association of Saami Reindeer Herders, thelast aboriginal tribe in Europe, and to the Norwegian government, in an effortto save the traditional Saami production culture. Reinert’s research andpublications, in the German/US historical/institutional tradition, attempts tolink the history of economic policy with economic history and the history ofeconomic thought, particularly as regards a qualitative understanding of theprocess of economic development. He can be contacted at esr@nifo.no.

     Esben Sloth Andersen is Associate Professor at the Department ofBusiness Studies, Aalborg University, Denmark. His PhD is in evolutionaryeconomics, and his research interests range from development of agent-basedsimulation models of multisectoral economic evolution to the history of theeconomic analyses of evolutionary processes. He is engaged in the DanishResearch Unit for Industrial Dynamics (DRUID) and in the development of theEuropean Doctoral Training Programme on the Economics of Technological andInstitutional Change, in both cases since their start in 1995. He has writtenthe book Evolutionary Economics: Post-SchumpeterianContributions (London: Pinter) as well as articles on economic organisation,innovation theory, evolutionary modelling, and the history of economic thought.He can be contacted at: esa@business.auc.dk.

HelgePeukertis scientific assistant at the Krupp Chair in Public Finance and FiscalSociology, University of Erfurt. His research interests are in the fields ofcritical institutional economics, economic sociology, economic history andhistory of economic thought. His works have appeared in German and in English inchapters in various books and scientific journals. He can be contacted at:Helge.Peukert@uni-erfurt.de

JürgenG. Backhaus (*1950),JSD 1976, PhD (Econ) 1985, holds the Krupp Chair in Public Finance and FiscalSociology at Erfurt University, being appointed to this position in November2000. In July 2001, he was elected Dean of the Faculty of Economics, Law, andthe Social Sciences. From 1986 to 2000, he held the chair in Public Economics atMaastricht University. He has published 43 books and monographs, nearly 200articles in refereed journals and book chapters, 28 scholarly notes and 63reviews. His research interests span economics, but also neighbouringdisciplines such as law, fiscal sociology and environmental sciences. In 1994 hefounded (with Frank H. Stephen) the European Journal of Law and Economics, ofwhich he is the managing editor. Having edited the "Elgar Companion to Lawand Economics" (Cheltenham: Edward Elgar, 1999), he is now -- together withRichard E. Wagner of George Mason University -- preparing another referencework, "The Handbook of Public Finance" (Boston: Kluwer). In addition,he has forthcoming an advanced graduate text in the history of economic thought,"The Founders of Modern Economics: Maastricht Lectures in PoliticalEconomy". In 1999, he hosted the 13^th Heilbronn Symposium inEconomics and the Social Sciences, on the topic of the German œuvre of JosephA. Schumpeter out of which grew the translation of the 7^th Chapter.The proceedings of this conference are to be published by Kluwer as Volume 1 ofa new series "The European Heritage in Economics and the SocialSciences."

                       Ursula M. Backhaus received her education at the University ofConstance (Diplom-Volkswirt, 1979) and Auburn University (Master of Science inEconomics, 1983). As a forecasting analyst of a leading manufacturer ofagricultural implements she specialized in empirical applied econometrics andagricultural economics. In 1987, she became a fellow in health economics at theSchool of Health Sciences at Maastricht University. Since 1992, she has been aresearch associate at the IssF Foundation and published a series of articles inhealth economics. Most recently, she translated Schumpeter's Seventh Chapter, aspublished in this issue.

John A. Mathewsis Professor of Management at the Macquarie Graduate School of Management,Macquarie University, Sydney, and Editor of Industry and Innovation. He holds aBSc (Econ) from the University of London (LSE) and a PhD from Imperial College,in the field of cybernetics. His research interests have focused in the 1990s onthe dynamics of new industry creation, with special reference to the rise ofEast Asia, culminating in the books Tiger Technology: The Creation of aSemiconductor Industry in East Asia (Cambridge 2000), co-authored with Dong-SungCho; and Dragon Multinational: A New Model of Global Growth (Oxford 2002).He has consulted with the World Bank, UNCTAD and particularly with UNIDO in thedrafting of the World Industrial Development Report 2002. He can be contactedat: john.mathews@mq.edu.au.

ABSTRACTS

How evolutionary is Schumpeter’s Theory ofEconomic Development?

