Monday, December 9, 2013

Joseph Schumpeter and the principle of indeterminateness

For most of his life, Joseph Schumpeter, the prophet of innovation, was seeking an exact science. It would be a science that would precisely predict the economic developments including innovations. However, Schumpeter’s quest for exact economics ended quietly in the penultimate year of his life in 1948. How did this transformation happen? Let’s look in this article.

“Despite all his pioneering work of integrating other disciplines into economics, Schumpeter in the mid-1940s was still looking for a key to ‘exact economics’ in the sense of a determinate and predictive science”. Thus begins the penultimate chapter (Chapter 27) of Schumpeter’s biography “Prophet of Innovation” written by Thomas McCraw. What, according to Schumpeter, was the key hurdle in creating such an exact science?

One hurdle Schumpeter felt was mathematics. He performed daily exercises in calculus and tried to master advanced techniques such as matrix algebra. In fact, he thought that a new type of mathematics may be needed for the exact science. However, as Schumpeter delved more into the business history, he started discovering a completely different barrier in creating a predictive science.

As Schumpeter studied business history he asked the question – “Who was it that acted, how and why and what may be the effects that may be traced to such actions?” As he analysed various innovations he realized that a creative response which is “outside the range of existing practice” can never be predicted and is therefore indeterminate. He called this insight – Principle of Indeterminateness. He announced the verdict of his quest in his presidential address at the annual meeting of the American Economic Association on December 30, 1948 (see the picture above).

Schumpeter had realized that social location of individuals plays a significant role in shaping their intuition which in turn determines their creative response. In fact, he felt that psychology is at the heart of all social sciences. And he noted with regret that economists did not consult or work with professional psychologists. Instead they preferred to invent their own assumptions about the mental processes of producers, consumers and people in general.

It would take another half a century before a psychologist (Daniel Kahneman) would get a Nobel Prize in Economics. Incidentally, the first cognitive illusion Kahneman would discover – the illusion of validity – would be closely linked to the principle of indeterminateness. Kahneman writes in the chapter titled “The illusion of validity” in his book “Thinking, fast and slow” – The main point is not that people who attempt to predict the future make many errors… it is that the errors of prediction are inevitable because the world is unpredictable.