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Thursday, March 09, 2006

Land, Labor, Capital, and for Some, the Entrepreneur

Parkin's introductory economics text includes the entrepreneur as a factor of production. Case and Fair's text does not, stating that

Early economics texts included entrepreneurship as a type of input, just like land, labor, and capital. Treating entrepreneurship as a separate factor of production has fallen out of favor, however, partially because it is unmeasurable...

William Baumol would like to see more attention to entrepreneurship in the economics literature:

Economics rediscovers the entrepreneur, The Economist: The French, according to George Bush, have no word for them, economic theory has surprisingly little room for them, and it is a mystery why anyone would choose to be one of them. Entrepreneurs are the ... venturesome protagonists who move the plot forward. ... Translated literally, entrepreneur means one who undertakes—one of life's doers. ... But it does not always demand much originality or power of invention. The fresh-born firm may be a mere clone of another one in a neighbouring town.

More interesting are the entrepreneurs who innovate, who introduce something new into the world. Unfortunately, such figures have been all but banished from the theory of the firm and the market. Microeconomics instead gives pride of place to prices... businessmen choose among different techniques of production (labour-intensive when workers are cheap, capital-intensive when they are scarce) but they do not reinvent or revolutionise them. ... they do not conjure up new products that no one had previously thought of.

William Baumol ... has been labouring for years to create more space for entrepreneurship and innovation in economic theory. ... Mr Baumol's work ... pays homage to the insights of Joseph Schumpeter... [who] wanted to dislodge the price mechanism from its “dominant position” in “the sacred precincts of theory”. In the real world, he said, the competitive weapon that counts is not lower prices, but new commodities and techniques. These weapons are much deadlier, striking “not at the margins of...the existing firms but at their foundations and their very lives.”

If innovation threatens companies with obsolescence and extinction, they cannot afford to leave it to chance. Rather than waiting for flashes of inspiration, they set up research-and-development (R&D) departments and commit an annual budget to the pursuit of new products and processes. ...

Most innovations are merely incremental improvements on something that already exists ... as Mr Baumol puts it. A rare few represent discontinuous breakthroughs, such as the incandescent lamp, alternating electric current or the jet engine. All of the above ... were introduced not by the regimented R&D of established corporations, but by scrappy new firms... Mr Baumol ventures that most breakthroughs arise this way—the offspring of independent minds not incumbent companies. He has two explanations for this. First, radical innovation is the only kind lone entrepreneurs can do; and, second, they are the only ones who want to do it.

The first explanation seems paradoxical. Breakthroughs are, by definition, more difficult than routine innovations. Surely, they should be beyond the meagre means of the independent entrepreneur? But as Mr Baumol points out, building the Kitty Hawk was much cheaper, and less complicated, than upgrading the Boeing 737 to the 747. Genuinely new ideas are often breathtakingly simple. ...

The second explanation is more intuitive. Revolution is a risky endeavour. Of 1,091 Canadian inventions surveyed in 2003 ..., only 75 reached the market. Six of these earned returns above 1,400%, but 45 lost money. A rational manager will balk at such odds. But the entrepreneur answers to his own dreams and demons. Mr Baumol thinks a “touch of madness” is probably one of the chief qualifications for the job.

Economists have little to say about madness, of course. But they can point out its economic implications. If money isn't everything to the independent inventor, he is likely to be cheap. Indeed, he will be the lowest-cost provider of the kind of risky, painstaking endeavour that lies behind the breakthrough inventions. Big firms could pursue the big ideas, but since they would be employing professionals not amateurs for these quixotic ventures, they would have to pay them in money, not love.

Thanks to Mr Baumol's own painstaking efforts, economists now have a bit more room for entrepreneurs in their theories. But it remains a mystery why anyone would want to be one.

    Posted by on Thursday, March 9, 2006 at 04:39 PM in Economics | Permalink  TrackBack (0)  Comments (29)

          

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