UlrichWitt: Thegeneric features of an evolutionary theory which are identified in theconceptional discussion of the present paper can be shown to be present alreadyin Schumpeter’s 1912 work, The Theory of EconomicDevelopment.Nonetheless, it is argued that Schumpeter fell short of a level of generality bywhich he would have succeeded in providing a true foundation for evolutionaryeconomics. The reason is his eagerness -- very clearly visible in the “lost”seventh chapter -- to align his theory with the economic reasoning ofcontemporary “pure” economic theory that was molded in anequilibrium-oriented heuristic and the methodology of comparative statics.Schumpeter’s conception -- which,in opposing the idea of borrowing from Darwinian thought, he called“development” --is rather a special theory of the unsteady capitalist growth process passingthrough booms and crises. Throughout all of Schumpeter’s writings the notionof development is therefore closely related to the business cycle phenomenon.The paper argues that this special framing implies not only some arbitraryhypotheses which are difficult to accept in an evolutionary interpretation, butalso some limitations in his understanding of (what he refused to call) economicevolution, particularly with respect to its driving forces.

Schumpeter in the context of twocanons of economic thought

ErikS. Reinert: Thepublication of Schumpeter’s ’lost’ seventh chapter – with the holisticand Faustian title ‘The Economy as a Whole’, so typical of the Germaneconomic tradition – again raises the question of the ‘duality’ inSchumpeter’s economic thinking: On the one hand Schumpeter’s typical‘Germanic’ approach, emphasising dynamics, technical change and theentrepreneur, on the other hand his admiration for the mechanical economics ofWalras. This paper attempts to explain Schumpeter’s duality – his‘schizophrenia’ – by placing his work in the context of two differentcanons of economic thought, the standard mainstream canon (the ordnendeand passivist-materialist tradition in Werner Sombart’s terms) and whatwe have labelled “The Other Canon” (the verstehende and activist-idealisttradition in Sombart’s terminology). The paper attempts to show that in thelight of the now almost extinct Other Canon of economics, Schumpeter appears farless original than what he does to today’s mainstream. It is argued that whilethe Harvard economics department during Schumpeter’s tenure there moved awayfrom the Other Canon type economics, Schumpeter found ample support and researchactivity in this alternative canon of economics at Harvard Business School. Thepaper explores the possible influences and similarities of thought on Schumpeterfrom three economists associated with Harvard Business School: Herbert SomertonFoxwell, Edwin Gay and Fritz Redlich.      

Railroadizationas Schumpeter’s standard case: 
An evolutionary-ecological account

           Esben Sloth Andersen:In his 1939 book Business Cycles,Schumpeter declared that the railroad and its consequences for the economicsystem is the standard example of his analysis of capitalist evolution. Thispaper demonstrates that Schumpeter went quite far in the analysis of his case of‘railroadization’ and in suggesting how his model could be adapted to it,but today we see that he failed because of his lack of adequate analyticaltools. In the light of modern evolutionary economics and evolutionary-ecologicalanalysis, the paper revisits Schumpeter’s suggestions. The parameters of thelogistic equation and the Lotka–Volterra equations are shown to be centralvariables in an evolutionary process that includes different types of economicagent. The specification of the roles in this process helps to redefineentrepreneurs, managers, and financiers. Furthermore, a new interpretation ofthe system-level dynamics is made, both in general and in relation to the caseof railroadization.

Schumpeter’s“lost” seventh chapter: A critical overview

Helge Peukert: The“lost” seventh chapter to Schumpeter’s first edition of TheTheory of Economic Development was planned as a synthesis of the results andas presenting the overall configuration of the economy, as the title of thechapter “The economy as a whole” indicates. The article discussesSchumpeter’s exposition of the core process, external data changes and hisreception of the classics. Further the article discusses Schumpeter’s views onthe notion of the organic unity of the economy, the welfare problem, hissynthesis of statics and dynamics, the “greatness” of entrepreneurs andtheir role in culture. The conclusion is that an elaborated systems approachcomparable to that of Sombart is (still) missing. The plan of a general theoryof culture, society and economy, following the insight of chapter seven that thesocial process is one indivisible whole, was formulated but not realized. It isargued that Schumpeter’s later work Capitalism,Socialism and Democracy (1942) comes closest to this program. Chapter sevenis not only an important document in the history of economic thought but is alsoone of the first explicit claims to develop a holistic, evolutionary and dynamicapproach to economy and society.

Presentation:Schumpeter’s 7^th chapter “The economy as a whole”

JürgenBackhaus:Schumpeter's seminal theory of economic development (1912) originally containedseven chapters. The last chapter was later omitted in both the German editionsand the English translation. It is an ambitious attempt to place economicdevelopment within a larger sociological context, one of the pioneering classicsin economic sociology. The presentation provides some of the background that ledto this work and to its later neglect.

