The following points highlight the three major criticisms of Schumpeter’s theory of trade cycle. The criticisms are: 1. Assumption of Full Employment 2. Innovations Alone Cannot Generate Trade Cycles 3. It Ignores Other Influences on Expansion and Recession.
Schumpeter’s Theory Criticism # 1. Assumption of Full Employment:
The Schumpeter’s theory is based on the assumption of full employment of resources in the economy.
Innovations involve a shift of the resources in the economy from old to new industries which ultimately results in the start of recession in the old industries that spreads eventually to the whole of the economy.
Schumpeter’s arguments would be rendered irrelevant if there is unemployment of labour and other factors, for in such a situation the expansionary effect of innovations would not be as intense as would possibly be when there is full employment.
Schumpeter’s Theory Criticism # 2. Innovations Alone Cannot Generate Trade Cycles:
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Hayek is of the opinion that innovations alone cannot cause cyclical fluctuations. It is along with the monetary factors that innovations bring about trade cycles. If entrepreneurs decide to finance innovations from their retained earnings, these will generate only a mild expansion.
In the same way, if the banking system expands its credit on the basis of real savings made available to it by the public, there will be no inflationary pressures on the economy. Thus, Schumpeter’s theory is incomplete.
Schumpeter’s Theory Criticism # 3. It Ignores Other Influences on Expansion and Recession:
The intensity of the expansion and depression does not depend upon innovations alone. The intensity and duration of a business cycle depends also upon whether an innovation is introduced before the previous cycle has run its full course.
These are also influenced by the credit created by the banking system during the prosperity phase, the time period needed for carrying through an innovation, the competitive impact of innovations.
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If innovations are; introduced in the latter phase of prosperity, the recession may be considerably delayed. Further, if some entrepreneur ventures to introduce innovation during depression itself, some of the firms which might be on the verge of collapse may get a fresh lease of life. Since the general price level will be prevented from falling, revival may start earlier.
Moreover, if the banking system gives huge amounts of credit to finance the innovations, the inflationary forces generated would be as strong as would need serious adjustments to bring the prices into equilibrium. The extent of the gestation period of the innovations also influences the degree of adjustment needed. Longer is the time lag, more violent are the fluctuations. Furthermore, the impact of the innovation on competition is also a decisive factor in the amplitude of the fluctuations.
If the impact of the demand for the new product is spread over a large number of other products, the fluctuations caused would be of a mild nature. On the opposite, if the impact is confined’ to a few old products, the unemployment generated by the replacement of the old products by the new product will be felt to be more intense.
Despite these shortcoming, Schumpeter’s theory is commendable because it suggested an explanation of the business cycles as a part of the process of growth of an economy and also because it pinpointed technology as a powerful factor in the generation of trade cycles.