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Home Theories of Economic Growth Schumpeter Model of Economic Growth


Schumpeter Model of Economic Growth:


The Schumpeter model of economic growth moves round the inventions and innovations. This model is explained with the followings:


(1) Process of Production, (2) Dynamic Analysis of the Economy, (3) Trends of Growth, (4) The Demise of Capitalism.


(1) Process of Production in Schumpeter Model:


The process of production shows the combination of productive forces which result in the production of goods. These productive forces are composed of material and immaterial factors. The physical or material factors consist of land, labor and capital, while non-physical or immaterial factors are composed of technical facts and social organization.


Thus Schumpeter production function is as:


Y = f (L, K, N, S, U)


Where; Y = output of the economy, K = produced means of production, L = labor, N = natural resources, S = technology and U = social set-up or social organization.


Taking total differential of production function and then dividing it by dt.



According to this equation the production of the economy depends upon the rate of change of productive forces (dK/dt, dN/dt, dL/dt), the rate of change of technology (dS/dt) and the rate of change of social set-up (dU/dt).


(2) Dynamic Evaluation of Economy in Schumpeter Model:


In respect of dynamic analysis of economy we present two types of effects.


(i) The effects of change in factors of production like K, L and N, which he calls "Growth Components".


(ii) The effects of change in technological and social changes, as the effects of changes in S and U, which he calls "Evolution Components".


In respect of growth components he keeps the land as fixed. As dN/dt = 0.


Then we have the remaining two variables like change in population (dL/dt) and change in means of production (dK/dt).


dL/dt: Regarding population he says that it is an exogenous variable. In other words, the exogenous factors determine population in the economy. He further says that the population growth is a slow process, and it is not furnished with heavy fluctuations. Thus the population function will be as: L = f (t).


dK/dt: Regarding capital goods or produced means of production Schumpeter says that their change depends upon savings. Whereas savings depend upon rate of profit. But it is not possible to get profits without development and without profits the development is not possible. He says that according to circular flow of NI, the value of a product will be equal to its costs. In this way, no profits will be accrued. But Schumpeter says that when new technique? are introduced they will generate profits. It means that in capitalistic system the profits depend upon technology. In other words, the stock of capital changes due to change in applied technical knowledge. It is as:


dK/dt = k (dS/dt)


This shows that in Schumpeter model the capital accumulation is attached with technical changes. The increase in technical changes lead to increase in capital accumulation.


dU/dt: Regarding institutional and social changes Schumpeter says that it is a complicated situation and it is attached with social, psychological, technical and political atmosphere of a country. Thus, it is as:


dU/dt = u (K, L, N, S, U)


Thus we find that in Schumpeter model the change in production of the economy depends upon technological change and socio-cultural set-up of the economy.


Role of Technology in Development:


Now we discuss the effect of technology on economic development. Schumpeter says that economic development is the result of discontinuous technical changes. He says that the process of economic development can be initiated with five different events, like:


(i) Introduction of some new good, (ii) Introduction of some new technique of production, (iii) Discovery of some new market, (iv) Discovery of some new source of supply, (v) The change in the structure and organization of some industry.


Because of such all changes the absorption of factors of production changes.


Role of Entrepreneurs in Development:


Schumpeter says that 'Entrepreneur' is such a factor of production who introduces new combinations of factors of production. He is neither a technician, nor he is a finance manager. He just makes inventions and innovations. He makes inventions just for the sake of inventions. However, he is also influenced by the desire of profit and socio-cultural set-up of the society. In order to perform his economic functions the entrepreneur is need of two things:


(i) He must be having technical knowledge so that he could produce new goods.


(ii) He could easily get the funds. In this respect, credit plays an important role. Because of credit, an entrepreneur gets a command over factors of production. Not doubt, in short run the credit leads to create inflation in the economy, but still it encourages the inventions and innovations.


The above discussion reveals that in Schumpeter model, economic growth depends upon technical and technological conditions of the economy. Whereas the technological changes depend upon the activities of entrepreneurs; and the activities of entrepreneurs depend upon entry of new. entrepreneurs and creation of credit.


(3) Trends of Growth in Schumpeter Model:


According to Schumpeter the capitalistic economies possess the properties of cyclical fluctuations, i.e., they are furnished with booms and depressions. The entrepreneur or entrepreneurs who invent some new technique of production or some new product when it is introduced in the market the producers earn heavy profits. After some interval the other firms also produce that very product. In this way, the supply of that product increases in the market. As a result, the economy will experience increased level of income and employment. But, because of abundance of goods in the market the prices of goods fall leading to create depression in the economy. In such situation some new entrepreneurs will come forward who will invent new techniques of production or some new product. This will create revival and then boom in the economy and finally the economy will enter into the phase of boom. All such means that according to Schumpeter the inventions and innovations are responsible for trade cycles in the capitalistic economies.


(4) Prediction on Decline of Capitalism:


Like Karl Marx Schumpeter also thinks that eventually the capitalism will come to an end and it will be replaced by Socialism.


In this respect, he gives following arguments:


(i) Along with the evolution of capitalism the entrepreneurs and their techniques of production will get obsolete. The salaried managers will take-over the charge of industrial units in place of entrepreneurs.