Introduction:Schumpeter’s “lost” seventh chapter

JohnA. Mathews

Joseph AloisSchumpeter burst onto the world economic stage in the early years of the 20^thcentury, creating a lasting challenge to the orthodoxy of his peers. Born in1883, the year of the death of Karl Marx, he died in 1950, leaving behind anastonishing body of work with which the world of economics is still seeking tocome to terms. As a young man, before he turned 30, he had published three majortexts that made him world famous. “What is more unheard of” – asked hiscontemporary, Arthur Spiethoff – “a 25 year-old and a 27 year-old who stirsat the foundations of the discipline, or a 30 year-old who writes itshistory?”[1]

Schumpeter’sfirst book, based on his Habilitation thesis completed by the young student atthe University of Vienna, was a bold attempt to bring the new concepts ofmarginal and equilibrium analysis into German-speaking economics, where theemphasis was on historical and institutional analysis. This work, Das Wesenund der Hauptinhalt der theoretischen Nationalökonomie [The Essence andPrincipal Contents of Economic Theory] published in 1908 when Schumpeter was notyet 25, remains untranslated into English. In the next book, published in 1912but whose theses were outlined in an article published in 1910, Schumpeteroutlined an even bolder framework for a dynamic, evolutionary approach toeconomic theory. This work, entitled Theorie der wirtschaftlichen Entwicklung[Theory of Economic Development], departed radically from the conventionaleconomic framework, dubbed the static, “circular flow” and instead proposeda source of developmental novelty in the form of entrepreneurial initiative,which was turned into the core of a comprehensive theory of the workings of thecapitalist economy, encompassing profits, interest, credit, cyclicalfluctuations and the rise and fall of industries. This book was capped by athird, on the history of economic doctrines, entitled Epochen der Dogmen- undMethodengeschichte [Economic Doctrine and Method: An Historical Sketch] –all by the time he turned 30. By the eve of the First World War, the world ofeconomics lay at Schumpeter’s feet.                

Then,as is well known, he turned away from academic achievement, to seek his fortunefirst in politics (rising to be short-lived Minister of Finance in the socialistpost-war government of Austria in 1919) and then in business, as chairman of abank. Both careers ended ignominiously: he was dismissed from his position inthe government, and was wiped out financially by the crash of 1924, which sawhim dismissed from his position of chairman at the bank, and burdened with manypersonal debts. By 1925 he was back in academic life, now with a professorshipof public finance at the University of Bonn – an appointment that created asensation in the German-speaking world of economics.[2] But Schumpeter was by now a much more cautious man, and in the secondGerman edition of his 1912 book, which he published in 1926, he made a verysignificant change: he dropped the far-reaching seventh chapter.

Itis this seventh chapter, lost to the world after Schumpeter’s decision to dropit from his second edition (which then formed the basis of the Englishtranslation published only in 1934) that forms the subject of this special issueof Industry and Innovation. The chapter, entitled Das Gesamtbild dervolkswirtschaft [The economy as a whole] provides a fascinating missing“chapter” in Schumpeter’s thought, previously inaccessible to theEnglish-speaking world. The chapter, clearly written in haste late in 1911 tocatch a printing deadline, sketches a highly original summation of his model ofinternal economic development, where transformation is generated from internaldynamics represented by entrepreneurial initiative – in contrast with theprevailing doctrines, which saw change in economic circumstances, and growth, asresponding to external stimuli, such as population growth, or technologicalinnovation, or the opening up of new geographic markets. In this broadframework, which he dubbed “dynamic” in contrast with the “static”mainstream and classical doctrine, he made the first clear distinction betweenstatic and dynamic analysis, and demonstrated how the static analysis isaccurate at any point in time, but completely misleading if applied over aperiod of time. He went further, and stretched his framework to encompass thesocio-economic totality, arguing that the same principle of entrepreneurialinitiative could account for evolutionary change in all sectors of the socialsystem, from politics, to the arts, to science itself. He saw this, quiteexplicitly, as laying down a sketch of a unified approach to the development ofthe social sciences. Little wonder that Schumpeter’s book had createdsomething of a sensation.

Whythen, did Schumpeter drop this innovative chapter from the second edition, andnever refer to it again in his own published work? There is no clear or easyanswer to this question. Perhaps he saw it as too precocious, too bold, and notappropriate for a more mature man of the world who by now aspired to aprofessorship at Harvard (which he secured in 1932). Perhaps he was bemused bythe fact that it attracted most attention in the early reviews, and was praisedin particular by reviewers who used his broader framework to argue against theanalytical approach to economics that Schumpeter had espoused in his first book.Perhaps he felt that it held him as hostage to a too bold and demanding programof research that he could never realistically hope to substantiate.

