Schumpeter Entrepreneurs and Innovation

Joseph Schumpeter Entrepreneurs and Innovation

Schumpeter Entrepreneurship

Like Menger and the second-generation Austrians, Schumpeter described competi­tion as a process involving mainly the dynamic innovations of the entrepreneur. Schumpeter used the concept of equilibrium as Weber had used the stationary state— as a theoretical construct, a point of departure. He coined a phrase to describe this equilibrium state: "the circular flow of economic life." Its chief characteristic is that economic life proceeds routinely on the basis of past experience; there are no forces evident for any change of the status quo. Schumpeter outlined the nature of produc­tion and distribution in the circular flow in the following terms:

[I]n every period only products which were produced in the previous period are consumed, and ... only products which will be consumed in the following period are produced. Therefore work­ers and landlords always exchange their productive services for present consumption goods only, whether the former are employed directly or only indirectly in the production of consumption goods. There is no necessity for them to exchange their services of labor and land for future goods or for promises of future consumption goods or to apply for any "advances" of present consumption goods. It is simply a matter of exchange, and not of credit transactions. The ele­ment of time plays no part. All products are only products and nothing more. For the individ­ual firm it is a matter of complete indifference whether it produces means of production or con­sumption goods. In both cases the product is paid for immediately and at its full value (Economic Development, pp. 42).

In this hypothetical system, the production function is invariant, although factor substitution is possible within the limits of known technological horizons. The only real activity that must be performed in this state is "that of combining the two orig­inal factors of production, and this function is performed in every period mechani­cally as it were, of its own accord, without requiring a personal element distin­guishable from [mere] superintendence.. . ." (Economic Development, p. 45). In this artificial situation, the entrepreneur is a nonentity. There is nothing for him or her to do because equilibrium is automatic and permanent. But such a state of being does not apply to the dynamic world in which we live.

Schumpeter wrote in Capitalism, Socialism, and Democracy (p. 84) that the re­ally relevant problem is not how capitalism administers existing structures, but how it creates and destroys them. He called this process "creative destruction," and main­tained that it is the essence of economic development. In other words, development is a disturbance of the circular flow. It occurs in industrial and commercial life, not in consumption. It is a process defined by the carrying out of new combinations in production. It is accomplished by the entrepreneur.

Schumpeter reduced his theory to three elemental and corresponding pairs of op-posites: (1) the circular flow (i.e., tendency toward equilibrium) on the one hand ver­sus a change in economic routine or data on the other, (2) statics versus dynamics, and (3) entrepreneurship versus management. The first pair consists of two real processes; the second, two theoretical apparatuses; the third, two distinct types of conduct. The theory maintained that the essential function of the entrepreneur is dis­tinct from that of capitalist, landowner, laborer, inventor. According to Schumpeter, the entrepreneur may be any and all of these things, but if he or she is, it is by coin­cidence rather than by nature of function. Nor is the entrepreneurial function, in prin­ciple, connected with the possession of wealth, even though "the accidental fact of the possession of wealth constitutes a practical advantage" (Economic Development, p. 101). Moreover, entrepreneurs do not form a social class, in the technical sense, although they come to be esteemed for their ability in a capitalist society.

Schumpeter admitted that the entrepreneur's basic function is almost always min­gled with other functions. "Pure" entrepreneurship is difficult to isolate from other economic activity. But "management" does not describe the truly distinctive role of the entrepreneur. "The function of superintendence in itself, constitutes no essential economic distinction," Schumpeter wrote (Economic Development, p. 20). The func­tion of making decisions is another matter, however. In Schumpeter's theory, the dy­namic entrepreneur is the person who innovates, who makes "new combinations" in production.

Schumpeter described innovation in several ways. He first spelled out the kinds of new combinations that underlie economic development. They encompass the fol­lowing: (1) creation of a new good or new quality of good, (2) creation of a new method of production, (3) the opening of a new market, (4) the capture of a new source of supply, and (5) a new organization of industry (e.g., creation or destruc­tion of a monopoly). Over time, of course, the force of these new combinations dis­sipates, as the "new" becomes part of the "old" in the circular flow of economic ac­tivity. But this does not change the essence of the entrepreneurial function. According to Schumpeter, people act as entrepreneurs only when they actually carry out new combinations, and lose the character of entrepreneurs as soon as they have built up their business, after which they settle down to running it as other people run their businesses.

Later, and in a more technical sense, Schumpeter defined innovation by means of the production function. The production function, he said, "describes the way in which quantity of product varies if quantities of factors vary. If, instead of quanti­ties of factors, we vary the form of the function, we have an innovation" (Business Cycles, p. 62). Mere cost-reducing adaptations of knowledge lead only to new sup­ply schedules of existing goods, however, so this kind of innovation must involve a new commodity, or one of higher quality. Schumpeter recognized that the knowl­edge behind the innovation need not be new. On the contrary, it may be existing knowledge that has not been utilized before. According to Schumpeter:

There never has been anytime when the store of scientific knowledge has yielded all it could in the way of industrial improvement, and, on the other hand, it is not the knowledge that mat­ters, but the successful solution of the task sui generis of putting an untried method into prac­tice—there may be, and often is, no scientific novelty involved at all, and even if it be involved, this does not make any difference to the nature of the process ("The Instability of Capitalism," p. 378).
In Schumpeter's theory, successful innovation requires an act of will, not of in­tellect. It depends, therefore, on leadership, not intelligence, and it should not be con­fused with invention. Schumpeter was explicit on this last point:

To carry any improvement into effect is a task entirely different from the inventing of it, and a task, moreover, requiring entirely different kinds of aptitudes. Although entrepreneurs of course may be inventors just as they may be capitalists, they are inventors not by nature of their function but by coincidence and vice versa. Besides, the innovations which it is the function of entrepreneurs to carry out need not necessarily be any inventions at all (Economic Devel­opment, pp. 88-89).