Entrepreneurship and Innovation: What is Schumpeter’s legacy with respect to both understanding entrepreneurship and innovation and the application of that understanding?
Joseph Schumpeter had three goals in his life: To become the greatest lover in Austria, the greatest horseman in Europe and the greatest economist in the world. (Sandmo, 2011)I cannot assess his achievements in the first two areas but there is no doubt that he became an important economist and father of entrepreneurship and innovation research.
This essay will show how Joseph Schumpeter influenced the evolution of conceiving and developing concepts of entrepreneurship and innovation. This essay will be structured in threesections. In the first section I will explain Schumpeter’s theory on equilibrium and economic development and I will describe the role of the entrepreneur as an agent of change, also taking into account the time context and his peers. The second section will show how Schumpeter became the foundation and a source of inspiration for subsequent scholars in the area of entrepreneurship and innovation research. The last section will critically look at the importance of Schumpeter for our understanding of entrepreneurship and innovation but also the limitations of his work.
Schumpeter and his theory in the context of the history of economic thought
Schumpeter, like Marx, had a different understanding with respect to market equilibriums than neoclassical economist. He rejected the concept of markets that contained a large number of competitors who only sought for short-term profits, and therefore assumed technology and prices as exogenous. Although Schumpeter considered the Walrasian model of general equilibrium the greatest achievement of nineteenth-century economic science, he didn’t accept the limited explanation power it has, given that it only allows the economic system to reproduce itself by maintaining its own structure unaltered. (Screpanti & Zamagni, 2005) As explained in more detail below, he had the vision of an agent of change who will destroy equilibriumand not only the existence of “ordinary business man”who behaved in an adaptive and routine way, only trying to efficiently use the given input factors and the given technique. In other words, Schumpeter introduced the notion that entrepreneurs discover opportunities that others do not see.Furthermore the Walrasian model is not able to explain economic phenomena like change, growth, technical or organizational progress or recessions, which were the most important factors in Schumpeter’s view on economic growth.
He used the term “market equilibrium” only to emphasise his argument that this is just one aspect of an economy that is actually in constant change all the time. He believed there was no steady state. For a capitalist society it was rather necessary to have steady movement between equilibrium and disequilibrium. He saw the dynamics of a capitalist development explained by means of this economic pendulum.
The function of the entrepreneur, first in Schumpeter Mark I understood as the heroic entrepreneur and later, in Schumpeter mark II, incorporated in an organizational context, is vital to Schumpeter’s understanding of the innovation process. For him the entrepreneur was an endogenous function with a distinctive role to the owners or the financiers. Hagedoorn (1996) also emphasises the importance of internalizing technology in the explanation of competition and economic development. The owner in Schumpeter’s realm is not the agent of change; his function is rather to make profits with the existing combinations, which decrease with the increase of competitors of the same product or service. With this differentiation one can see that Schumpeter didn’t see the entrepreneur as a risk taker.
The entrepreneur is a profit seeker who is constantly seeking for new ways to generate value. The value creation through recombination of knowledge or resources or the combination of both can facilitatethe production of a new product, the improvement of an existing product, the use of a new production method, the opening up of a new market, capturing new supplies of raw materials or intermediate products or using a new organizational method.In general, this value generation is achieved by seeking new ways of combination. Combination in that sense can be understood as innovation activity, ultimately leading to a reorganisation of a market structure, by building or breaching monopolies.
Schumpeter didn’t see the marked up prices monopolists could ask for as an outcome of exploiting market power, but rather as compensation for the (re)combination activities of the entrepreneur. Although it can be assumed that bigger firms have more capital and/or resources to invest into risky innovation activity and therefore might be able to be better at innovative outcome. These means come from prior innovation where high profits could be realised. The profit the entrepreneur generates the difference between revenue and costs and is a residual income activated by the innovation. After all, this monopolistic like rent is only temporary, as indicated previously. Schumpeter argues that sooner or later imitators will adapt to the new combination introduced by the first mover and therefore the innovation will diffuse. Hence the residual income of the first mover will gradually decline until there is again a market of perfect competition where costs equal prices and neither profits nor losses will be generated. At this point Schumpeter considers the economy to be in equilibrium again until a new combination arises and the readjustment process as just described iterates.