Onepossibility that ought to be seriously considered is that Schumpeter came todisagree with the framework outlined in the seventh chapter – as he came todisagree with his own first book (which perhaps explains why it was nevertranslated). But this seems most definitely not to be the case. If thereis one thread that connects the life work of Schumpeter, it is the strenuouscontention that economic change is driven by internal dynamics arising fromentrepreneurial initiative. Certainly he changed his mind concerning thecharacter of entrepreneurship as such – moving to see it as being embodied inlarge firms rather than in heroic individuals, in his later 1942 exposition, Capitalism,Socialism and Democracy. He fleshed out the cyclical fluctuations aspect ofthe framework at great length in his 1939 work, Business Cycles – butthis did not depart from the 1912 work in fundamentals.

Hencethe great interest in this first English translation of Schumpeter’s“lost” seventh chapter: it allows us to see his life work as in a sense aworking out of the lines first sketched in this youthful masterpiece. As heaccommodated to the world of English-speaking economics, Schumpeter apparentlyfelt it prudent to keep this chapter locked away in a “bottom drawer” –drawing on it extensively in his later writings, in a way that remainedunsuspected by scholars with access only to his English language works, or tothe second and third German editions of his 1912 book (which had quickly becomea rarity). The second German edition of The Theory of Economic Developmentcontained an extensively reworked chapter 2, which reflected the content of thedropped chapter 7. But this was not available in English until 1934. The firstintimations to the English-speaking world of Schumpeter’s revolutionaryapproach, were his 1927 and 1928 articles, ‘The explanation of the businesscycle’ (published in Economica, Dec 1927) and ‘The instability ofcapitalism’ (published in the Economic Journal, Sep 1928).[3] Apart from a couple of earlier pieces, these were the major articles thatestablished Schumpeter’s reputation in English – paving the way to a chairat Harvard in 1932. These articles are widely viewed as early intimations of hislater works, namely Business Cycles (1939) and Capitalism, Socialismand Democracy (1942). With the benefit of the translation of chapter 7, wecan now see these instead as reworkings of chapters 6 and 7 of his 1912 book,elaborated and extended and brought to an English-speaking audience.

Themost important reason for offering a translation of Schumpeter’s seventhchapter, is that it is so fresh and challenging. It grows in significance withthe passage of time. Schumpeter’s emphasis on the internal dynamics oftransformation of the economic system, remains the first and most brilliantsketch of a comprehensive theory of economic dynamics, startlingly in line withtoday’s conceptions of self-organized complexity and emergence within dynamicsystems. His emphasis on the power of entrepreneurial initiative grows instature, as interest worldwide becomes focused on the dynamics of the “NewEconomy” with its fresh appreciation of the power of knowledge-richentrepreneurial startups. Schumpeter’s emphasis on “creative destruction”– a concept he took over from Werner Sombart, but made his own – also has anintensely modern ring to it, as entrepreneurial startups in one sector afteranother, from infotech to biotechnology, constantly challenge the status quo andincumbent competitive advantage. His emphasis on situating economics within awider social science, where the disciplinary areas have their relative autonomybut interconnect with each other, remains a fresh source of inspiration, andagain of increasing interest in the light of the evolutionary approach to thesocial sciences.[4] Above all, his emphasis on developing economic theory out ofpainstakingly gathered data, but approaching this task with bold “models” ofthe process of change, remains the single most important challenge to thedullness and tedium of today’s economic orthodoxy. Schumpeter launched adevastating attack on conventional economics – an attack that has neveradequately been answered. This is the most important reason why the translationof his youthful “lost” seventh chapter is an event of such intellectualimportance. If Schumpeter lost to Keynes the distinction of being the mostimportant economist of the 20^th century, he might well be compensatedby seeing his fame eclipse that of his rival in the 21^st century.

Afew words now on this special issue. It draws together, in addition to the newtranslation, original articles from neo-Schumpeterian scholars of great stature.

