Schumpeter’s legacy in understanding innovation and entrepreneurship
1. Introduction
“Profit is the payment you get when you take advantage of change” is one of the many defiant quotes written by Joseph Schumpeter in which he states the importance of change, instead of defining profit in a more traditional manner. His role on the understanding of the significance of change for economic growth and in portraying economics on a more “dynamic, change-oriented and innovation-based fashion” constitutes a crucial legacy until current days (Michaelides and Milios, 2005). This paper explores Schumpeter’s main written work focusing in three of his books, his legacy on understanding entrepreneurship and innovation and the application of that legacy. The document is organized in four sections. The first section is a brief biography of his life; section 2 presents who influenced him, his main written work and principal concepts depending on the time of each writing. Section 3 sets out the theories of innovation and entrepreneurship that have become his legacy, its current applications and the limitations of his work. The final section concludes the research about Schumpeter’s legacy.
Joseph Alois Schumpeter was a Moravian-born American economist, sociologist and political scientist who lived from 1883 until 1950 (Swedberg, 1992). In regards to his academic career, he graduated in Vienna and taught at the Universities of Czernowitz, Graz, and Bonn to latter join Harvard University as a Professor, where he served from 1932 until retirement (Encyclopædia Britannica, 2016). Schumpeter also participated in public and government related activities: he served briefly as a Minister of Finance in the Republic of German-Austria after World War I (Allen, 1991); and also worked at the private banking industry where in 1921 held the position as President of the Biedermann Bank in Vienna (Seidl, 1994). In regards to his personal being, he had a complicated life, surrounded by various cases of migration; death of loved ones; business failures; and lived through two World Wars and the Great Depression (Leonard, 2009). Schumpeter had to reinvent himself to keep forward, as Bell (1976) said “Here was a rarity: an economist with a tragic sense of life.” In conclusion, he was a rich thinker and has been acknowledged as one of the most prominent economists of the past century.
2. Influences & Written work
During his career, Schumpeter wrote several books, journal articles, and reviews, which have contributed to our understanding of various concepts such as business cycles, innovation and the role of entrepreneur, being the last two his most distinguishing contributions to economics. Among his principal work there could be find the following books: The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle (1911, translated to English in 1934); Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process (1939); Capitalism, Socialism, and Democracy (1942); and History of Economic Analysis (1954) (Swedberg, 1991). For the purpose of this paper, there will be further analysis of the main concepts written in the first three books of this list. These are some of his literature, which have influenced our past and present in regards to understanding innovation and entrepreneurship.
It is fundamental to understand what was happening at the time Schumpeter was writing and who influenced his literature to better understand his work and legacy. Furthermore, his earlier work does not present the same conceptualization and theories than his latter literature. Despite he was a challenger of Socialism; some authors argue that he wrote his books to appeal to socialists (Sloth, 1993). He was also a very meticulous reader of Marx. Moreover, according to some authors Schumpeter was highly influenced by the Historical School of Economics of which they were both members (Sloth, 1993; Michaelides and Milios, 2005). The Historical School of Economics appeared in Germany in the 19th Century as a different view to public administration and academic economics (Shionoya, 2005). Some of the other notorious figures of the School were Gustav von Schmoller (1838-1917), Karl Polanyi (1886-1964), Adolph Wagner (1835-1917), and as mentioned above, Max Weber (1864-1920) (Michaelides, 2009). Accordingly, there are arguments that work presented by Schumpeter on innovation and entrepreneurship were a continuation of ideas that were introduced by the Historical School of Economics leaders.
2.1 The Theory of Economic Development
The topics that prevails the most in Schumpeter’s writings are the role of innovation and the role of the entrepreneur in economic growth. Along the years, he changed his views on the concepts of innovation and it can be seen in his writings. In his earlier work, The Theory of Economic Development, Schumpeter’s hero was the entrepreneur, the “agent of innovation” (Schumpeter, 1934). He also argued that during development stages of an economy when a new business is born due to innovation and replaces the old one, a business cycle containing both, booms and recessions (Graph 1) are unavoidable to generate this additional or new capital through innovation (Schumpeter, 1934; Witt, 2002). Schumpeter (1934) advocated that a business cycle without innovation would be turned into a stationery state where perfect competition prevails. Additionally, Schumpeter presented that the role of the entrepreneur is vital as he is the one who breaks that state of equilibrium, this process shall continue in a cyclic manner along time (Graph 2) (ibid). Summarizing, during this stage of his career, Schumpeter argued that innovation relies on the entrepreneur, as he is the one responsible for generating the conditions, the turmoil, to develop economic growth.
