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Schumpeterian puzzles
Book reuiews / J. of Economic Behavior & Org. 26 (I 995) 299-310 Berndt, & H. White, eds., Dynamic Symposium on Economic Theory Press) 199-245. Brock, W.A., and CL. Sayers, 1988, Journal of Monetary Economics 22, Scheinkman, J.A. and LeBaron, B. 1989, 311-337.
305
econometric modeling, Proceedings of the Third International and Econometrics (Cambridge, MA: Cambridge University Is the business cycle characterized by deterministic chaos? 71-90. Nonlinear dynamics and stock returns, Journal of Business,62,
Maria Brouwer, Schumpeterian Puzzles (The University of Michigan Press, Ann Arbor, Michigan, 1991) pp. x + 257, $36.00. The work of Joseph Schumpeter has had a major impact on researchers attempting to understand processes of technological progress and economic evolution. In Schumpeterian Puzzles, Maria Brouwer provides a review and assessment of Schumpeter’s published work. In addition she attempts a synthesis of the main strands of his analysis, a synthesis that utilizes economic analyses and evidence that have become available since Schumpeter’s work. The book is an ambitious undertaking and there are things to commend the book. However, the book falls short of achieving its goal of a satisfactory synthesis, for some of the same reasons that Schumpeter’s analysis fell short of its goal of linking innovations to observed business cycle fluctuations. Schumpeter’s research can be divided into two principle stages. The first stage was a formulation and analysis of what could be termed, “competitive capitalism”. This was articulated in The Theory of Economic Development (TED) (1919) a 1928 Economic Journal article, and in Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process (BC) (1939). This stage one formulation was Schumpeter’s attempt to relate technological innovations to business cycle fluctuations in the context of a competitive market economy. In Capitalism, Socialism and Democracy (CSD) (1943), Schumpeter provided a view of “ trustified capitalism” that emphasized the role of the modem corporation in the innovative process. This second stage of his research provided new explanations of the roles of monopolistic practices and market concentration. The wellknown ‘Schumpeterian Hypotheses’ on the relationships between market structure, firm size and innovative activity are derived from this second stage. This second stage of his work in CSD is also where Schumpeter coined the term, ‘creative destruction’ (although this concept also applies to his stage one formulation). In chapter one Brouwer provides a review of Schumpeter’s research on innovation and technological progress. This review focuses on the stage one competitive capitalism formulation. This emphasis is useful because many readers would be less familiar with Schumpeter’s stage one research than with Schumpeterian Hypotheses on market structure are R&D. Brouwer emphasizes that Schumpeter’s view of the innovative process evolved over the course of his career as a researcher. Therefore, some of the hypotheses derived from this second stage of
306
Book reviews / .I. of Economic Behavior & Org. 26 (1995) 299-310
Schumpeter’s work are at odds with the views that he advanced in his earlier stage one writings. Schumpeter’s formulation of competitive capitalism was an ambitious attempt to link technological innovations to disruptions (disequilibrium) in the economy that would result in business cycle fluctuations. The basic idea was that an innovation (or, series of innovations) would stimulate a process of diffusion of the innovation and disequilibrium adjustments that would entail predictable patterns for macroeconomic variables such as interest rates, real investment, and nominal wages and prices. In Business Cycles, Schumpeter discusses how innovative activity could contribute to ordinary business cycles as well as to “long wave” (Kondratieff) cycles, depending upon the magnitude of the innovation. After the diffusion of the innovation and the resultant reallocation of labor and capital resources, the economy would reach a new equilibrium. A new cycle begins when a new innovation emerges. Schumpeter’s competitive capitalism formulation, “ . . . was not greeted with unanimous approval.” [Brouwer, p. 11 In a review of Business Cycles, Simon Kuznets (1940) identified what appeared to be flaws in the analysis. For instance, Kuznets argues that the evidence for true Kondratieff cycles had always been scant and that Schumpeter does not add convincing empirical evidence that supports the existence of these cycles. Perhaps the key issue raised by Kuznets concerns the linkage between innovative activity and business cycles: why should the observed distribution of innovative and entrepreneurial activity