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Schumpeter 2.0

Wednesday, June 23, 2010

A great thinker’s contribution not only appears in his or her finished works and arguments, but also within the rich intuitions or core ideas that underlie the arguments.

During the last decade or so, the theories of Joseph Schumpeter have gone through a revival, and much attention has been devoted to his work. By now many economists and commentators value his work highly, especially what he says about entrepreneurship and creative destruction.

While this work on Schumpeter is very valuable, one might also adopt a different attitude towards him. Instead of trying to explicate and apply his ideas, one may more freely use Schumpeter’s intuitions to construct new theories and approaches to economic topics.

Two Key Intuitions: The Notions of Combination and Resistance to Entrepreneurship

Two of Schumpeter’s core ideas, present already in the first edition of his great classic, The Theory of Economic Development (1911), are the notions of combination and resistance to entrepreneurship. Individually, these are potent ideas. Together, they are even more so and can produce a new (Schumpeterian) theory of entrepreneurship.

Two of Schumpeter’s core ideas are combination and of resistance to entrepreneurship.

The notion of combination stands at the center of Schumpeter’s theory of entrepreneurship. Indeed, he famously defines entrepreneurship as a new combination:

To produce means to combine materials and forces within our reach. To produce other things, or the same things by a different method, means to combine these materials and forces differently… Development [or entrepreneurship] in our sense is then defined by the carrying out of new combinations. (Theory of Economic Development, 65–66; emphasis added)

This quote also shows that Schumpeter sees the whole economic process as a combination. The existing economic situation is a combination; when this is recast into a new combination, you produce an innovation.

Schumpeter also provides the reader of Theory with his famous list of the five main types of innovations: “a new good,” “a new method of production,” “a new market,” “a new source of supply of raw materials,” and “the carrying out of a new organization of any industry” (Theory, 66; emphasis added).

We also realize why entrepreneurship is so hard and complex. Maybe the person who conceives of the iPod does not know how to produce it—or market it, or profit from it.

At this point we may stop for a moment and ponder a peculiar fact. If we take these five innovations and lay them next to each other, so to speak, we notice that they compose a whole economic process. First, the raw material is needed, then the process of production, then the new product, and finally its marketing.

Did Schumpeter do this consciously? It matters little, but does point to an interesting ambivalence in how Schumpeter speaks about innovations. We already know he argued that separate parts of the economic process can be seen as innovations (a good, a method of production, and so on). But it is clear that he also felt that the whole economic process itself could be seen as a combination—and this implies a much broader approach to innovations, namely as a process starting with a conception, continuing over production, and ending with a sale. The figure below spells out the difference between the two approaches.

Swedburg Fig. 1 6.22

The conventional way of looking at an innovation sees it as a distinct and novel item; say, a new good or new technology. This is how most of us look at innovations, and it makes sense. But there is also a second view that Schumpeter seems to have sensed but never fully spelled out. This views the whole process as the innovation: conceiving the good, producing it, marketing it and, importantly, making a profit.

According to the conventional view of innovations, you conceive of, say, an iPod, and you have an innovation. According to the second and amended Schumpeterian view, to innovate you not only have to come up with the idea of the iPod, but also to produce it, market it, and make a profit. Once spelled out, it is clear that this second version is more realistic. We also realize why innovation is so hard and complex: maybe the person who conceives of the iPod does not know how to produce it—or market it, or profit from it.

A New (Schumpeterian) Theory of Entrepreneurship

The notion of combination is Schumpeter’s master concept, and we are not yet through with it. It cannot only be used to produce a novel concept of innovation, but also a novel theory of entrepreneurship.

We have already suggested that an innovation may be viewed as a combination in the sense that it constitutes a full mini-economy of its own (you must have raw material, produce the good, market it, and make a profit). The reader may also know that Schumpeter pays much attention, in Theory, to the notion of resistance to entrepreneurship. What makes innovation and entrepreneurship so hard, he says, is the strong resistance to it. This resistance can be manifested in three ways: The entrepreneur, like many of us, mentally resists doing something new; it is always hard to carry out a new task; and society is hostile to novelties.

What makes it so hard to be innovative and entrepreneurial, Schumpeter says, is the strong resistance to entrepreneurship.

But what about Schumpeter’s argument regarding combinations? Remember that every economy, according to Schumpeter, can be seen as a combination. Also, what Schumpeter calls resistance can also be described as habits, norms, common ways of doing things, and the like. This means that what causes resistance is the existing combination. How we habitually combine things, to phrase it differently, has become so entrenched in people’s minds that it cannot change without a huge effort: it offers resistance.

Schumpeter’s two concepts of combination and resistance, which are independent of one another in his work, can link to each other organically. Under certain conditions, an (existing) combination creates resistance to a new way of doing things. To innovate, in other words, means to break up an existing combination—to break through the resistance it creates, and to replace it with a new combination.

Earlier, when discussing the concept of innovation in Schumpeter’s work, we mentioned that an innovation was not “finished” once produced and marketed; it also must produce a profit. While Schumpeter does not discuss profit in connection with his five types of innovations, the concept plays a central role in his theories. He had his own concept of “entrepreneurial profit,” which was especially important to his work on the business cycle.

One may summarize Schumpeter’s notion of entrepreneurial profit as follows: The entrepreneur innovates and is rewarded with profit. This sets off a process that will ultimately create a wavelike movement in economic life. Since the innovation is so profitable, others will imitate it; first only a few other entrepreneurs, who are all amply rewarded for their effort. But others will also want to get into the game, until the profit is gone and the new way has become the standard.

It is clear that Schumpeter felt that the whole economic process itself could be seen as a combination—and this implies a much broader approach to innovations, namely as a process starting with a conception, continuing over production, and ending with a sale.

What has happened if we summarize this cycle but instead use the terms “combination” and “resistance”? We began the whole process with a combination that creates resistance because all the economic actors accept and take it for granted. The entrepreneur now emerges and suggests a different way of doing things. He or she must face all the resistance head-on and, if successful in dealing with all obstacles, is rewarded with full entrepreneurial profit. Then come the first imitators, followed by a whole flock of imitators. The new way of doing things is soon not so new any longer. Eventually, the new and radical combination becomes the common and existing combination. All the entrepreneurial profit is by now gone, and things are back to where they started.

The process we have just presented constitutes a full theory of entrepreneurship, as illustrated in Figure Two (see below). From this perspective, entrepreneurship can be defined as the act of creating a new combination that ends one economic order or way of doing things and clears the way for a new one.

Swedburg Fig. 2 6.22

This article has purposed to show the richness of Schumpeter’s work, but not by stating what Schumpeter says or by applying his theories to some empirical case. While these are both valuable ways to deal with Schumpeter’s work, we have instead wanted to focus on Schumpeter’s core ideas and to play with them: break them up, extend them, add to them. A great thinker’s contribution not only appears in his or her finished works and arguments, but also within the rich intuitions or core ideas that underlie the arguments.

Richard Swedberg is a professor at Cornell University and Thorbjørn Knudsen is a professor at the University of Southern Denmark. See their work in the October 2009 issue of Capitalism and Society, an electronic journal published by Columbia University.

FURTHER READING: Robert Fairlie discusses “The Importance of Family for Entrepreneurial Success,” and Jeffrey Friedman’s “Capitalism Without Romance” looks into the financial crisis and its implications for the future of capitalism. Marian Tupy recalls in “The Road From Serfdom” the last time countries tried socialism with gusto. And AEI’s Kevin Hassett describes how “Obama Flunks Schumpeter Creative Destruction 101.”

Image by Darren Wamboldt/Bergman Group.

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