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Schumpeter To Rajan: Unlike Banks “I Died Before I Got Old”

Yesterday Raghuram Rajan published an interesting article on competition in finance. He made the important point that competition was a very positive force in the financial sector after deregulation in the 1980s. The drawback was, however, that forces of competition never really became real in finance as they would be in an ordinary industry, because regulators sheltered banks from the ultimate consequences of failure.

Yet I was left feeling a little puzzled about Rajan’s references to Schumpeter. Rajan seemed to suggest a contrast in Schumpeter’s writing between early praise for competitive entrepreneurial innovation and later tolerance of monopoly. When I read Schumpeter’s early and later writing I was not left with this stark picture of a ‘younger’ and ‘older’ man. My lasting impression was only that Schumpeter cleverly and successfully pulled off the remarkable feat of reconciling monopoly with competition in the special case of innovation.

I thought it would be worthwhile revisiting Schumpeter’s arguments, if for no other reason than to double-check my interpretation. For interest -- though I have proven nothing about the ageing process in so doing! -- the dates of Schumpeter’s publications are provided.

Schumpeter usually began with a positive analysis of crisis and the shifting neighbourhoods of equilibrium and disequilibrium. A balanced system “that at every given point of time fully utilises its possibilities to the best advantage” will not be as good for development as a system that experiences disturbances and continually struggles to improve its performance (1947). Real economic development occurs in disequilibrium, when a disturbance forces the system to depart from the circular flow. The cause is innovation. Continual product and process innovation is the “outstanding fact in the economic history of capitalist society” (1939). “New combinations” of materials and forces of production, and the new ideas that change the way something is produced, sold or consumed, in turn transform economies by generating new industries, firms, ideas, goods, methods, and organisations.