over time give rise to discemable macroeconomic business cycles? Innovations could surely contribute to macroeconomic fluctuations, but unless major innovations tend to be “bundled together” during some time periods and absent (or, less frequent) during other periods, there would not appear to be a good argument as to why they would lead to cycles. Brouwer reviews more recent evidence on the bundling hypothesis later in her book. The evidence is mixed. Some researchers have found that a disproportionately large number of major innovations appeared during depressions or recessions. On the other hand, time series of total patents in the U.S. and the U.K. appear to be procyclical. However, the invention embodied in a patent requires investment and lead time before being translated into an innovation that has an impact on the economy. If the associated investment activity and lead times change over the business cycle then innovations need not be “bundled”, even when the patented inventions are strongly procyclical. In the last part of her book, Brouwer modifies Schumpeter’s competitive capitalism model so as to incorporate more reasonable (empirically) views of innovation and the market structures in which the process unfolds. These modifications incorporate market structure features from stage two of Schumpeter’s work. These modifications also take into account more recent results on diffusion of innovations and on innovation and market structure. Many of these results are reviewed by Brouwer in the middle portion of the book.
Book reviews/J.
of Economic Behavior & Org. 26 (1995) 299-310
307
Brouwer describes several extreme cases in order to highlight the role of market structure. For example, one case involves a situation with no entry, in which incumbent firms invest in capital goods that embody an innovation. A second case involves entrant investment in innovation-embodying capital goods and increased market concentration as a result of creative destruction. One problem with Brouwer’s analysis of the various cases is that there is no formal model that pins down the key linkages between observable variables. For example, Brouwer has a process innovation leading to higher net investment and higher nominal prices (at least initially). However, a process innovation can also reduce producer marginal costs and have a nominal pricereducing effect that could offset some or all of the inflationary effect of the increased demand for capital goods. Also, there is no discussion of where innovative rents go. These rents would ultimately end up in the hands of some consumers and should have demand-expanding effects. There is a further difficulty in Brouwer’s attempt to confront her modified version of competitive capitalism with empirical data. This goes back to the innovation bundling issue raised by Kuznets. As Brouwer states, “ . . . his [Schumpeter’s] scheme did not stand up to a confrontation with real-world data very well. Empirical validation of his theoretical scheme will be an unrewarding pursuit, because the available empirical evidence is a blend of both evolution and mere growth.” [Brouwer, p. 2171 Essentially the same sorts of criticisms apply to Brouwer’s revised model and analysis. Existing macroeconomic data reflects a mixture of underlying economic growth, disruptions and adjustments induced by innovations, and various other sorts of “shocks” or disturbances to the economy. Even with an improved conceptual model of the process of innovation, diffusion and adjustment, it is still very difficult to sort out what is driving economic fluctuations at a macroeconomic level. The real business cycle (RBC) approach that has been developed in recent years offers an alternative perspective on the connections between innovative activity and macroeconomic fluctuations. The RBC approach posits that productivity growth has a random component - which could be due in part to unpredictable changes in the numbers and magnitudes of innovations. These productivity shocks lead to period-to-period changes in consumption, employment and capital investment that reflect optimal choices by economic agents in an uncertain environment. For example, if productivity shocks follow a random walk, then an equilibrium RBC model will predict a particular pattern for consumption, employment and investment over time. However, it is important to note that RBC models do not predict a regular sine wave pattern of activity over time precisely because new disturbances are entering into the system in every period. While there would almost surely be correlation of productivity disturbances over time, these disturbances would not be “bundled” in the sense that no new disturbances would be forthcoming until the economy had fully adjusted to the previous productivity change.
