Abstract
Schumpeter’s business cycle theory can be divided into three component parts: entrepreneurs produce innovations, innovations generate local plan failures, and local plan failures at times grow sufficiently large to generate global recessions. The third component of Schumpeter’s theory is susceptible to the diversification argument, i.e. small micro-changes tend to average out in a large economy thereby generating little macro-fluctuation. While Schumpeter was cognizant of this problem, he did not develop an explicit mechanism to nullify the averaging out of micro-changes. We argue that the network dynamics generated by Schumpeterian innovations is the missing link in his theory. More specifically, innovations change the production network by prodding firms to seek new suppliers of inputs and new buyers of output. These production network dynamics ensure that micro-changes are not independent of each other, rather micro-changes occur in response to each other, thereby nullifying the diversification argument. Production network dynamics are capable of transforming micro-flux into macro-turbulence.
Similar content being viewed by others
Change history
12 January 2021
A Correction to this paper has been published: https://doi.org/10.1007/s40844-020-00197-8
Notes
In so far as thought can be thought to be contained with geographical or historical boundaries.
References
Acemoglu D, Carvalho VM, Ozdaglar A, Tahbaz-Salehi A (2012) The network origins of aggregate fluctuations. Econometrica 80(5):1977–2016
Acemoglu D, Ozdaglar A, Tahbaz-Salehi A (2017) Microeconomic origins of macroeconomic tail risks. Am Econ Rev 107(1):54–108
Alan K (2016) Networks: a paradigm shift for economics? The Oxford handbook of the economics of networks. Oxford University Press, Oxford, pp 13–46
Atalay E, Hortacsu A, Roberts J, Syverson C (2011) Network structure of production. Proc Natl Acad Sci 108(13):5199–5202
Axtell RL (2001) Zipf distribution of US firm sizes. Science 293(5536):1818–1820
Axtell R, Guerrero O, López E (2019) Frictional unemployment on labor flow networks. J Econ Behav Organ 160:184–201
Barrot J-N, Sauvagnat J (2016) Input specificity and the propagation of idiosyncratic shocks in production networks. Q J Econ 131(3):1543–1592
Baumol WJ (1996) Entrepreneurship: productive, unproductive, and destructive. J Bus Ventur 11(1):3–22
Carvalho VM (2014) From micro to macro via production networks. J Econ Perspect 28(4):23–48
Dosi G, Fagiolo G, Roventini A (2010) Schumpeter meeting Keynes: a policy-friendly model of endogenous growth and business cycles. J Econ Dyn Control 34(9):1748–1767
Fallick B, Fleischman CA (2004) “Employer-to-employer flows in the US labor market: the complete picture of gross worker flows.” Finance and Economics Discussion Series No. 2004-34, Federal Reserve
Gabaix X (2011) The granular origins of aggregate fluctuations. Econometrica 79(3):733–772
Goodwin RM (1991) Schumpeter, Keynes and the theory of economic evolution. J Evolut Econ 1(1):29–47
Hagemann H (2003) Schumpeter’s early contributions on crisis theory and business-cycle theory. Hist Econ Ideas 11(1):47–67
Hayek FA (1948) The meaning of competition. Individualism and economic order. The University of Chicago Press, Chicago, pp 92–107
Kauffman SA, Johnsen S (1991) Coevolution to the edge of chaos: coupled fitness landscapes, poised states, and coevolutionary avalanches. J Theor Biol 149(4):467–505
Lovejoy A (1936) The great chain of being. Harvard University Press, Cambridge
Lucas RE (1977) Understanding business cycles. Carnegie-Rochester Conf Ser Public Policy 5:7–29
Mandelbrot BB (1997) Fractals and scaling in finance. Springer, New York
Minsky H (1986) Stabilizing an unstable economy. Yale University Press, New Haven
Phillips BD, Kirchhoff BA (1989) Formation, growth and survival: small firm dynamics in the US economy. Small Bus Econ 1(1):65–74
Scheinkman JA, Woodford M (1994) Self-organized criticality and economic fluctuations. Am Econ Rev 84(2):417–421
Schumpeter JA (1927) The explanation of business cycle. Economica 21:286–311
Schumpeter JA (1928) The instability of capitalism. Econ J 38(151):361–386
Schumpeter JA (1934) The theory of economic development. Harvard University Press, Cambridge, p 1983 (Reprinted by Transaction Publishers in)
Schumpeter JA (1935) The analysis of economic change. Rev Econ Stat 17(4):2–10
Schumpeter JA (1939) Business cycles: a theoretical, historical, and statistical analysis of the capitalist process, vol 1. McGraw-Hill, New York (Reprinted in 2005 by Bartleby’s Books (Chevy Chase, MD) and Martino Publishing)
Schumpeter JA (1946) The decade of the twenties. Am Econ Rev 36(2):1–10
Schumpeter JA (2010) Development by Joseph A Schumpeter. J Econ Lit 43:112–120 (translated by Markus C. Becker and Thorbjorn Knudsen)
Shackle GL (1972) Epistemics and economics: a critique of economic doctrines. Cambridge University Press, Cambridge
Wagner RE (2010) Mind, society, and human action: time and knowledge in a theory of social-economy. Routledge, London
Wagner RE (2020) Macroeconomics as systems theory: transcending the micro-macro dichotomy. Palgrave Macmillan, London
Author information
Authors and Affiliations
Corresponding author
Additional information
Publisher's Note
Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.
About this article
Cite this article
Veetil, V.P. Schumpeter’s business cycle theory and the diversification argument. Evolut Inst Econ Rev 18, 273–288 (2021). https://doi.org/10.1007/s40844-020-00190-1
Published:
Issue Date:
DOI: https://doi.org/10.1007/s40844-020-00190-1