The translation wasoriginally prepared for the 13^th Heilbronn Symposium in Economics andthe Social Sciences, held June 23-25, 2000, on the subject of the work of JosephA. Schumpeter. The Heilbronn symposia, organized by Professor Jürgen Backhaus(now at Erfurt University) have been held annually since the 1980s, always on atheme of the German tradition in economics. The 2000 symposium was the firstconference that paid particular attention to Schumpeter’s seventh chapter. Thetranslation was prepared by Ursula Backhaus, with funding provided by The OtherCanon Foundation, headquartered in Norway. The translation has been extensivelyrevised and edited for its publication in this special issue of Industry& Innovation.[5] Professor Backhaus provides a succinct presentation of the chapter, basedon his remarks made at the Heilbronn symposium. Professor Helge Peukert, acolleague at Erfurt University, also provides an elaborated and edited versionof his critical evaluation of the seventh chapter, setting it in the widercontext of Schumpeter’s work.

           The special issue also contains originalarticles on Schumpeterian themes by Professors Ulrich Witt, Erik Reinert, andEsben Andersen. Ulrich Witt sets the youthful work by Schumpeter in the contextof debates over evolutionary dynamics. These have their origin in the biologicalsciences, but now attract enormous attention in the social sciences (as inevolutionary psychology, evolutionary linguistics, and evolutionary anthropology– not to mention evolutionary epistemology as characterized by the work ofPopper, Lakatos and Donald T. Campbell). Witt is concerned to emphasize howoriginal was Schumpeter’s model of economic dynamics, anticipating many of thefeatures now seen as evolutionary in character – but explicitly denying any“Darwinian” analogy himself, for fear of being typed as a German“organicist” by his economics peers. Witt’s article thus demonstrates theperennial interest of Schumpeter’s youthful work and his efforts of a lifetimeto draw out its main developments.

ProfessorReinert, originator of the concept of “The Other Canon” of economicanalysis, drawing on now almost forgotten traditions of historically informedanalysis, in Italy, Germany, and the United States in the 19^thcentury (when it was a developing country), sets Schumpeter’s work within thiscontext. This has the dual effect of making his work more accessible andcomprehensible, and at the same time, making it less original than it appears tobe to English language readers not acquainted with the German debates in whichSchumpeter was formed. Reinert notes how Schumpeter drew on Nietzsche and otherGerman writers for his concepts of entrepreneurship, and on his contemporarySombart for the notion of “creative destruction” – always, it must benoted, with minimal or no attribution. But it is what Schumpeter did with theseconcepts that is important. The paper by Reinert then goes on to establish somevery interesting connections between German historical scholarship and the earlyyears of the Harvard Business School – as exemplified in the famous “case”approach to teaching, which was introduced under the first Dean, Edwin Gay, whohad been a student of Gustav Schmoller, the leading proponent of the German“historical school.” Reinert explains that it was these and similarconnections that attracted Schumpeter increasingly towards the Business Schoolat Harvard in his later years, as he found the Economics Department movingsteadily towards the neoclassical synthesis and Keynesian ideas.

ProfessorAndersen, from Aalborg University in Denmark and a member of the DRUID group ofscholars, demonstrates the power of Schumpeterian analysis in his reconstructionof the case of “railroadization” in the 19^th century. Schumpetersaw this case, involving the innovation and diffusion of railroads across theentire world in the mid-century years, as exemplary for his model of restlessinnovation and destruction in the capitalist system. Andersen subjects theentire historical experience to a “Schumpeterian retrospect” thatencompasses the historical data as now known, utilizing models of diffusion suchas the logistic function, and of coevolution in the form of the Lotka-Volterraequations; he applies the insights from these frameworks to the dynamics ofinnovation and diffusion of the railroad system. This is a superb demonstrationof the freshness and originality of Schumpeter’s insights, and how theycontinue to pose a radical challenge for scholarship in the economics sciences.

           My thanks to Professor Backhaus for allowing Industryand Innovation to carry this first English translation of an important pieceof German scholarship, and to The Other Canon Foundation for its role inbringing the work to fruition. Above all, my thanks to Ursula Backhaus for hertireless efforts in bringing Schumpeter’s highly idiosyncratic German to thewider English-speaking world.

References

Clemence,R.V. (ed) 1951/1989. Essays on Entrepreneurs, Innovations, Business Cycles,and the Evolution of Capitalism, by Joseph A. Schumpeter. With newintroduction by Richard Swedberg in 1989. New Brunswick, NJ: TransactionPublishers.

Schumpeter,J.A. 1912/1934/1983. The Theory of Economic Development. With anIntroduction by John E. Elliott. New Brunswick, NJ: Transaction Publishers.

Shionoya,Y. 1995. Schumpeter and the Idea of Social Science. Cambridge: CambridgeUniversity Press.

Swedberg,R. 1991. Schumpeter: A Biography. Princeton, NJ: Princeton UniversityPress.