Innovation, Knowledge and Growth

Adam Smith, Schumpeter and the Moderns

Heinz D. Kurz

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781136583575
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This book deals with the prime movers of socio-economic development, innovations and technical change, their origins, forms and effects. It contains a set of closely related chapters, some of which have been previously published as papers in scholarly journals

1   Introduction

This volume contains a set of chapters I published during the past couple of years, which deal with a theme that is again high on the agenda in economics since the mid-1980s: the problem of innovation, knowledge and economic growth. It was at the centre of interest during the time of the classical economists from Adam Smith and David Ricardo to Karl Marx; it gave way largely to a concern with the static problem of resource allocation in early marginalist authors from William Stanley Jevons and Carl Menger to Léon Walras; it was rediscovered by Joseph Alois Schumpeter, who saw capitalism as a restless system that continuously generates economic, social and cultural change from within, epitomised in his famous formula of ‘creative destruction’; and it became again the focus of attention in more recent times in what was dubbed ‘new’ or ‘endogenous’ growth economics.

Closely related questions such as the following ones ought to be asked. What are the characteristic features of the different approaches to the problems at hand – classical, Schumpeterian and modern marginalist? Wherein do these approaches differ from one another? What are the roles of invention, innovation and imitation in the process of economic development and growth? Is there progress in our understanding of the phenomena under consideration? What is meant by ‘progress’, and how can it be measured? What are the benefits of the formalisation of economic ideas, what its costs? What is the meaning of ‘knowledge’ and related concepts? How can knowledge be measured? Etc. etc.

Any progress in the field of economic dynamics, as in any other field as well, needs time to take place and necessitates a comparison with earlier states of the subject. Hence, history matters, here the history of economic analysis. It is a characteristic feature of all chapters contained in this book that they blend concerns with economic theory and the history of economic thought. Paul Samuelson put forward a cogent argument in favour of studying the history of economic thought:

the higher prize [is] to get on with the subject’s advancement by utilizing and acknowledging whatever was already to be found in the literature, eschewing what Gunnar Myrdal acidly called ‘unnecessary Anglo-Saxon “originality”.’ Then, if one could leap a cubit from those ethereal heights the fulfillment was the greater.

(Samuelson 1983: xxv)

Unfortunately, ‘unnecessary Anglo-Saxon “originality”’ is still with us, but what according to Myrdal in the past has been local, in the meantime seems to have become global. One of the reasons of unnecessary originality is the fact that economists appear to know less and less about the history of their subject in general and even about the history of the sub-fields in which they specialise. In terms of David Lowenthal’s famous saying: ‘The past is a foreign country, where we come from’, one of the aims of this book is to bring back the past and compare it with the present in the field under consideration. This allows one to see better what has been achieved since the times of Adam Smith, which path the subdiscipline has taken, which problems have successfully been tackled and which not, which problems have disappeared from the research agenda not because they have been solved, which have newly entered it, etc.

1.1 Composition of the book

Chapter 2 deals with the treatment of technical progress, capital accumulation and income distribution in Adam Smith, David Ricardo and Karl Marx. It is argued that while Smith and Ricardo could not possibly have had a full picture of the role and different forms of ongoing technical change in the development of the capitalist economy, they and Marx deserve to be credited with having contributed to the elaboration of an analytical framework and concepts that allow us to describe and analyse almost any such technical change. In particular, they saw clearly that while some commodities (and kinds of work performed) were bound to disappear over time, becoming ‘obsolete’, others entered the stage, with the overall number of commodities, and thus variety, increasing. The approach they sought to elaborate thus was designed to capture the increasing variety and heterogeneity of goods, both consumer and capital good. They would in all probability have met with surprise and disbelief in the fact that later economic theorists thought able to deal with the problem of technical change and economic growth in terms of one-good models. It is also shown that the classical economists were far from downplaying the importance of technical progress and that Ricardo’s analysis was not overwhelmed, as is frequently contended, by a concern with diminishing returns in agriculture in combination with Malthus’s law of population. He repeatedly stressed that ‘we are happily yet in the progressive state, and may look forward to a long course of prosperity’, and that ‘it is difficult to say where the limit is at which you would cease to accumulate wealth and to derive profit from its emplyoment’ (Ricardo 1951–1973, VII: 17 and IV: 179).

Chapter 3 provides a summary account of the life, work and consequences of Joseph Alois Schumpeter. The names of Karl Marx and Léon Walras mark the antipodes between which Schumpeter’s thinking and writing moved. He started out valuing Walras’s theory of general equilibrium as the ‘Magna Carta’ of economics. However, he recognised that it was not capable of dealing with the dynamic forces and anarchic tendencies of the system. The Walrasian system was populated by ‘boring equilibrium men’, hedonic utility maximisers eagerly seeking to optimally adjust to given constraints. It thus missed out the all-important role of a second type of agent, ‘entrepreneurs’ (that is, ‘energetic men’), keen to overcome the constraints in terms of ‘innovations’. According to Schumpeter it was only Marx who had a clear understanding of the restlessness of capitalism and its drive to incessantly change the economy and society from within. However, whereas in Schumpeter entrepreneurs are seen as the prime movers of the system, in Marx it is a systemic characteristic of capitalism that is responsible for the permanent revolution of the types and qualities of goods produced, of the methods of production used and of the ways in which firms and markets are organised: the ‘coercive law of competition’ compels producers to innovate.

