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SCHUMPETERIAN BUSINESS CYCLES: PAST, PRESENT AND FUTURE Ondrej Tichy Brno University of Technology, Czech Republic, tichy@fbm.vutbr.cz Abstract This paper uses the theoretical framework developed by J oseph A. Schumpeter to examine the contemporary kinds of innovations and this way, contribute in searching for the next major one. Schumpeter in his theory of the economic development criticised authors who based the explanation of economic theory on equilibrated state because there are always dynamic processes in economy which cannot be described this way. So he came with an entrepreneur and his role, importance and impact on the business cycles. Actually, the business cycles are the most important contribution to the economic theory. He processed three types of waves with graduated impact on economy and showed that superimposition of those waves leads to explanation as well as certain kind of prediction of development in real economy. The paper closer refreshes Schumpeters theory and tries to help in searching for the next wave with major impact on economy. Once, when this major wave will be definitively recognised there can be taken some actions to take advantage of it. Keywords: Schumpeter, Business cycles, Schumpeterian waves, Kondratieff wave, entrepreneur. JEL Classification: B31, E32. Introduction The paper presents a confrontation of Schumpeters Business cycles theory with contemporary authors, theirs opinions, contributions to the topic and also some critics through the secondary research. Schumpeter released finished theory of Business cycles in 1939 (Schumpeter, 1939) and although it was not generally positively accepted by other economists even today there are followers who have found the theory important and continue in advancing of it. The purpose of the paper is to refresh Schumpeters theory and via presented Schumpeters point of view to try to identify some innovation directions which are about to cause upcoming major wave. Wagner-Dbler says that in times of economic stagnation, the debate about "long waves" of economic growth typically refreshes (Wagner-Dbler, 1998). One can admit it, especially in present tough times, but the Schumpeters theory of Business cycles includes thoughts which conceal potential to be exercised even in times of prosperity. And yet this way it is possible to predict close future which is, however, very good for entrepreneurs as well as for businessman or managers because they can work with it in theirs business plans 1 . Joseph Alois Schumpeter J oseph Alois Schumpeter (1883-1950) was born in todays the Czech Republic region which was a part of the Austria-Hungary empire. Schumpeter began his career studying law at the University of Vienna. Then, he became a professor of economics and government. He subsequently taught at the three universities over the German-speaking countries in Europe. Meanwhile, he also served as the Austrian Minister of Finance and a president of a private bank. After that he moved to the United States where he taught at Harvard University until his death (Bukvaj, 2004). He published many articles and a couple of books. In his works he was focused on economics and sociology. Schumpeters legacy J oseph Schumpeter was undoubtedly one of the leading economic theoretician of the Twentieth century. Michaelides and other authors claim that Schumpeters views were strongly influenced by the German Historical School, especially by Rudolf Hilferding and Emil Lederer (Michaelides et al., 2010). His fame rests on relationship of Philosophy, Logic, Psychology, Mathematics, Economic Sociology and Law (Aufricht, 1958). Schumpeter, Schumpeterian and neo-Schumpeterian economists are focused on a micro level of economy (Dabic et al., 2011).