(ii) Technical changes on the one side, create economies. But, on the other hand, the expansion in the industrial net-work along with the growth of capitalism, the trade unions and other bargaining activities will flourish.


(iii) Along with the growth of capitalism the 'Liberalism' will increase. This will weaken the institution of 'Monarchy'. The capitalistic class will get weaker, and it will depend upon civil and military bureaucracy. In this way, an unrest will develop in the society.


(iv) The capitalism will promote emaciation and women rights. It will disrupt the family life.


(v) The capitalism provides the right to speak and write. The people will express their dissatisfaction against capitalism in tea-houses, parks, hotels and in journals and newspapers.


In this way, the capitalism will finally convert into socialism. Thus according to Schumpeter the capitalism will have a 'Self-Demise".




(i) In Schumpeter Model 'the inventor and innovator' has been accorded as an 'Ideal Man'. But now a days the inventions and innovations are the routine activities of industrial concerns. Schumpeter further says that economic fluctuations occur because of inventions and innovations. But it is not true. They come into being because of business expectations, psychological behavior and monetary and fiscal measures.


Again, Schumpeter assigns top importance to inventions and innovations in respect of economic development. But in Pakistan like countries where there is shortage of funds and resources the inventions cannot be made.


(ii) Schumpeter depends upon credit creation for the sake of inventions. But it is objected by saying that in short run the Bank Credit may be helpful for industrial development. But in case of long run the bank loans will be inadequate for such development. In such situation, the industrial development will be depending upon sale of shares etc.


(iii) According to Meir and Baldwin it is wrong to say that society, will eventually move towards socialism. As if we analyze Europe and America like capitalist countries they have a higher degree of industrial development. They have a right to speak and write. But till now no possibility has emerged whereby the rich capitalist country could turn towards socialism. While the reverse has occurred and the socialists countries are converting themselves into 'Market Economies', after the disintegration of Soviet Union.


Schumpeter's Model and UDCs:


(i) Schumpeter's model is concerned with that particular social and economic structure which prevailed in Europe and US in 18th and 19th century. But such model is least applicable in case of Pakistan like developing countries. Our socio-economic structure is different from them. We do not have the necessary requirements of growth.


(ii) The Schumpeterian model is based upon 'Entrepreneurs'. But in UDCs, there is a shortage of these people. Here the rate of profit is low. The technological level is poor. Consequently, the spirit to invent and innovate remains lacking. Moreover, lack of funds, poor means of transportation and research facilities discourage the potential entrepreneurs.


(iii) In UDCs so many projects are controlled by govts. because they have low profits, the risks are more; and they are run by bureaucrats and managers which hardly engage themselves in inventions and innovations.


(iv) Economic development is associated with so many economic and non-economic factors. Whereas Schumpeter attaches economic development with just inventions and innovations.


(v) In case of UDCs the entrepreneurs follow and copy those techniques and products which have gone obsolete in DCs, rather making inventions.


(vi) According to Schumpeter the internal circumstances of an economy will generate economic development. But UDCs are surrounded by centuries old sufferings, problems, agonies, traditions, customs and techniques of production etc. In such like situation, the Schumpeter's model will lose its efficacy there.


(vii) In UDCs the population growth is a big issue. The rising population often distorts the growth efforts. In such state of affairs what the Schumpeter's inventions will do?


(viii) Schumpeter depends upon 'Credit' for economic development. But in case of UDCs where production can not be enhanced the inflation will rise which will thwart the process of growth.


Relevant Articles:


Adam Smith's Model of Economic Growth
Ricardo's Model of Economic Growth
Classical Model of Economic Growth
Marxian Model of Economic Growth
J.E. Meade's Model of Economic Growth
Schumpeter Model of Economic Growth
Secular Stagnation - Hansen's Thesis
Kaldor - Mirrlees Model of Economic Growth
Golden Rule of Economic Growth
Neo-Classical Theory of Economic Growth

Principles and Theories of Micro Economics
Definition and Explanation of Economics
Theory of Consumer Behavior
Indifference Curve Analysis of Consumer's Equilibrium
Theory of Demand
Theory of Supply
Elasticity of Demand
Elasticity of Supply
Equilibrium of Demand and Supply
Economic Resources
Scale of Production
Laws of Returns
Production Function
Cost Analysis
Various Revenue Concepts
Price and output Determination Under Perfect Competition
Price and Output Determination Under Monopoly
Price and Output Determination Under Monopolistic/Imperfect Competition
Theory of Factor Pricing OR Theory of Distribution
Principles and Theories of Macro Economics
National Income and Its Measurement
Principles of Public Finance
Public Revenue and Taxation
National Debt and Income Determination
Fiscal Policy
Determinants of the Level of National Income and Employment
Determination of National Income
Theories of Employment
Theory of International Trade
Balance of Payments
Commercial Policy
Development and Planning Economics
Introduction to Development Economics
Features of Developing Countries
Economic Development and Economic Growth
Theories of Under Development
Theories of Economic Growth
Agriculture and Economic Development
Monetary Economics and Public Finance

History of Money

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