Joseph Schumpeter, an Austrian-American economist (but definitively not a scholar from the Austrian school of economics), pioneered an abstract and conceptual understanding of the entrepreneur in the service of developing his models for long-run economic growth. His work with respect to modeling an entrepreneur’s place in long-run growth was one of the first academic entrees into distinguishing an entrepreneur from other labor functions (e.g. creditor/lender, engineer, etc.), and much of the academic lens through which I analyze innovation has been shaped by Schumpeter’s treatise on academia. To that end, it’s worth spending some time understanding how Schumpeter’s philosophy revolutionized academic understanding of entrepreneurs and to establish a language for discussing entrepreneurs in both macro- and micro- contexts.
Macroeconomists consider modeling growth to be a core tenet of their field—the key question can be summarized as: “what drives economic growth?” Generally applied to the context of a country, this question broadly refers to what factors mechanically and causally affect the growth of an economic system over time. In colloquial discussions, we tend to use the expansion of equities markets, credit markets, and employment as indicators of economic growth – and these indicators are definitively linked to the expansion of business, investment, and wages in a given region. However, these are observed metrics, and they do not explain the underlying growth taking place – we can use the expansion of the stock market or low unemployment as justification for a growing economy, but they do not explain why the economy is actually growing. And as you may imagine, describing the why of economic growth is a summarily difficult question to answer – and it’s a much more useful question to answer, as developing some explanatory model of growth would allow policymakers, firms, and voters to better align on sound economic policy.
However, as you also may imagine, there is little consensus as to what governs growth. While politically-charged discourse in the United States waffles between “low interest rates and no regulation” and “higher corporate taxes and universal basic income,” the reality is that growth cannot be unilaterally predicted with one philosophy; the context surrounding an economy – such as its trade relationships, international relations, health and environmental factors, level of human capital, etc. – are endogenous with policy ideas, which means one policy (e.g. low interest rates) may be conducive to growth in one region whereas the same policy may be detrimental to growth in another region. As such, contemporary economists are wary to unilaterally state that one form of policy will always stimulate growth. Tangentially related and equally nuanced, is the question of whether economic growth, however we choose to measure it, is actually beneficial for society and leads to socially optimal outcomes in terms of quality of life, environmental preservation, etc. While growth policy may be locally influential on economic progress, the externalities associated with larger markets, looser credit, and full employment may be negative and counterproductive to society. As such, considering the underlying question of what externalities may be associated with a growth policy is an equally important parallel thought stream.
With the epistemological disclaimers out of the way, let’s examine how Schumpeter’s model of the entrepreneur can be considered a driving force of modern economic growth. First, it’s important to establish Schumpeter’s abstraction of the entrepreneur in the economy – what defines an entrepreneur? Defining the entrepreneur’s role is perhaps best illustrated with its juxtaposition to another labor role defined by one of Schumpeter’s contemporaries, Thorstein Veblen. Veblen’s theory of economic growth asserted that “engineers” or the developers of new technology were responsible for economic growth – through the creation and ideation of new technology, the average laborer’s productivity would improve and they would be able to contribute more to the economy. However, Schumpeter argued that the “engineer” was insufficient for driving economic growth, and that the mere existence of innovative technologies does not facilitate growth. Rather, the implementation or operationalization of innovative technologies, which is a function not necessarily filled by the engineer themselves, is what drives the productivity gain from technology. In other words, technology needs to be made usable by laborers before it can drive economic growth via productivity gains. In Schumpeter states that this is the role of the entrepreneur, to implement and operationalize technology. An entrepreneur and an engineer are not necessarily distinct people – an engineer can function as an entrepreneur – but the two roles markedly differ.
We can observe numerous examples of this distinction in a modern economy. Steve Jobs and Steve Wozniak’s most fundamental contribution to computing was through making computers accessible to the average person – while they didn’t invent computing, they made it accessible to the average individual. While Henry Ford did not invent the automobile, he did develop a process for manufacturing and distributing the automobile widely (or in other words, made it more accessible to the average consumer). As we can see, this distinction, between the engineer and the entrepreneur, helps to clarify the relationship between technological ideation and its ultimate effect on economic growth – the entrepreneur is that bridge.
