1. Endogenous Growth: Introduction

David Warsh (2006) points out that it was in Paul Romer’s (1990) paper “that the economics of knowledge at last came into focus, after more than two centuries of informal and uneasy presence in the background” (p. xv).

The innovative producer plays such an important role that even consumer tastes are moulded or created by him. “[W]e must always start from the satisfaction of wants, since they are the end of all production, and the given economic situation at any time must be understood from this aspect. Yet innovations in the economic system do not as a rule take place in such a way that first new wants arise spontaneously in consumers and then the productive apparatus swings round through their pressure. We do not deny the presence of this nexus. It is, however, the producer who as a rule initiates economic change, and consumers are educated by him if necessary; they are, as it were, taught to want new things, or things which differ in some respect or other from those which they have been in the habit of using” (Schumpeter 1934, p. 65).

In the static world of Walrasian equilibrium while there is consumer sovereignty, there is no leadership role for the entrepreneur, the rate of interest and that of profit is zero and there are no innovations or qualitative changes. In the dynamic world, the entrepreneur has a leadership role in innovation, consumer tastes are actively influenced by him, and the rates of interest and profit are positive. New ventures are financed by bank credit as they cannot be financed by the revenues of the stationary circular flow. See Elliot (1983, pp. xvi-xvii). Further, the capitalist process cannot be understood by abstracting from money. Money is not a factor of production but a distinct agent which stands between the entrepreneur and factors. Bank credit is used to buy the existing means of production to be withdrawn from their current uses and put into new ventures. See also Moura (2018, pp. 115–16).

Schumpeter (1928, p. 369, n.2; quoted from Clemence 1951, p. 55) was of the view “that economies before becoming ‘external’ must generally be internal ones in some firm or firms of the same or some other industry”.

Schumpeterian competition is not price competition as noted by Rosenberg (2000, p. 10). It takes the form of new product, new technology, new source of supply, and new type of organization (e.g., large-scale units), and gives decisive cost or quality advantage. In The Theory of Economic Development, Schumpeter (1934, p. 66) defines development as carrying out of new combinations which covers five cases: (1) the introduction of a new good, (2) the introduction of a new method of production, (3) the opening of a new market, (4) the conquest of a new source of supply of raw materials, and (5) creation of new industrial organization like a monopoly position.

Schumpeter viewed capitalism as an evolutionary system rather than a system that reverts back to equilibrium after departures from it (Rosenberg 2000, p. 9). For him “capitalist reality is first and last a process of change” (Schumpeter 1942, p. 77). At another place Schumpeter stated: “Whereas a stationary feudal economy would still be a feudal economy, and a stationary socialist economy would still be a socialist economy, stationary capitalism is a contradiction in terms” (Clemence 1951, p. 174). Moreover, he strongly felt “that there was a source of energy within the economic system which would of itself disrupt any equilibrium that might be attained. If this is so, there must be a purely economic theory of economic change which does not merely rely on external factors propelling the economic system from one equilibrium to another” (ibid., p. 160). As is clear, he had an endogenous view of growth but he still viewed Walras’s static general equilibrium theory as the backdrop against which his own theory of change should be seen as a contrast. “Thus, the model of Walrasian circular flow constitutes Schumpeter’s starting-point in understanding the essential elements of capitalist reality precisely because it shows how the system would behave in the absence of its most distinctive feature – innovation” (Rosenberg 2000, p. 15).

Schumpeter (1928; Clemence 1951, p. 70) is of the view that the existing firms cannot create external economies; it is the new firms (embodying innovation) which can change “internal” economies into “external” ones; and in so far as it means disturbance, external economies become important in the negative sense of destroying the old. “The new processes do not, and generally cannot, evolve out of the old firms, but place themselves side by side with them and attack them” (ibid., p. 70).

Even his business cycle explanation is linked with “swarms” of innovations. This leads to the idea of development occurring in waves. “The swarm of projects explains the economic upswing, whereas the downswing occurs when the projects are no longer able to carry the increased economic activity. This idea of waveform economic evolution was an important part of Schumpeter’s vision of the essence of capitalism…” (Andersen 2011, p. 115). Schumpeter was also of the opinion that the cycle is the form which growth takes. “The recurring periods of prosperity of the cyclical movement are the form progress takes in capitalistic society” (Schumpeter 1927; Clemence 1951, p. 30). He disagreed with Hawtrey (1919, 1923) that a cycle is a purely monetary phenomenon. “Booms and consequently depressions are not the work of banks: their ‘cause’ is a non-monetary one and the entrepreneur’s demand is the initiating cause… But booms and depressions would not without banks be what they are…” (Schumpeter 1927; Clemence 1951, pp. 41–42). He also opined that cycles cannot be regarded as merely “evil”; they serve a purpose in capitalist evolution. It is possible to control them through credit management, but “this does not imply that it is in any sense desirable” (ibid., p. 43).

Anderson (2011, p. 68) points out that though Schumpeter’s vision of the role of the entrepreneur in social and economic evolution was unique, it had more similarities with Marx than with other economists or social scientists.

In this regard Schumpeter (1928) writes: “Capitalism, whilst economically stable, and even gaining in stability, creates, by rationalizing the human mind, a mentality and a style of life incompatible with its own fundamental conditions, motives and social institutions, and will be changed, although not by economic necessity and probably even at some sacrifice of economic welfare, into an order of things which it will be merely matter of taste and terminology to call socialism or not” (as in Clemence 1951, pp. 71–72).

Schumpeter does not see depressions as a failure of the capitalist system as development itself occurs through the cyclical process. As Elliot (1983, p. xxvii) puts it “the fundamental cause of depression is prosperity itself”. Similarly, Schumpeter sees monopoly in a dynamic process of capitalist evolution, and does not regard it as a flaw, a contradiction or a failure of the system (ibid., p. xxxvi). In static conception, monopoly may lead to lower output and higher prices; in the dynamic world “Schumpeter’s hero is not competitive market but the creative, daring entrepreneur, the ‘captain of industry,’ who makes the innovations that introduce new products, embodies resource discoveries and technological improvements, opens new markets, and, in the process, builds new industrial empires” (ibid., p. xxxvii). Further: “The ‘perennial gale of creative destruction,’ whereby new products and processes displace old ones, is vastly more important than price competition among existing firms and products” (ibid., xxxvii).

In trustified capitalism, innovation is not embodied in new firms but takes place in big units as a matter of course on the advice of specialists and loses its connection with individual persons. It becomes possible to have a conscious policy towards demand (in the sense of creating new wants) and long-term view towards investment. The fear of failure loses its grip. Progress becomes more automatized and impersonal, and depends less on leadership or individual initiative. See Clemence (1951), pp. 70–71.

In this regard Steven Pressman (1999) points out that families are important for capitalism because they are the main reason for saving. “Families save so that if anything happens to the main breadwinner, other family members will be provided for. By undermining the motivation to save, capitalism destroys its own foundation – the capital needed for future growth” (ibid., p. 108).

For an appraisal of Kaldor’s sectoral view of increasing returns, see Chandra (2019) and Chandra and Sandilands (2021).

For an appraisal of Currie’s leading-sector strategy, see Chandra (2006, 2020).

Young (1990, p. 52) stated that most patents (99%) are utterly useless because they depend on fundamental research or processes which are not patentable. For example, steam engines made use of Joule’s laws of thermodynamics which were not patentable. The old process of inventing is probably less important than systematic scientific research. The system is so intricate that one patent is valueless without the other, so that the entire system can be done away with without affecting growth.