Schumpeter on Entrepreneurship

By Dr. Hassan Shirvani –Since the great Austrian economist Joseph Schumpeter (1883-1950) introduced the concept of entrepreneurship into economics almost a century ago, economists have struggled to systematically incorporate this concept into their models of economic development, with only limited success.   As a result, the initial enthusiasm over the unique role of entrepreneurs as heroic agents of economic innovation has gradually dissipated, with entrepreneurship nowadays embracing all attempts to start new businesses, regardless of their nature and importance.  In other words, it is now claimed that any properly trained individual could easily become an entrepreneur.  This explains why many colleges are now joining the gold rush of offering entrepreneurship courses and programs to all those eager to avoid the vagaries of the job market by striking it rich on their own.  In addition, there is now even a growing and lucrative industry for training college instructors how to teach entrepreneurship.

Entrepreneurship, as originally defined by Schumpeter, however, is much more than just starting any new business.  It is the introduction of truly revolutionary changes in business methods and practices, including the launching of outstanding new products, production techniques, and organizational approaches.  As such, through what Schumpeter termed its “creative destruction,” entrepreneurship is the driving force of economic progress.  Thus, true entrepreneurs are the dynamic agents of change, the visionaries who through their sheer ingenuity and diligence periodically disrupt the conventional ways of doing business.  In this sense, only such personalities as James Watt, Thomas Edison, Henry Ford, and Steve Jobs, are true entrepreneurs.

Given the importance of entrepreneurship to long term economic growth, the questions naturally arise as to (1) what causes the periodic emergence of entrepreneurs, and (2) whether government policy can play a role in promoting entrepreneurial talent.  More specifically, we would like to know whether entrepreneurship is primarily an exogenous process, where entrepreneurs fall like manna from heaven, or is it rather an endogenous process, where entrepreneurs emerge in response to favorable economic conditions and policies.  The rest of this post looks at the evolving s views of Schumpeter on these issues.

Entrepreneurship: The Early Schumpeter

In his early writings on entrepreneurship (1911), Schumpeter draws a sharp distinction between inventions and innovations.  Inventions are largely the results of a linear process of continuous, gradual, and predictable accumulation of scientific knowledge.  In contrast, innovations represent the sudden commercial applications of the existing scientific knowledge.  Thus, while inventions tend to grow at a slow and steady pace, their innovative adoptions are often sudden and disruptive events.  Indeed, most innovations are considered as the brainchildren of revolutionary entrepreneurs who periodically emerge to trigger massive discontinuities in the paths of economic development.  In addition, once an entrepreneur has shown the new and better way of doing things, the competitive free market forces will rapidly give rise to a new generation of imitators, resulting in the rapid spread of new ideas throughout the economy.  Thus, for the early Schumpeter, the free market system is as essential to economic progress as the periodic emergence of the entrepreneurial talent.

Entrepreneurship: The Later Schumpeter

In his later writings (1942), Schumpeter largely rejects his own earlier notion that a combination of competitive markets and random appearances of heroic entrepreneurial figures is essential to economic prosperity.  For him, modern industrial economies are largely characterized by noncompetitive markets, in which giant corporations exercise significant monopolistic power over their prices and outputs.  In addition, given their substantial financial resources, many corporations also enjoy considerable control over their paces of both invention and innovation activities through their large R&D expenditures.  At the same time, many large businesses offer significant financial support to top research institutions and universities, whose scientific achievements are often used to meet the commercial needs of their corporate sponsors.

Under these conditions, corporations handle all aspects of their businesses, from the development of new products to their financing, production, and marketing.  In other words, thanks to modern business, many traditional entrepreneurs have been replaced by corporate bureaucrats who routinely handle all business innovations.  Thus, rejecting his own earlier views, the later Schumpeter believes that the main source of business innovation is no longer the presence of exceptional individuals with bright new ideas, as was the case in the past, but increasingly the corporations themselves, which have both the resources and economic power to develop and market new products and processes.  If true, it follows that governments can, through their corporate grants and other business dealings, speed up the pace of creative innovations in their economies.

Entrepreneurship: After Schumpeter

The Schumpeterian pessimism regarding the gradual disappearance of the independent entrepreneurial spirit has itself proven somewhat misguided.  There is no question that many of the most important business innovations have come from highly concentrated industries, such as aviation, chemicals, electrical engineering, and machinery manufacturing.  However, it is also true that many technological advances of the recent decades, especially in the information technology sector, have been produced outside big corporations.  In many of these cases, the smaller creative firms and entrepreneurs have subsequently been absorbed into their giant competitors.  Thus, directly or indirectly, the entrepreneurial spirit seems to be much more durable than Schumpeter ever foresaw.  In addition, Schumpeter also seems to have greatly overestimated the extent to which corporations can control the pace and impact of their innovations on the economy.  The recent global financial crisis, which was a direct result of the misguided and mishandled financial innovations by the financial sector, provides convincing evidence against such a claim.

Conclusion

While there is wide agreement among economists regarding the role of entrepreneurship in fostering economic development, there is less agreement about the ways in which entrepreneurs emerge to exploit scientific advances to the benefits of society.  History shows that both individuals and organizations can play important complementary roles in the process.  At the same time, not unlike the cases of business ethics and business leadership, the jury is still out about the extent to which genuine entrepreneurship can be taught in the classroom.  After all, many recent entrepreneurial icons, such as Bill Gates and Steve Jobs, were all college dropouts.

Hassan Shirvani, Ph.D.
Professor Cullen Foundation Chair in Economics

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