1 He [entrepeneur or businessman], therefore, acts as a rule on the conditions of a phase of longer cycles as if these conditions were permanent. This is obviously so in the case of the Kondratieff [wave] (Schumpeter, 1939, p.173). ISSN 1822-6515 ISSN 1822-6515 EKONOMIKA IR VADYBA: 2011. 16 ECONOMICS AND MANAGEMENT: 2011. 16
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Schumpeter was publishing his ideas at the same time as his fellow J ohn Maynard Keynes. And from the publication of the General Theory of Employment, Interest and Money in 1936 until late in the 20th century, Keynes was generally recognised as the centurys leading economist (Corrocher et al., 2007). Moreover, some of Keynes ideas were implemented into the real economy. So, the Schumpeters theory needs to be viewed in light of that prevailing mainstream of economic thought and that explain why his thoughts always stood in the background of the interest of economists. However, Schumpeter criticised Keynes because he, and his follower, did presume a stationary state or equilibrium, excluding any dynamic changes. Although Keynes was aware of the importance of innovations by quoting Schumpeter neither he nor the post-Keynesian economists had dealt extensively with innovations and technical change (Dabic et al., 2011). On the other hand, according to Corrocher N. and her co-authors they write in their article that Pulitzer Prize winner Thomas K. McCraw, In the early years of this century, computerized databases have begun to show more references to Schumpeters works than to Keyness - a situation that would have been inconceivable only a few years before (Corrocher et al., 2007). According to them younger economists and others accepted without reservation Keynes diagnosis of the problem - lack of consumer demand and shrinking investment opportunities - and his proposed solution - large public spending programs and discretionary fiscal policy. Even though Schumpeter had written extensively about both money and the business cycle, his diagnosis of these issues attracted much less attention. And yet, at the very early stage of the post-WWII period, major implications of Keynesian analysis were not being borne out by economic reality (Corrocher et al., 2007). However, Peter F. Drucker regarded both J oseph A. Schumpeter as well as J ohn M. Keynes as the two greatest economists of the Twentieth century (Drucker, 1983). Agent of change Schumpeters model starts with economy in certain kind of balance or equilibrium. That state can be represented by a moment, a stationary flow 2 or even just a theoretical construct. A person or human agency (Ebner, 2000) hits to this equilibrated state this way he crashes the state by introducing an innovation 3 . That can be entitled an engine of growth which causes the short run fluctuations (Dadkhah, 2009). If it is a basis innovation typically it calls into life completely new branch of industry (Wagner- Dbler, 1998). For better imagination that innovation can be represented by i.e.: railway, electricity, telegraph, car, airplane, computer and so forth (Dadkhah, 2009). Schumpeter calls the individuals who carry them [the innovations] out Entrepreneurs (Schumpeter, 1939, p. 102). He continues with the explanation of the term on the same place. The distinction between the entrepreneur and manager is no more difficult than the distinction between a workman and a landowner. The entrepreneur introduces the good or process, while manager is focused on managerial functions (such as: deciding how much wool to buy and so on). Actually, Schumpeter was aware that nobody ever is an entrepreneur all the time and nobody can ever be only an entrepreneur [but it] must always be combined with, and leads to, others. (Schumpeter, 1939, p. 103). Which means that: a man who carries out a new combination will unavoidably have to perform current non-entrepreneurial work in the course of doing so... (ibid).
2 Schumpeter writes that in this case the equilibrium and the stationary flow are analytically equivalent (Schumpeter, , p. 42) and the stationary flow defines as: [an] economic process which flows on at constant rates in time and merely reproduces itself (Schumpeter, 1939, pp.35-36) and continues No other than ordinary routine work has to be done in this stationary society, either by workmen or managers. (Schumpeter, 1939, p. 40). 