Finance and Growth: Modern Interpretations of the Thoughts of Schumpeter

Abstract

Studies of the 2007-09 credit crisis and the resulting recession have revealed the inadequacy of the predominant theoretical frameworks and their failure to propose adequate policy solutions. The presence in the economy of “bank money” and a financial system (not only constituted by banks) characterized by financial innovation and speculation fundamentally changes the nature of credit creation. As J.A. Schumpeter (1934) and other scholars (such as Shackle, 1967) have recognized the central role of credit creation in the economic system, a new perspective on the financial role in defining the growth path needs to be developed by filling the gaps in New Growth Theory (NGT) (Aghion and Howitt, 1998) and Evolutionary Theory (ET) (Nelson and Winter, 1982) - which we call the two Sons of Schumpeter - and in some way combining them. The financial instability of the economy seems to depend on the financial structure. The goal of this survey is to explain the main hypothesis of the historical passage of the economy from a virtuous to a bad cycle and to show the existence of what we label the wealth trap: that is, the consequence of the presence of a technologically advanced and greedy financial system within the economic system. This new point of view can help to answer some important questions that in the literature remain unsolved. Future extensions of this survey will develop a quantitative ABM (Agent-Based Model) able to demonstrate the existence of the “two cycles” and will finally undertake experiments to build policy proposals for the restoration of the virtuous cycle and to prevent this cycle from becoming a bad one again.