308
Book reviews/J.
of Economic Behavior & Org. 26 (1995) 299-310
This reviewer does not wish to give the reader the impression that the RBC approach is necessarily the “correct” approach to modelling macroeconomic fluctuations. Most RBC models have been relatively simple one sector stochastic growth models that do not seem to be capable, for instance, of explaining the magnitude of observed employment fluctuations. However, the RBC approach does have the virtue of linking some source of economic fluctuations (productivity shocks or innovations) to observed fluctuations via an internally consistent model of choices. Given the ambitious nature of the undertaking, it should not be too surprising that Brouwer does not provide a wholly satisfactory reformulation and synthesis of the Schumpeterian system. However, for students of technological progress, Brouwer’s book provides a helpful review of Schumpeter’s research, particularly the somewhat neglected competitive capitalism part of his research. In addition, this book may stimulate the thinking of researchers on technological progress by raising interesting questions about the ways in which innovative activity is linked to observed economic fluctuations. Stanley S. Reynolds University of Arizona, Tucson, AZ, USA
References Kuznets, S., 1940, Schumpeter’s business cycles, American Economic Review 30, 257-271. Plosser, C., 1989, Understanding real business cycles, Journal of Economic Perspectives 3, 51-77. Schumpeter, J., 1939, Business cycles: A theoretical, historical and statistical analysis of the capitalist process (McGraw Hill, New York). Schumpeter, J., 1943, Capitalism, socialism and democracy (Unwin University Books, London). Schumpeter, J., 1928, The instability of capitalism, The Economic Journal, 361-386. Schumpeter, J., 1978, The theory of economic development, an inquiry into profits, capital, credit, interest and the business cycle (Harvard University Press, Cambridge; English translation from the 1919 German edition).
Alfred0 Medio, Chaotic Dynamics. Theory and Applications to Economics (Cambridge University Press, Cambridge 1992) pp. xv + 344, $54.95. Over roughly the past fifteen years, two parallel research programs in economics have developed with a focus on chaotic dynamics. The first has concentrated on demonstrating the possibility of cyclical and chaotic dynamic behavior arising in a wide set of theoretical models. The second line of work is more empirical, concerning itself with the development of statistical tests of chaos and application of these tests to macroeconomic and financial time series.
305
econometric modeling, Proceedings of the Third International and Econometrics (Cambridge, MA: Cambridge University Is the business cycle characterized by deterministic chaos? 71-90. Nonlinear dynamics and stock returns, Journal of Business,62,
Maria Brouwer, Schumpeterian Puzzles (The University of Michigan Press, Ann Arbor, Michigan, 1991) pp. x + 257, $36.00. The work of Joseph Schumpeter has had a major impact on researchers attempting to understand processes of technological progress and economic evolution. In Schumpeterian Puzzles, Maria Brouwer provides a review and assessment of Schumpeter’s published work. In addition she attempts a synthesis of the main strands of his analysis, a synthesis that utilizes economic analyses and evidence that have become available since Schumpeter’s work. The book is an ambitious undertaking and there are things to commend the book. However, the book falls short of achieving its goal of a satisfactory synthesis, for some of the same reasons that Schumpeter’s analysis fell short of its goal of linking innovations to observed business cycle fluctuations. Schumpeter’s research can be divided into two principle stages. The first stage was a formulation and analysis of what could be termed, “competitive capitalism”. This was articulated in The Theory of Economic Development (TED) (1919) a 1928 Economic Journal article, and in Business Cycles: A Theoretical, Historical and Statistical Analysis of the Capitalist Process (BC) (1939). This stage one formulation was Schumpeter’s attempt to relate technological innovations to business cycle fluctuations in the context of a competitive market economy. In Capitalism, Socialism and Democracy (CSD) (1943), Schumpeter provided a