Graph 1
Graph 2
2.2 Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process
His other major books were published decades later with a different economic environment in place, greatly affected by the Great Depression and its subsequent effects in societies. In the early 1940s, there was a general sense that capitalism was on its way out to give place to socialism (Pepperell, 2014). Despite the fact that his book Business Cycles did not have as much recognition as his other work, there are valuable concepts in the book. According to McCraw (2006) it was Schumpeter’s least successful book based on both, his professional ambitions and other measures but it also presents useful insights that may have not received enough attention. First, Schumpeter’s way of thinking about capitalism, changed after the remarkable study done to write this book. He changed to a more historical and pragmatic approach that also is seen in his other literature (ibid). Second, in this book, Schumpeter presents a triple alliance between the entrepreneur, innovation, and the banking system, as a union that gives impetus to economic development (Kuznets, 1940). Finally, in Business cycles he discusses how the entrepreneur’s behaviour forms a primary model to understand the business cycles, but also argues that there are limitations to this model when taking into account secondary factors such as errors, propagation through the credit system, and others (ibid.). Accordingly, despite it was not his best work, this book is also an important element to form Schumpeter’s legacy.
2.3 Capitalism, Socialism, and Democracy
Capitalism, Socialism, and Democracy (1942) on the other hand, is Schumpeter’s most widely read piece. The book has been reprinted in various occasions and in several languages, it is also a well-known cited source (McCraw, 2007). This book has manifold valuable concepts within its pages, although for the purpose of this paper, the three main points to pay attention to are: Schumpeter’s view of Capitalism; the introduction of the term “creative destruction;” and finally his view of the importance of large companies in innovation. In regards to the first matter, one of the main chapters of Capitalism, Socialism, and Democracy begins with the following question and answer: “Can Capitalism survive? No. I do not think it can.” He coincides with Marx in terms of capitalism eventually collapsing. Although, the key analysis is not Schumpeter’s response, but the reasons behind his answer, which despite some argue sounded socialist, does not portray the same motives or beliefs as Marx (Schumpeter, 2009). While Marx argued that capitalism would be abolished by the proletariat, who felt exploited by capitalism; Schumpeter argued that capitalism would inevitable succumb due to its own successes (Leonard, 2009). Furthermore, he suggested that capitalism would create an intellectual class which would critique social matters and would stand up for the interest of others, leading to more socialist governments (ibid.). Therefore, Schumpeter’s assessment of capitalism, as a model that would eventually loose power is still relevant nowadays.
Second, in this book Schumpeter introduces the widely used term “creative destruction” as capitalism’s fundamental element. He stated:
Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary. […] The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers' goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates. […] [Creative destruction is the] process of industrial mutation […] 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 (Schumpeter, 1950, pp. 82–83).
With these words Schumpeter establishes the linkage between innovation, capitalism and creative destruction. Moreover, Freeman (2009) suggested: “the central point of his whole life work [is]: that capitalism can only be understood as an evolutionary process of continuous innovation and 'creative destruction'” (p. 126). Consequently, we can argue that Schumpeter’s ideas were rich, wise and even revolutionary, especially for that period, and are still valid today.
Finally, Schumpeter also presented that as a consequence of the deterioration of capitalism, there is a change in players for innovation. In 1942, Schumpeter suggested a shift from his previous work. He moved away from the entrepreneur as an individual and argued that the entrepreneur could be a corporation, a country, not necessarily an activity perform by individuals as he mainly presented in his earlier work (Cantwell, 2001). According to Schumpeter (1950), larger oligopolistic corporations begin to play a more vital role for economic growth. His argument is based on the fact that those corporations have market power and can invest in research and development (R&D) in order to remain with the advantage associated to oligopolies, as a more extreme case, leading to monopolies. In conclusion, through out Schumpeter changed his initial focus on the entrepreneur as an individual to a broader player; currently both concepts can be studied as complimentary.
3. Schumpeter’s Legacy
After exploring his books, it can be argued that Schumpeter’s writings were mainly focused on economics but not closely limited to it. He pictured and studied economics from various approaches: economic theory, economic history, economic sociology and statistics (Swedberg, 1991). Consequently, he left a broader legacy and more ways of understanding and applying his theories and concepts. His main legacy is formed by his theories of the entrepreneur and innovation, and both are closely related. Schumpeter argued that the role of the entrepreneur and innovation are key drivers for economic development. Furthermore, his written work and concepts have been a source of inspiration for various writers who have also gone in more detail on the subjects. This section explores Schumpeter’s theories of entrepreneurship and innovation and its current applications.
3.1 Theory of Entrepreneurship
Within Schumpeter’s theories both concepts: entrepreneurship and innovation, are meticulously linked, as the entrepreneur is the one who have the ability to innovate, the ability to generate economic growth. In his earlier work, Schumpeter defined the entrepreneur as follows:
Change that is endogenously generated within the economy is brought about by the innovative capacity of entrepreneurs, the only agents who are capable of carrying out new combinations of resources and transforming organizational forms (Schumpeter, 1934, p. 74).