Schumpeter then goes on to clarify the entrepreneur’s motivation – why would an entrepreneur work diligently to bridge the gap between an untested technology and a theoretical consumer market? Doing so is inherently risky, and the entrepreneur assumes tremendous risk in terms of both financial resources and opportunity cost by attempting to make a technology implementable. The core reason, in Schumpeter’s view, is that an entrepreneur, by implementing a technology, creates a mini-monopoly in the short-term on the productivity gains that stem from using that technology. Essentially, if an entrepreneur successfully implements a technology that improves productivity for its consumers, since they are the first to do so, they can capture monopoly-like profits in the short-term – or at least until (1) the patent expires or (2) other entrepreneurs enter the market identified by the entrepreneur. In the latter case, as additional entrepreneurs enter the market, the market structure changes and economic profit for each additional entrepreneur diminishes.
The introduction of additional entrepreneurs into the market established through the implementation of a technology is what leads to technological penetration in an economy. For every implemented technology (e.g. cloud computing), firms continue to emerge to try and capture that market’s economic profit – as such, the cost of the technology decreases, accessibility increases, and the technology begins to establish itself in a given region. This is the socially impactful role of an entrepreneur – they help technology spread across a region. While an incentives-driven model would assume that the entrepreneur is motivated by capturing short-term profit, they are nonetheless crucial with respect to improving the overall efficiency and productivity of a population’s labor force through the widespread uptake of their technological implementation.
It should be noted, however, that this model of economic growth places productivity at the heart; by improving productivity, the incentive for which are the profits associated with a short-term monopoly on the implementation of technology, economies can produce more per unit of labor in the economy. However, Schumpeter was keen to note that an entrepreneur’s work inherently causes negative social consequences through the implementation of technology that improves productivity – summarily stated, it causes structural unemployment. At a high-level, the logic works like this: given that technology improves output per capita, it would then follow that firms require fewer employees of a given function and consequently replace those employees with the new technology. Across history, these effects can be observed through the introduction of new technology – from Amazon replacing hundreds of brick-and-mortar businesses to factories obsolescing guilds and artisans, the cost of productivity is a replacement of old forms of employment. This process of destroying an old industry through the implementation of new technology is referred to by Schumpeter as “creative destruction.” However, while there are beneficial outcomes that emerge through creative destruction, there is a self-destructiveness to it that Schumpeter argued needed to be reined in by state policy.
Schumpeter argued that a developed economy needed to provide social services in order to insulate against the negative social consequences that stem from new technology (i.e. creative destruction). While the incentives to capture short-term profit are necessary to facilitate technological improvement, and consequently, the standard of living enhancements that come through innovation, the economic state needs to provide socialized services to support those who lose their livelihoods due to new technology. As such, many of Andrew Yang’s policies such as universal basic income (UBI) as well as other socially-minded policies such as subsidized/free college and upskilling, universal healthcare, and other forms of welfare to support individuals who have become structurally unemployed, are necessary fixtures of a functional capitalist state. To implement these types of policies, Schumpeter argued, was not only a moral imperative and a just form of state action, but ultimately necessary in order to maintain social order – from a pragmatic view, socialized support for all members of society was necessary in order to prevent disintegration of social order into chaotic warfare. Essentially, the perpetual destruction of previously extant industries, firms, and markets to facilitate productivity gains displaces large swathes of a population; as this structurally unemployed population increases, divisions in standards of living will deepen, which will in turn lead to civil unrest. To prevent the degradation of society, the state has to collectively support its populations that are displaced by new technological implementation.
Schumpeter’s model of the entrepreneur offers a compact way of explaining how technology can facilitate growth in an economy, and he captures the incentives of an entrepreneur, entrepreneurs’ dynamic market structures, and the broader consequences of entrepreneurialism and technological uptake for society. While technological innovation inherently improves standards of living, it doesn’t do so in a vacuum, according to Schumpeter’s model – economic growth has collective social consequences which need to be considered before policy decisions are made. Further, from both moral and pragmatic perspectives in Schumpeter’s paradigm, socialized services, to an extent, can help facilitate economic growth by allowing structurally unemployed workers to flexibly adapt their skills and human capital to changing labor demands. Ultimately, Schumpeter’s view instructs us that (1) growth is not a singular force, and that policies that may encourage growth can lead to unintended negative consequences for society, and (2) the entrepreneur’s role in facilitating growth is through improving productivity and returns to capital.
Special thanks to my brother Sajan for discussing this theory with me.