3 Schumpeter devoted to definition of inovations many pages. He writes that it means by virtue of their nature, a big step and a big change (Schumpeter, 1939, p. 101). By means of production function he also defines inovations as the setting up of a new production funcition (Schumpeter, 1939, p. 87). On the different place he also suggests that the innovation does not necessary mean an increase in existing factors of production, but [at least] the shifting of existing factors from old to new uses (Schumpeter, 1939, p. 111). After approximately ten years he started with using the term creative destruction which emerges from the process of innovation and revolutionizes ... the economic structure from within, incessantly destroying the old one, incessantly creating a new one (Schumpeter, 1950, p. 83). And Lanzillotti explains that statement this way: creative in the sense that it creates new value and gives an example: what contemporary economics characterizes as increased consumer welfare and destructive in the sense that the economic returns to capital/labour producing obsolete products are lowered or eliminated entirely (Lanzillotti, 2003). ISSN 1822-6515 ISSN 1822-6515 EKONOMIKA IR VADYBA: 2011. 16 ECONOMICS AND MANAGEMENT: 2011. 16
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Furthermore, Braunerhjelm & Svensson define the entrepreneur as follows: (1) is innovative, i.e. perceives and creates new opportunities; (2) operates under uncertainty and introduces products to the market, decides on location, and the form and use of resources; (3) manages his business and competes with others for a share of the market. (Braunerhjelm & Svensson, 2010)
Michaelides et al. define the entrepreneur as a man who innovate, in contrast to the routine behaviour of the majority of people (Michaelides et al., 2010). They further compare Weber and Schumpeter. Both of them resorted to human agency and in particular to the effects of entrepreneurial action which disturbs the stationary state by introducing innovations and consequently forcing violent adjustments upon the economic system. For Weber, entrepreneurial activity consisted in setting up a factory, changing the marketing methods and introducing the principle of low prices and large turnover (Weber, 1930, p. 68). Weber focused exclusively on the religious background while Schumpeter did not narrow down the underlying mechanism leading to entrepreneurial behaviour (ibid). According to Ogbor, Schumpeters discussion of entrepreneur and entrepreneurship is related to how the economy changes by basically putting together already existing elements into new combinations (Ogbor, 2000). He also brings the genesis of the term entrepreneur. As he writes the term entrepreneur is traditionally recognized to be rooted in Cantillons (Cantillon, 1755) Essai sur la nature du commerce en gnral. Cantillons vision of an entrepreneur is likened to anyone who is either a farmer or who conducts business (undertaking) in the face of uncertainty (ibid). But whenever the entrepreneur sees a profit opportunity he needs financing 4 . Schumpeter distinguished three possible states. The first and the most smooth is the state when the company has a fund that have been saved or accumulated, presupposes previous profits, hence previous waves of evolution (Schumpeter, 1939, p. 110) and this way the innovation is financed 5 . The rest two states require some kind of external financing. And the financial sector 6 , that is, the intermediary between those who save and invest, provide the credit so that the entrepreneur can embark on his venture (Dadkhah, 2009). Schumpeter writes about so called credit creation by banks 7 (Schumpeter, 1939, p. 111). The states are: New Men setting up New Firm (Schumpeter, 1939, p. 111) from a scratch and the cancelling of an old and the issuing of a new order to the owners of factors with financing by the credit creation (Schumpeter, 1939, p. 112). Cyclical changes - waves Let Schumpeter explain the cyclical changes in economy. As we already know the Schumpeterian model starts in state of equilibrium. There is no savings, population is constant and everything else is in a state that conforms to the Theoretical Norm. One man [entrepreneur] decide[s] on the production of a new consumers goods he borrows from a bank [,] he founds a new firm [and he] follow[s] in the path of innovations if the innovation had consisted in the introduction of a novel method of producing it, the physical quantity per unit of time of the new total output would be greater than that of the old one the process gathers momentum, these effects steadily gain in importance and disequilibrium begins to show the effects on the old firms [are] easy to understand. It superimposes itself on the disequilibrium caused by the setting up of the new plant and equipment and the expenditure incident thereto. But while the effects of this were, even in those cases in which they spelled net losses, softened by the flow of that
