Schumpeter (1942) Capitalism, Socialism, and Democracy

1. Schumpeter (1942) Capitalism, Socialism, and Democracy • Schumpeter stands out among early contributors to the economics of innovation • His ideas are foundational, and much of the literature that follows builds on his work, uses his concepts, and attempts to test his conjectures and assertions • Schumpeter identified and discussed the importance of innovation at a time when most economics emphasized static price theory • The emphasis on static price theory persists in microeconomic theory courses to this day despite our growing knowledge of dynamics • I will review some of Schumpeter’s most important ideas

2. Entrepreneurship and the Origins of Competitive Advantage • Simple neoclassical microeconomic theory allows for little or no role for entrepreneurs • A firm is a production function; it transforms inputs into outputs • The way the firm transforms inputs into outputs is assumed to be technically and economically efficient • Where do techniques come from? How are they improved, and why? • Schumpeter emphasizes the role and importance of entrepreneurs

3. Entrepreneurship • In reality, some firms exploit opportunities for creating profitable competitive positions that other firms either ignore or cannot exploit • Seizing such opportunities is the essence of entrepreneurship • Entrepreneurship involves discovery, innovation, and acting on the opportunities that discovery and innovation create (page 132): • “To undertake such things is difficult and constitutes a distinct economic function, first, because they lie outside the routine tasks which everybody understands and secondly because the environment resists in many ways that vary, according to social conditions, from simple refusal either to finance or to buy a new thing, to physical attack on the man who tries to product it.”

4. Creative Destruction • Schumpeter believed that innovation causes most markets to evolve in a characteristic pattern • There are periods of relative stability, when firms that possess superior products, technologies, or organizational capabilities earn positive economic profits • These periods are punctuated by fundamental shocks or discontinuities that destroy old sources of competitive advantage (profits above the norm) and replace them with new ones • The entrepreneurs who exploit the opportunities these shocks create achieve positive economic profits during the next period of stability

5. The Long-Run Performance of the Economy • According to Schumpeter, the process of creative destruction implies that static efficiency – the optimal allocation of society’s resources at a given point in time – is less important than dynamic efficiency – the achievement of long-term growth and technological improvement • What really counts is competition between new products, technologies, and organizational techniques, not price competition (pages 84-5): • “This kind of competition is as much more effective than the other as a bombardment is in comparison with forcing a door, and so much more important that it becomes a matter of comparative indifference whether [price] competition in the ordinary sense functions more or less properly; the powerful lever that in the long run expands output and brings down prices is in any case made of other stuff”

6. Policy and Managerial Implications • Schumpeter’s ideas have been used to defend monopoly, on the grounds that high economic profits are a necessary reward to encourage innovation, which results in higher long-run growth • Policy analysis should focus more on the impacts of policies on innovation and less on the impacts on prices and current welfare • A key managerial implication is that even competitive advantages based on inimitable resources or capabilities or early-mover advantages are vulnerable in the long run as new technologies arise, tastes change, or government policy evolves • Firms must manage to bridge the discontinuities that characterize creative destruction if they are to succeed over the very long run