Named after the economist Joseph Schumpeter, this paradigm focuses on quality-improving innovations and the competitive dynamics they create.

6.1. The Engine of Growth: Profit-Seeking R&D

In the Schumpeterian view, economic growth is driven by entrepreneurs who invest in Research & Development (R&D). They do this in the hope of creating a higher-quality product that will allow them to outcompete existing firms. The incentive that fuels this entire process is the prospect of earning temporary monopoly profits if their innovation is successful.

6.2. The Core Concept: Creative Destruction

Schumpeter coined the term “creative destruction” to describe the essential dynamic of capitalism. It is the process where new, superior innovations render old products, technologies, and firms obsolete. In this view, the continuous turnover of firms—where new, innovative firms drive out older, less efficient ones—is not a sign of economic instability but is the very engine of progress. The exit of old firms is a necessary and positive part of long-run growth.

6.3. Key Insight: Why “Creative Destruction” is Different

This focus on replacement and obsolescence marks a crucial difference from the product-variety models.

• In a product-variety model, a new product is added to the economy without displacing an old one. Therefore, the exit of a firm (and its product) would actually reduce growth by reducing the overall variety of inputs.
• In a Schumpeterian model, growth occurs precisely because new products replace old ones. Firm exit is a sign that a superior technology has been introduced, pushing productivity forward.

This distinction highlights the unique importance of competition, turnover, and replacement in the Schumpeterian vision of economic growth.