Furthermore, Schumpeter (1950) presented that innovators were those people with a high level of entrepreneurship, who could generate new industries and trigger changes within the structure of an economy. Entrepreneurs studied as individuals are the topic of multiple seminars globally, focus of various researches, postgraduate programs, schoolbooks, among others. Biographies on entrepreneurs such as Steve Jobs is embedded on today’s literature. According to Wooldridge (2014), there are two different interpretations and usage of the term entrepreneur. Some authors argue that entrepreneurs are those people who build their own companies, typically small businesses (ibid.). On the other hand, Schumpeter’s (1934) view, which suggests that the entrepreneur is an innovator who brings new ideas and new combinations of resources to generate profit. Therefore, it can be discussed that in his initial approach to innovation, Schumpeter considered that the entrepreneur was the key element to innovation.
Despite the fact that later he presented large companies as main players for innovation, his theory of the entrepreneur is still relevant today. Entrepreneur, businesses and markets are crucial not only for economic but also for social development, reason why the topic is still avidly important and researched today (Swedberg, 1991; Foss and Klein, 2002). The Economist even had a weekly column named Schumpeter until a couple of years ago, where they published business and finance articles (Economist.com, 2014). Just as presented by Schumpeter decades ago, today it can be seen that entrepreneurs are still considered vital for economic development.
3.2 Theory of Innovation
Nowadays innovation is a well-known and widely used term; it was not always as such, Schumpeter was among the first economists to clearly define the term innovation. He made a clear differentiation between two terms that can sometimes be used interchangeably: invention and an innovation. Schumpeter claimed (1934): “Innovation is the market introduction of a technical or organizational novelty, not just its invention.” Invention and discovery are on one side, and innovation, commercialization of the innovation and entrepreneurship on another. Schumpeter specified that an entrepreneurial capacity does not rely on invention or creativity (Stinchcombe, 1990; Cantwell, 2001). Consequently, an invention that is not commercialized does not contribute to economic development reason why the focus of his research was on innovation, which generates profit, economic growth and had a constant influence on the market.
Decades after Schumpeter wrote his first theory on the entrepreneur and its role on innovation, he appreciated the prominence position that R&D was playing in the 20th century. The literature now makes a distinction of the two models of innovation presented by Schumpeter, differentiating them as “Mark I” and “Mark II” (Phillips, 1971). Mark I refers to the entrepreneur as the hero and centre of innovation activities, whilst Mark II refers to a model based on routinely activities performed by large corporations who have the funds to invest in R&D and to present new innovations (ibid.). In Mark II, Schumpeter argued that due to high level of barriers to entry the markets that monopolies and oligopolies enjoy, new comers would have to present radical changes to gain participation. This threat of newcomers generates pressure to current companies, which will have to remain competitive by routinely investing in R&D (Cantwell, 2001). Additionally, according to Malerba and Orsenigo (1996), Mark I has the following features, innovation activities are not highly concentrated, innovators are individuals or small size firms and the number of new innovators is relatively high. On the other hand, Mark II presents the subsequent aspects, innovative activities are highly concentrated, innovators are large size corporations and the entry of new innovators is lower due to high entry barriers (Cantwell, 2001). Schumpeter theory of innovation and his claims that change is the only constant in the evolution of capitalist economies, and innovations is the main catalyst for growth are crucial in today’s economies.
3.3 Limitations
Schumpeter’s work does have limitations in regards to the role of large firms in his theory of innovation. Empirical research proposes results that discredit the relationship between market power, firm size and innovation presented by Schumpeter in Mark II (Cantwell, 2001). Some researchers advocate that smaller firms might also have high levels of innovation especially due to the interaction with large firms within the same industry (Audretsch, 1995; Cantwell, 2001). Therefore, large firms contribute to innovation not necessarily due to their market power but also through the spillovers of research and development that become valuable resources for other companies (Loasby, 2003). McCaffrey (2009) presents another limitation to Schumpeter’s work; he advocates that some of Schumpeter’s ideas on capitalism are not entirely appropriate. McCaffrey suggests that the various successes of capitalism cannot be seen as the only cause for the decline of the capitalist society as argued by Schumpeter. He defends that non-capitalist institutions were also an important part of the erosion of capitalism and are not discussed as such in Schumpeter’s work. Finally, it is also argued that Schumpeter’s work present certain lack of generality and that otherwise his legacy would have been even greater by the provision of a valid foundation for the evolution of economics (Witt, 2002). Summarizing, Schumpeter’s work have given major legacies but there are also limitations to his work such as a broader scope on the role the different firms sizes can play in economic growth.
4. Conclusion
Schumpeter was one of the most recognized thinkers of the past century and his influence in theories of economics was abundant. His contributions to economics are enormous mainly in regards to the role of the entrepreneur and the role of innovation to generate economic growth; it is not limited to economics as it also influences other social sciences. His arguments on the recombination of knowledge to generate value are highly valid in current days. People like progress, the next new thing, and people consume those innovations. As Schumpeter suggested, innovation and entrepreneurial activities are crucial for adding value otherwise economy stagnates. Schumpeter (1950) also suggested the importance of change, as he wrote: “[Capitalism] not only never is but never can be stationary […]” (p. 83). Nowadays, with globalization and technological advances change is inevitable and is in all aspects of daily live, people have to cope with it; Schumpeter’s theories of innovation and the entrepreneur will remain as a legacy for future generations to come.