To get the four-phase cycle above, Schumpeter begins with a "pure" model of the economy in which there is no change. Schumpeter's pure economy is characterized by a balanced circular flow of economic activity in which all knowhow and processes are routine. This system, which is effectively the neoclassical economic model, is characterized by general equilibrium and a lack of profits; all factor inputs receive payments equal to the value they add to output.
After building his pure, equilibrium model of the economy which, by definition, is a system in which there is no tendency for change, Schumpeter introduces entrepreneurship and innovation. In other words, he introduces change. Due to innovation, the balanced circular flow of the economy is disrupted and, consequently, profit opportunities emerge. In order to exploit these opportunities, financial investment, credit, and interest emerge. Productivity increases and there is economic growth. Financial boom, high expectations and prosperity are realized: a business cycle upswing has been triggered.
Eventually the impact of innovation runs its course and a growth recession occurs. What were once "new" ideas have become a routine part of the economy. As profits dwindle, investments fail to offer their expected return. The recession soon becomes a depression as bankruptcies occur, credit contracts, expectations turn negative, and investment activity drops-off.
nevitably the downwave of "creative destruction" reaches a bottom and a recovery ensues. The economy eventually returns to f~ll production and equilibrium, but at a higher level of productivity than had been the case before innovation was introduced.
After using two approximations to establish the simple four-phase business cycle of prosperity, recession, depression, and recovery, Schumpeter develops a third and final approximation which results in the simultaneous occurence of three different four-phase business cycles in an economy. By introducing innovations in periodic clusters and with varying scale impact, Schumpeter shows that the capitalist system will be characterized by at least three business cycles of different length (22). Specifically, his model demonstrates how the 40-month Kitchin cycle, 9- to la-year Juglar cycle, and 50- to 60-year Kondratieff cycle occur simultaneously.
Importantly, while Schumpeter found the above scheme to be "useful" in his work, he did not consider it a comprehensive model of the business cycles that occur in the capitalist system. He understood that the number of cycles could be indefinite- a point Robert Prechter would be quick to second. (20)
After completing his dynamic, disequilibrium model of the economy, Schumpeter takes but one more radical step beyond neoclassical economics and actually provides exhaustive empirical support for his theory. (Obviously orthodox economists fail to do so for the most part because examining economic reality would falsify their "equilibrium" models.) In Business Cycles, Schumpeter devotes the first five chapters and 220 pages to building his economic model of general disequilibrium and then spends ten chapters and 830 pages corroborating his model with a "histor.ical and statistical analysis of the capitalist process".
Specifically, Schumpeter reviews American, British, and German economic history from the late-eighteenth century through the Great Depression of the 1930's in the context of the varying scale business cycles depicted in his model. In other words, he overviews the historical pattern of disequilibrium and change that is involved in the "capitalist process".
While Schumpeter believes that entrepreneurial activity is responsible for the smaller scale business cycles, what is most pertinent here is what role he thought innovation played in large-scale business cycles in the American economy, i.e., the Kondratieff wave.
All in all, Schumpeter recognized that cycles of prosperity and depression are part of the process involving ongoing innovation and dynamic change called "capi talism" . He ties the three completed Kondratieff waves in American history to key innovations that changed the overall way of doing things within the economy. These radical transformations corresponded with radically changing knowhow and procedures throughout society which both required and fed into a highly dynamic and unstable mass psychology.
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In summary, Schumpeter's theory of economic development can be reduced to four basic propositions (25):
1. Innovation is the fundamental impulse which sets and keeps the capitalist engine in motion.
2. Innovations are an essentially discontinuous phenomenon: they appear in swarms.
3. Therefore economic development is a cyclical process: 'cyclical "waves" are essentially the form "progress" takes in competi ti ve capitalism' .
4. Innovations have different impacts. That is why, simultaneously, cycles of different length exist. The long wave is caused by such basic innovations as railroadization, electrification and motorization. -----------
'Being a contrarian is tough, lonely and generally right'
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