4 It is important to point out that Schumpeter distinguished between capitalists and entrepreneurs. While entrepreneurs bring inovations, capitalists are those who bring capital and undertake a risk (Schumpeter, 1934, p.75). 5 But also Schumpeter notices that the state does not imply about the role of financing by entrepreneur (Schumpeter, 1939). 6 In this relation Dadkhah adds: The implication is that the financial sector too should be freed from too many rules and regulations to be able to innovate and play its role. Here perhaps a note of caution is in order. While the idea of freedom for the financial sector is correct, we should note that finance and money are ultimately based on confidence and trust. Therefore, total freedom or a frontier attitude toward this sector may be detrimental to the health of the economy. Nowhere is this illustrated better than in the Great Depression and in the financial crisis of 20072009 (Dadkhah, 2009). 7 Schumpeter credit creation clarifies this way: considered as the monetary complement of innovation (Schumpeter, 1939, p. 111). ISSN 1822-6515 ISSN 1822-6515 EKONOMIKA IR VADYBA: 2011. 16 ECONOMICS AND MANAGEMENT: 2011. 16
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expenditure, the new disequilibrium enforces much more obviously difficult adaptations. They proceed not exclusively under the stimulus of loss. For some of the old firms new opportunities for expansion open up: the new methods or commodities create New Economic Space [and/or disrupt the current ways of production, organisation and distribution (Breschi et al., 2000).]. But for others the emergence of the new methods means economic death; for still others, contraction and drifting into the background. Finally, there are firms and industries which are forced to undergo a difficult and painful process of modernization, rationalization and reconstruction 8 As long, however, as new enterprises continue to emerge and to pour their stream of expenditure into the system, all those effects may be overcompensated entrepreneurial activity slackens and eventually stops The result of innovation act directly on certain individual prices, and therefore set definite limits on further advance in that direction or related directions not only the full increase in the new product, which will be brought about by more and more firms taking up production, and the incident fall in its price have been perfectly correctly foreseen by the first in the field, but also that those who came later also foresaw correctly what possibilities were left to them. It is easy to see that a point will be produced at minimum unit cost equal to the price at which it will sell. Profits will be eliminated, the impulse of innovation will, for the time being, have spent itself [and] entrepreneurial activity upsets the equilibrium of the system a revision of values of all the elements of the system becomes necessary and this, for a period of time, means fluctuations and successive attempts at adaptation to changing temporary situations 9 . This, in turn, means the impossibility of calculating costs and receipts in a satisfactory way the difficulty of planning new things and the risk of failure are greatly increased. In order to carry out additional innovations, it is as necessary to wait until things settle down as it was in the beginning to wait until things settle down as it was in the beginning to wait for an equilibrium to be established 10 new products streaming into markets and repayment of bank loans by entrepreneurs, annihilating balances This process of economic change or evolution goes on in units separated form each other by neighbourhoods of equilibrium. Each of those units, in turn, consists of two distinct phases, during the first of which the system, under the impulse of entrepreneurial activity, draws away from an equilibrium position, and during the second of which it draws toward another equilibrium position. prosperity and recession. (Schumpeter, 1939, pp. 130-138) Schumpeter calls those fluctuations/cyclical processes in economic life Business cycles. On the next pages he introduced a formation of three waves 11 . The formation is consisted of Kondratieff wave (with a period of approximately 54 years), J uglar wave (a period of approx. 9-10 years) and Kitchin wave (a period of approx. 40 months) 12 . He called them formation of a three-cycle schema 13
