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 Schumpeters most important ideas

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

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.

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

The Long-Run Performance of the Economy

According to Schumpeter, the process of creative destruction implies
that static efficiency the optimal allocation of societys 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

Policy and Managerial Implications

Schumpeters 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