view of “ trustified capitalism” that emphasized the role of the modem corporation in the innovative process. This second stage of his research provided new explanations of the roles of monopolistic practices and market concentration. The wellknown ‘Schumpeterian Hypotheses’ on the relationships between market structure, firm size and innovative activity are derived from this second stage. This second stage of his work in CSD is also where Schumpeter coined the term, ‘creative destruction’ (although this concept also applies to his stage one formulation). In chapter one Brouwer provides a review of Schumpeter’s research on innovation and technological progress. This review focuses on the stage one competitive capitalism formulation. This emphasis is useful because many readers would be less familiar with Schumpeter’s stage one research than with Schumpeterian Hypotheses on market structure are R&D. Brouwer emphasizes that Schumpeter’s view of the innovative process evolved over the course of his career as a researcher. Therefore, some of the hypotheses derived from this second stage of
306
Book reviews / .I. of Economic Behavior & Org. 26 (1995) 299-310
Schumpeter’s work are at odds with the views that he advanced in his earlier stage one writings. Schumpeter’s formulation of competitive capitalism was an ambitious attempt to link technological innovations to disruptions (disequilibrium) in the economy that would result in business cycle fluctuations. The basic idea was that an innovation (or, series of innovations) would stimulate a process of diffusion of the innovation and disequilibrium adjustments that would entail predictable patterns for macroeconomic variables such as interest rates, real investment, and nominal wages and prices. In Business Cycles, Schumpeter discusses how innovative activity could contribute to ordinary business cycles as well as to “long wave” (Kondratieff) cycles, depending upon the magnitude of the innovation. After the diffusion of the innovation and the resultant reallocation of labor and capital resources, the economy would reach a new equilibrium. A new cycle begins when a new innovation emerges. Schumpeter’s competitive capitalism formulation, “ . . . was not greeted with unanimous approval.” [Brouwer, p. 11 In a review of Business Cycles, Simon Kuznets (1940) identified what appeared to be flaws in the analysis. For instance, Kuznets argues that the evidence for true Kondratieff cycles had always been scant and that Schumpeter does not add convincing empirical evidence that supports the existence of these cycles. Perhaps the key issue raised by Kuznets concerns the linkage between innovative activity and business cycles: why should the observed distribution of innovative and entrepreneurial activity over time give rise to discemable macroeconomic business cycles? Innovations could surely contribute to macroeconomic fluctuations, but unless major innovations tend to be “bundled together” during some time periods and absent (or, less frequent) during other periods, there would not appear to be a good argument as to why they would lead to cycles. Brouwer reviews more recent evidence on the bundling hypothesis later in her book. The evidence is mixed. Some researchers have found that a disproportionately large number of major innovations appeared during depressions or recessions. On the other hand, time series of total patents in the U.S. and the U.K. appear to be procyclical. However, the invention embodied in a patent requires investment and lead time before being translated into an innovation that has an impact on the economy. If the associated investment activity and lead times change over the business cycle then innovations need not be “bundled”, even when the patented inventions are strongly procyclical. In the last part of her book, Brouwer modifies Schumpeter’s competitive capitalism model so as to incorporate more reasonable (empirically) views of innovation and the market structures in which the process unfolds. These modifications incorporate market structure features from stage two of Schumpeter’s work. These modifications also take into account more recent results on diffusion of innovations and on innovation and market structure. Many of these results are reviewed by Brouwer in the middle portion of the book.
Book reviews/J.