8 Schumpeter continues: It should be observed that these vital parts of the mechanism of econoic evolution, which are readily seen to dominate many business situations and to prduce results of fundamnetal importance, can never be revealed statistically by measuring variation in an index of production, or analyzed theroetically in terms of total outuput. Such an index would display nothing except increase. But mere increase in total output would not produce those effects 9 In this context Schohl quotes Kuznets with criticism: critics asked why such an outstanding person as the pioneering entrepreneur is supposed to wait until imitators have competed his profits away; he should have both the capability and the means of staying ahead of his rivals by continually producing innovations. The regularity of business cycles called for the rhythmical emergence of pioneering moves which was not guaranteed by Schumpeter's equilibrium-state argument (Kuznets, 1940) (Schohl, 1999). 10 However, Schumpeter further states that based on statistical and historical picture of a movements, whenever some innovation has been successfully carried into effect, the next wave is much more likely to start in the same or a neighborning field than anywhere else (Schumpeter, 1939, p. 167). 11 Schohl here quotech Tichy who criticised that formation: the notion of equilibrium which plays an essential role for the working of the model gets obscured, because the superimposition of three different waves yields eighteen different types of equilibrium. This is due to the fact that points of rest for shorter waves are located on points of unrest of the longer waves. The theoretical consequences of this are not mentioned in the treatise (Tichy, 1984). (Schohl, 1999). 12 Each of that waves had existed even before (the waves have always autors name) but Schumpeter superimpositioned them. Schumpeter further admitted that there are also other fluctuations which, however, are not caused by economic changes and he was aware of it. One can think of: seasonal fluctuations; harvest; historical and statistical meaning; or even gold production (Schumpeter, 1939, p.176). 13 Actually, in many sources there are stated that Schumpeter used a formation of forth waves, Kuzeets or Wardwell included (depend on source) with a period of 25, 15 years, respectively. Schumpeter mentioned them (Schumpeter, 1939, p. 165) but he does not work with that type of wave in his schema. ISSN 1822-6515 ISSN 1822-6515 EKONOMIKA IR VADYBA: 2011. 16 ECONOMICS AND MANAGEMENT: 2011. 16
1072 (Schumpeter, 1939, p. 169). Dal-pont Legrand & Hagemann quoted Schumpeter where he explains what led him to this conviction:I took it for granted that there was a single wave-like movement, viz. that discovered by J uglar. I am convinced now that there are at least three such movements, probably more, and that the most important problem which at present faces theorists of the cycle consists precisely in isolating them and in describing the phenomena incident to their interaction. But this element has not been introduced into the later editions (Dal-pont Legrand & Hagemann, 2005). Kondratieffs waves The following part of the article is focused only on the Kondratieffs wave as a part of the three-cycle schema. The reason is that this type of wave has the major impact on economy and though it is often easy to identify it. Table 1 summarises the Kondratieffs waves as Schumpeter states them 14 in his publication. Actually, it is not always easy to settle the accurate beginning of the wave. And yet the waves beginnings and ends may vary from country to country 15 . Table 1. Summary of Kondratieffs waves Kondratieff wave Period Innovation 1st 1780s-1842 Industrial revolution 2nd 1842-1897 The age of steam and steel Railroad*, cement*, telegraph*, photos* 3rd 1898-1950* Electricity, chemistry, motors, automobile industry Aluminium*, plane*, cinema* 4th 1950-2000* Electronics*, TV*, nuclear energy*, plastic*, cosmonautic*, computers* 5th 2000*->>> ??? *Based on (Czesany, 2006).
The economic reality via the three-cycle schema is carried to the spring of 1938 by Schumpeter. The additional innovations and years of the waves are based on his followers. The year of 2000 as start of the 5th Kondratieffs wave is not definitively established because we are speaking about almost presence and it is likely to be changed, specified respectively. The same we can say about the major innovation which will cause that wave. 5th Kondratieffs wave There are various authors who are focused on innovations in specific fields of study and they have published articles related to their topics. However, some of them are not aware of our wider (Schumpeters) context of their contribution to the economic reality. Actually, they often write about i.e. engine of growth (Bogliacino & Pianta, 2010) but with regards to Schumpeters theory of innovations cycles (and the Kondratieffs waves), in some circumstances, we can talk about the major innovations 16 . This way we can identify indication of the fifth Kondratieffs wave in some of these fields of study 17 :
ICT (Information and Communication Technologies) (Corrocher et al., 2007).