Chapter 4 deepens the preceding argument by reformulating Schumpeter’s theory of development within the classical theory of competition, as it was elaborated by Piero Sraffa (1960). For this purpose innovations of various kinds are introduced into a Sraffian model of inter industry pricing and income distribution. It is shown how the possibility of a process innovation upsets the existing economic order and how a successful innovation defines a new long-period constellation of prices and the distribution of income between wages and profits. It is argued that whether an invention can be expected to become an innovation does not only depend on the technical characteristics of the invention, but also on the environment into which it is born, that is, prices and income distribution. As is well known, Schumpeter insisted that in the ‘circular flow’ of an economy, which is characterised by the absence of any innovations, there are neither profits nor interest. This zero-profits condition involves an extremely rapid transition to a new long-period position, because ‘static firms’ in the industry in which the innovation takes place quickly face losses as soon as the price of the industry’s product starts to fall, reflecting lower unit costs of production incurred with the new technique. The chapter also deals with a number of possible cases of technical change, including the return of the same method of production, that look strange only at first sight, but reflect the complexity of change even in the simple two-sectoral framework. It is concluded that competition is incompatible with a state of affairs in which the forces of change are dormant. It should be mentioned that the chapter does not address the process through which an innovation is absorbed into the existing economic system. This problem has in the meantime been analysed by Steedman and Metcalfe (2011).

Chapter 5 turns to the treatment of ‘knoweldge’ in recent contributions to the theory of economic growth, starting from the Solow model and leading up to models by Paul Romer and others. Following Fritz Machlup, two broad concepts of economically useful knowledge are distinguished: to know what, or propositional knowledge, and to know how, or procedural knowledge. It is then argued that while there is progress in growth theory, for the most part it relates to the formulation of not implausible ideas that have been with us for a long time. However, some of the formalisations are themselves anything other than plausible. Formalisation brings greater clarity. At the same time it is merciless in uncovering the limits of such formalisations. What is striking is the carelessness with which the central concepts of knowledge, human capital and physical capital are dealt with in some contributions. Especially, the growing diversity in the world of knowledge and of commodities is set aside in terms of some bold assumptions contending that there exists a cardinal measure of knowledge and one of capital, where the prices needed to aggregate different kinds of capital goods do not depend on income distribution. Wherever conceptual precision is lacking, mysterious ‘forces’ are invoked. It is argued that the development of growth theory is not a teleological process, moving forwards, and never backwards; occasionally it may move in circles.

Chapter 6 starts with another look at input–output analysis ante litteram and stresses that in the classical authors and especially the Physiocrats the material input–output structure was considered the core of the economic system that contains one of the keys to basically all important economic phenomena and magnitudes, including technical progress and its effect on income distribution. However, for a long time the potentialities embodied in the input–output structure have been lost sight of, only to be rediscovered by Wassily Leontief in one of his later papers dealing with the problem of technical change. He does so in terms of the classical approach to the choice of technique of cost-minimising producers as it had been put forward by Sraffa (1960). The upshot of the argument is a discussion of how different forms of technical change displace the constraint binding changes of the real wage rate (or the share of wages) and the general rate of profits, or ‘wage frontier’. In his illustration of such a shift of the wage frontier, Leontief assumes that the maximum real wage rate (and thus overall labour productivity) increases, whereas the maximum rate of profits (and thus the output-to-capital ratio) decreases. The case under consideration mimics the shift of the wage frontier in Ricardo’s famous chapter on machinery, in which Ricardo discussed the replacement of labour power by machine power.

Chapter 7 concludes with a critical discussion of arguments questioning the usefulness of the history of economic thought. Critics of the subject typically entertain the view that the process of the production and absorption of knowledge in economics is perfect: whatever is good and valuable will be retained, whereas whatever is weak and erroneous will be weeded out. If this was to be true, there could only be an antiquarian interest in the past: why bother about ‘the wrong opinions of dead men’, as Arthur Cecil Pigou famously put it. However, the view of economics as a relentless march from dark ages to light and wisdom cannot be sustained. While there are important advances in our understanding of certain economic phenomena, there is not only progress, but repeatedly there is also regress. Put somewhat differently: there are not only bubbles in financial and some goods markets, there are also bubbles in the market for economic ideas. The recent financial and economic crisis has raised severe doubts especially about New Classical Macroeconomics and the Theory of Financial Markets and more generally about the widespread ‘Whig history’ of economics, which is based on the idea that there is a perfect selection mechanism of economic ideas. It is argued that certain ideas and theories have prematurely been abandoned, because deficiencies in the form in which they have been put forward were mistaken for deficiencies in substance, while others have been retained despite the fact that they are known to be logically incoherent and do not satisfy the often invoked criterion of solid ‘microfoundations’. Several examples are given which demonstrate that what are considered to be new ideas are just old ones in new garb. Severe economic crises request the economics profession to reconsider its doctrines, abandon views that can no longer be sustained, return to views that can, or create new ones appropriate to the current situation.