of Economic Behavior & Org. 26 (1995) 299-310
307
Brouwer describes several extreme cases in order to highlight the role of market structure. For example, one case involves a situation with no entry, in which incumbent firms invest in capital goods that embody an innovation. A second case involves entrant investment in innovation-embodying capital goods and increased market concentration as a result of creative destruction. One problem with Brouwer’s analysis of the various cases is that there is no formal model that pins down the key linkages between observable variables. For example, Brouwer has a process innovation leading to higher net investment and higher nominal prices (at least initially). However, a process innovation can also reduce producer marginal costs and have a nominal pricereducing effect that could offset some or all of the inflationary effect of the increased demand for capital goods. Also, there is no discussion of where innovative rents go. These rents would ultimately end up in the hands of some consumers and should have demand-expanding effects. There is a further difficulty in Brouwer’s attempt to confront her modified version of competitive capitalism with empirical data. This goes back to the innovation bundling issue raised by Kuznets. As Brouwer states, “ . . . his [Schumpeter’s] scheme did not stand up to a confrontation with real-world data very well. Empirical validation of his theoretical scheme will be an unrewarding pursuit, because the available empirical evidence is a blend of both evolution and mere growth.” [Brouwer, p. 2171 Essentially the same sorts of criticisms apply to Brouwer’s revised model and analysis. Existing macroeconomic data reflects a mixture of underlying economic growth, disruptions and adjustments induced by innovations, and various other sorts of “shocks” or disturbances to the economy. Even with an improved conceptual model of the process of innovation, diffusion and adjustment, it is still very difficult to sort out what is driving economic fluctuations at a macroeconomic level. The real business cycle (RBC) approach that has been developed in recent years offers an alternative perspective on the connections between innovative activity and macroeconomic fluctuations. The RBC approach posits that productivity growth has a random component - which could be due in part to unpredictable changes in the numbers and magnitudes of innovations. These productivity shocks lead to period-to-period changes in consumption, employment and capital investment that reflect optimal choices by economic agents in an uncertain environment. For example, if productivity shocks follow a random walk, then an equilibrium RBC model will predict a particular pattern for consumption, employment and investment over time. However, it is important to note that RBC models do not predict a regular sine wave pattern of activity over time precisely because new disturbances are entering into the system in every period. While there would almost surely be correlation of productivity disturbances over time, these disturbances would not be “bundled” in the sense that no new disturbances would be forthcoming until the economy had fully adjusted to the previous productivity change.
308
Book reviews/J.
of Economic Behavior & Org. 26 (1995) 299-310
This reviewer does not wish to give the reader the impression that the RBC approach is necessarily the “correct” approach to modelling macroeconomic fluctuations. Most RBC models have been relatively simple one sector stochastic growth models that do not seem to be capable, for instance, of explaining the magnitude of observed employment fluctuations. However, the RBC approach does have the virtue of linking some source of economic fluctuations (productivity shocks or innovations) to observed fluctuations via an internally consistent model of choices. Given the ambitious nature of the undertaking, it should not be too surprising that Brouwer does not provide a wholly satisfactory reformulation and synthesis of the Schumpeterian system. However, for students of technological progress, Brouwer’s book provides a helpful review of Schumpeter’s research, particularly the somewhat neglected competitive capitalism part of his research. In addition, this book may stimulate the thinking of researchers on technological progress by raising interesting questions about the ways in which innovative activity is linked to observed economic fluctuations. Stanley S. Reynolds University of Arizona, Tucson, AZ, USA
References Kuznets, S., 1940, Schumpeter’s business cycles, American Economic Review 30, 257-271. Plosser, C., 1989, Understanding real business cycles, Journal of Economic Perspectives 3, 51-77. Schumpeter, J., 1939, Business cycles: A theoretical, historical and statistical analysis of the capitalist process (McGraw Hill, New York). Schumpeter, J., 1943, Capitalism, socialism and democracy (Unwin University Books, London). Schumpeter, J., 1928, The instability of capitalism, The Economic Journal, 361-386. Schumpeter, J., 1978, The theory of economic development, an inquiry into profits, capital, credit, interest and the business cycle (Harvard University Press, Cambridge; English translation from the 1919 German edition).
Alfred0 Medio, Chaotic Dynamics. Theory and Applications to Economics (Cambridge University Press, Cambridge 1992) pp. xv + 344, $54.95. Over roughly the past fifteen years, two parallel research programs in economics have developed with a focus on chaotic dynamics. The first has concentrated on demonstrating the possibility of cyclical and chaotic dynamic behavior arising in a wide set of theoretical models. The second line of work is more empirical, concerning itself with the development of statistical tests of chaos and application of these tests to macroeconomic and financial time series.