Schumpeter Advocates Innovation as True Driver of Progress 233.0

Joseph Schumpeter introduced the concept of the entrepreneur as the true locomotive of the modern economy.

Further, he identified that economy’s true context as the then ‘new normal’ of creative destruction from continuous innovation, and not the seeking of price equilibrium from perfect competition.

While the modern definition considers all businesspersons as entrepreneurs, Schumpeter equated entrepreneurs only with innovators.

In Capitalism, Socialism and Democracy (p.132), he defined the function of the entrepreneur as:

… to reform or revolutionize the pattern of production by exploiting an invention or, more generally, an untried technological possibility for producing a new commodity or producing an old one in a new way, by opening up a new source of supply of materials or a new outlet for products, by reorganizing an industry and so on.

In the context of his times when Marx was still influential, he called plain vanilla businessmen as capitalists.

In his sense, therefore, innovation as done by entrepreneurs, in profit-making or social enterprise, is the true driver of progress.

Innovation and Entrepreneurship in Modern Times. The fact that we accept the last statement above today as generally true is a measure of Professor Schumpeter’s influence according to author McCraw. The book, Prophet of Innovation, highlights the timelessness of the good professor’s many insights.

Other than for his timeless ideas, Thomas McCraw, Pulitzer prize winning author, wrote a timely biography of Joseph Schumpeter, for our time when people are starting to recognize the role of innovator-entrepreneur as drivers of the economy.

The good professor’s insights explain many characteristics of the growth part of the business cycles looking from the microeconomic perspective of firms (though he makes no policy prescriptions) while John Maynard Keynes’s explains declining phases better while inventing aggregates and macroeconomics in the process (and Professor Keynes did propose policy directions like deficit financing).

During his time, Professor Schumpter’s conclusions were radical as they were opposite of the accepted truth, i.e. that disorder not equilibrium was the real norm and that “creative destruction,” the famous phrase that he coined in his most famous work – Capitalism, Socialism, Democracy (CSD) – was the true route to progress.

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Some Evolutionary Economics. At length, I quote from CSD (p. 82 – 84) on the subject of capitalism and creative destruction – best to hear the Master’s words themselves:

p.82: The essential point to grasp is that in dealing with capitalism we are dealing with an evolutionary process…

p.82: Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary…

p.83: The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumer goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates [incidentally a definition of innovation]…

p.83: [this] illustrates the same process of industrial mutation – if I may use that biological term – that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.

p.84: Economists are at long last emerging from the stage in which price competition is all they saw.

p.84: …it is not that kind of competition which counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organization (the largest-scale unit of control for instance) – competition which commands decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of existing firms but at their foundations and their very lives.

On one hand, price equilibrium leads to the law of diminishing returns. It also makes for easier mathematical modeling with calculus or matrix math. In orthodox economics, technology is an externality, a black box, that Solow treated as a residual.

Making technology endogenous makes for messier math with multiple equilibria. It can also result into increasing returns and thus monopolies. In practice, from railroads to the Internet, monopolies do not happen because of other avenues of competition – not in price – but through R&D like obsolescence.

Schumpeter, SYNTHESiST and Innovative Entrepreneurship. In SYNTHESiST, I follow Professor Schumpeter and only feature innovative entrepreneurs as defined Marion Ewing Kauffman Foundation in the United States. This is not to put down businessmen-capitalists but merely supports the blog’s goal of highlighting innovators that create new wealth for the country through net value addition and not just those who engage in ‘business’ activities that transfer funds to make themselves wealthy.

I do support the entrepreneurship that gives livelihood and start people in the road to wealth. The good professor has shown that only those entrepreneurs that continuously innovate are those who really rise to the top.

He quotes a German proverb that is similar to the Chinese one on three generations going up to wealth and down. The German equivalent: “first generation [workman's] overalls; third generation [back to] overalls.

He attributes this apparently global phenomena to the following: the first generation continuously innovates to build wealth, the second generation works more to preserve the legacy; and the third generation losses most to new first generation players who innovate. Makes sense.

Subscribe to SYNTHESiST. The more I write on the subject; the more I meet Filipinos engaged in innovative entrepreneurship, in profit-making and social enterprises, in the Philippines and overseas. I will be posting about them in the future.

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