I should like to take this opportunity to thank colleagues and friends with whom I had the privilege to discuss and cooperate over many years in different areas of academic and intellectual life, who stimulated my thinking and supported me in numerous ways. I should like to mention in particular, in alphabetical order, Tony Aspromourgos, José Luìs Cardoso, Gilbert Faccarello, Pierangelo Garegnani, Christian Gehrke, Harald Hagemann, Geoff Harcourt, Peter Kalmbach, Mark Knell, Ulrich Krause, Christian Lager, Cristina Marcuzzo, Stan Metcalfe, Gary Mongiovi, Antoin Murphy, Takashi Negishi, Edward J. Nell, Yoshiasu Ono, Arrigo Opocher, Carlo Panico, Sergio Parrinello, Fabio Petri, Heinz Rieter, Neri Salvadori, the late Paul A. Samuelson, Bertram Schefold, Ian Steedman and Richard Sturn. Several of the papers reprinted here reflect the close collaboration I had over the years especially with Christian Gehrke and Neri Salvadori.

HDK

1.2 References

Ricardo, D. (1951–1973). The Works and Correspondence of David Ricardo, 11 volumes. Edited by Piero Sraffa with the collaboration of Maurice H. Dobb. Cambridge: Cambridge University Press. In the text, this is referred to by giving the volume number: page number.

Samuelson, P.A. (1983). Foundations of Economic Analysis. Enlarged Edition. Cambridge, MA and London: Harvard University Press.

Sraffa, P. (1960). Production of Commodities by Means of Commodities. Cambridge: Cambridge University Press.

Steedman, I and Metcalfe, S. (2011). ‘Herr Schumpeter and the Classics’. Manuscript, Manchester.

2 Technical progress, capital accumulation and income distribution in Classical economics

Adam Smith, David Ricardo and Karl Marx

The past is a foreign country, where we come from.

(David Lowenthal)

2.1 Introduction

The problem of endogenous technical change, its causes, forms and effects, has been high on the agenda of economic analysis ever since its systematic inception in the second half of the seventeenth century and its full blooming at the time of the English classical political economists. This is hardly surprising, since around the same time Western Europe experienced what has been called the beginning of the ‘great divergence’ (Pomeranz 2000); that is, its take-off on a path of sustained growth of income per capita. Technical change played an important role in the works of Adam Smith and David Ricardo and an even more important one in that of Karl Marx, who developed his own analysis in no small degree from a critical account of the analyses of Smith and especially Ricardo.¹ Marx, as is well known, saw capitalism as a hotbed whose historical function was to increase productivity ‘geometrically’.

However, the prevailing view in the history of economic analysis appears to be that although Smith and Ricardo lived through the Industrial Revolution, they misread its significance and vastly under-rated the importance of technical progress for economic development and growth.² In my view this assessment cannot be sustained. While it is true that Smith and Ricardo erred in some respects in regard to the problem under consideration, they can hardly be accused of having downplayed the importance of technical progress, as is often maintained. In particular, Ricardo’s respective thinking was not overwhelmed, as is frequently contended, by a concern with diminishing returns in agriculture in combination with Malthus’s law of population.³ In fact, these authors anticipated, and analysed, with the analytical tools they elaborated, what was not yet to be openly seen; that is, some of the characteristic features and long-term trends of the process of incessant technological and organisational change that had seized the Western European economies. Smith foresaw, for example, the emergence of a separate industry or trade engaged in what we would today call research, development and innovation as a part and parcel of the process of the deepening of the social division of labour. And Ricardo even contemplated the end-state of the process of mechanisation that took place before his eyes: a fully automated system of production, and reasoned about its implications for the distribution of income. While the classical authors may be criticised for not having correctly described the present and forecast the future development in sufficient detail, they deserve to be credited with having elaborated a framework and analytical concepts that allow us to describe and analyse almost any such development. They have enriched and deepened our understanding of the technological and economic dynam...

Table of contents

• Cover
• Series Page
• Title
• Copyright
• Contents
• List of figures and table
• Acknowledgements
• 1. Introduction
• 2. Technical progress, capital accumulation and income distribution in Classical economics: Adam Smith, David Ricardo and Karl Marx
• 3. Joseph A. Schumpeter: an economist between Marx and Walras
• 4. Innovations and profits: Schumpeter and the Classical heritage
• 5. On the growth of knowledge about the role of knowledge in economic growth: a critical assessment of recent literature on growth theory
• 6. Who is going to kiss Sleeping Beauty? On the ‘Classical’ analytical origins and perspectives of input–output analysis
• 7. Whither the history of economic thought? Going nowhere rather slowly?
• Notes
• Author index
• Subject index