Dal-pont Legrand & Hagemann states to this topic for quite a time he had even struggled to construct a four- cycle schema including also the Kuznets cycle. This idea was presented in a letter to Arthur Spiethoff of 8 J anuary 1931 and in a lecture on business-cycle theory delivered in Tokyo in the same month. (Dal-pont Legrand & Hagemann, 2005). 14 Schumpeter writes in this relation: These datings [of Kondriatieffs waves] do not lack historical justification. Yet they are not only tentative, but also by nature merely approximate. (Schumpeter, 1939, p.170). 15 Schumpeter works with three countries in the publication: United States of America, England and Germany. 16 Because there is always something which caused that grow, metaphorically, some kind of innovation. 17 Czesany also offers general outline of some fields of study in his book (Czesany, 2006). ISSN 1822-6515 ISSN 1822-6515 EKONOMIKA IR VADYBA: 2011. 16 ECONOMICS AND MANAGEMENT: 2011. 16
Conclusions There is no doubt that J oseph Alois Schumpeter made a significant contribution to economic development and become one of most quoted authors in the economic theory. His ideas on business cycles, economic development and role of entrepreneurs can serve as a valuable guide in todays worldwide challenges even after many decades from its releasing. This paper tries to bring a summary of those main topics and, via Schumpeters view, tries to identify some innovation directions which going to play the major role in upcoming future. Finally, one of the innovations prevails and then it will serve as a major innovation wave in economy. Many authors are persuaded that ICT (Information and Communication Technologies) become this major innovation which will drive the next Kondratieffs wave as the most important element of the Schumpeters three-cycle schema. Some of them even take it as a matter of fact. But as Schumpeter wrote: statistically, whenever some innovation has been successfully carried into effect, the next wave is much more likely to start in the same or a neighbouring field than anywhere else (Schumpeter, 1939, p. 167) and the question is if right ICT has the power to evoke it. However, the answer on that question has to give further research which confirm or refute it. References 1. Aufricht, H. (1958). The Methodology of Schumpeter's "History of Economic Analysis". J ournal of Economics, Vol. 18, Iss. 4, pp. 384-441. 2. Bogliacino, F. & Pianta, M. (2010). Engines of growth. Innovation and productivity in industry groups. Structural Change and Economic Dynamics, Vol. 21, Iss. 4, pp. 1-13. 3. Braunerhjelm, P., & Svensson, R. (2010). The inventors role: was Schumpeter right?. Journal of Evolutionary Economics, Vol. 20, Iss. 3, pp. 413-444. 4. Breschi, S., & Malerba, F., & Orsenigo, L. (2000). Technological Regimes and Schumpeterian Patterns of Innovation. The Economic J ournal, Vol. 110, Iss. 4, pp. 388-410. 5. Bukvaj, F., & Bily, J ., & Klaus, V. (2004). J osef Alois Schumpeter (1883-1950) : ekonom, politik, socialni filozof a humanista. Trest : Mesto Trest. 56, ISBN 8023928139. 6. Cantillon, R. (1755). Essai sur la nature du commerce en gnral. Translated by Higgs, H. (1931), Oxford University Press, Oxford. 7. Corrocher, N., & Malerba, F., & Montobbio, F. (2007). Schumpeterian patterns of innovative activity in the ICT field. Research Policy, Vol. 36, Iss. 3, pp. 418-432. 8. Czesany, S. (2006). Hospodarsky cyklus. LINDE PRAHA, Praha, 199 p. ISBN 8072015761. 9. Dabic, M., & Cvijanovic, V., & Gonzalez-Loureiro, M. (2011). Keynesian, Post Keynesian vs. Schumpeterian, Neo-Schumpeterian: an integrated approach to the Innovation Theory. Management Decision, Vol. 49, Iss. 2, pp. 1- 16. ISSN 00251747. 10. Dadkhah, K. (2009). The Reagan-Thatcher Revolution: The Age of Hayek and Schumpeter. The Evolution of Macroeconomic Theory and Policy, pp. 213-230. 11. Dal-pont Legrand, M., & Hagemann, H. (2005). Business Cycles in J uglar and Schumpeter. The European Society for the History of Economic Thought, 9. Retrieved from: <http://www.unil.ch/webdav/site/cwp/users/neyguesi/public/bc/J uglar_Schumpeter.pdf>. 12. Delgado, G. C. (2010). Economics and governance of nanomaterials: potential and risks. Technology in Society, Vol. 32, Iss. 2, pp. 137-144. 13. Drucker, P. F. (1983). Modern Prophets: Schumpeter and Keynes?. Drucker Society of Austria. Retrieved from: <http://www.druckersociety.at/index.php/peterdruckerhome/texts/modern-prophets-schumpeter-or- keynes?start=8>. 14. Ebner, A. (2000), Schumpeter and the Schmollerprogramm: integrating theory and history in the analysis of economic development, J ournal of Evolutionary Economics, Vol. 10, pp. 355-72. ISSN 1822-6515 ISSN 1822-6515 EKONOMIKA IR VADYBA: 2011. 16 ECONOMICS AND MANAGEMENT: 2011. 16
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