Early Economics and Schumpeter: Implications for Current Policymaking

The discipline of economics has undergone few fundamental changes since its inception more than 200 years ago. No change is more controversial or revolutionary to the study of economic growth as the theory of innovation and its role as an important and overlooked dynamic. In the simplest terms, innovations are new discoveries which drive economic expansion. We are all familiar with the breakthrough innovations that have revolutionized humanity. As a force that spurs growth in employment and fosters the most efficient allocation of resources, innovation and entrepreneurship have been critical to American 20th century hegemony.

Only recently have some modern economists begun to champion the role of innovation in modern economics. It has largely been ignored since Adam Smith's The Wealth of Nations created the discipline. Marking the dawn of the classical era of economics, The Wealth of Nations defined economics in terms of individual self-interest and distribution. It viewed technology as an external, or exogenous factor affecting economic growth; this flaws of this assumption will become evident later. As a body of thought, the classical school emphasized the role of labor in determining prices (Ricardo), capitalism's ability to allocate resources efficiently but not distribute income fairly (John Stuart Mill) and technology as a tool used in the industries of capitalism to separate the workers from the means of the production (Marx). These early theorists laid the groundwork for the economists to come.

The trend of empiricism in the hard sciences around the turn of the 20th century influenced the succeeding economists who evolved into the Neo-classical school. As the rush to quantify the visible world aquiesced in the scientific community, less quantitative factors like innovation and entrepreneurship, both difficult to measure, were quickly swept aside. Alfred Marshall completed economic's transformation to an empirical science by combining Walras's Marginalist School which was focused on supply and demand, equilibrium and Newtonian mathematical equations with his own views on economies of scale, price elasticity of demand and consumer surplus to create an economic model that has dominated the mainstay of economist's attention since. The concrete economic indicators that resulted from this combination of theoretical and mathematical economics became particularly useful to politicians and policy makers who used the estimates to legitimize rule making, measure its efficiency and take pulse of the American economy.

The Keynesian policies that helped cure the ills of the Great Depression lent credence to this mathematical equilibrium-based model, so much so, that when Joseph Schumpeter dared to step out of the confines of this rigid model and suggest that internal, or endogenous (within the economy) technological innovation was the main driver of economic growth, he was largely ignored. Schumpeter's Theory of Creative Destruction, based on the Austrian "laissez-faire" economic model, postulated that news firm created new inventions that attracted buyers away from old industries (destroying them) towards new industires (innovation) creating more wealth and expanding the overall size of the economy. It wasn't until the oil shocks and stagflation of the 1970's that Schumpeter's ideas received any serious attention. In 1987, David Birch famously publicized that new employment was driven by small firms, not large corporations as Neo-classical theory posited. In 1987, Robert Solow channeled Schumpeter and received the Nobel Prize for his findings that productivity gains due to technological change are the main determinant of economic growth.

It is sad that, in economics as in many other disciplines, intellectual rigidity has held back the potential for growth. From the earliest scientists who empiricized our world only to be persecuted for what we now know to be true to stem cell researchers whose incredible breakthroughs are hindered by religious dogma, rigidity in the scientific community all too often creates a consensus that ostracizes the radical, yet ultimately novel thinker for daring to think outside the box. The shift now underway towards endogenous growth theory is challenging the long-held and "traditional" view that technology is an unexplained technical progress. Rather, new thinkers are at the very beginning stages of building empirical, not just theoretical evidence to support the idea that innovation and entrepreneurship can be both measured, incentivized and supported.

We are now in a crucial time where out-of-the-box thinking, like that employed by innovators and pioneered by Schumpeter and Solow, may be the panacea to the global economic woes that trouble politicians and citizens alike. The fiscal situation in the developed countries of the world implores us to adopt new perspectives and wield new tactics in coaxing our economy to grow. Years of kicking the can down the road has led to gargantuan public debts that even the most extreme austerity measures and currency manipulation cannot fix. As a society we must embark with new momentum towards the future trusting that our commitment to the radical revolution of technology, society and business will foster an environment conducive to a long-term rise in gross domestic product.

In order to head towards this ideal point, we must shed partisanship in favor of common sense compromises. If the prescription is to simply raise taxes or cut spending then the result will surely be as narrow minded as the action. Instead, we must adopt thoughtful policies that increase the incentives individuals in our society have to invest in themselves, and thus in society in itself. Entrepreneurs must be supported by public policies that support their decision to take risks in order to reap the potential benefits of some previously unseen product, service or idea. Our youth must also find it prudent to seek an education that matches their eventual degrees and skill sets with the demands of the economy.

As each party digs in deeper for trench warfare, our nation's infrastructure is crumbling. Massive public projects, like Eisenhower's interstate highway system, were the breakthrough feats of modern government that provided employment and allowed the free flow of goods and people. America's once impressive system of roads, railways, water, electricity, waterways and airports is quickly decaying as major appropriations bills are stalled for political reasons. Talk of substantial public works projects is quickly labeled socialism and government grandeur yet are precisely what America needs to compete globally. As the US population expands and the economy operates at a quicker and more constant pace, we must double-down on our commitment to maintaining the public resources that enabled America's meteoric 20th century rise.

Even more startling is the dire state of public education. Despite devoted and talented educator's best efforts across the country, America's youth fall far behind the academic achievements of their overseas counterparts.  Many companies throughout the recession have complained that there is a lack of qualified candidates. Nearly everybody agrees that the current system of accountability-based education falls far short of the intentions found in the No Child Left Behind mandate but a lack of significant public attention pushes education to the back burner. Until our education woes are solved (another topic that will garner multiple posts and NLT publications), employers may struggle to find qualified employees in our mis-matched economy.

Innovation and entrepreneurship requires three basic resources to occur:

Public policies crafted specifically to encourage those who create something new whether it is tangible or intangible. Be it companies, products or ideas, public policy must reward those who make investments on the cutting edge because they drive the majority of the growth. Endogenous growth theory research indicates that new businesses, less than 5 years of age, as opposed to small businesses, create a majority of the jobs (a point that warrants its own entire post).
Wealth creators must have reliable systems of public infrastructure to support their activities. If goods and services cannot flow freely and reliably through the economy, future economic growth will stagnate alongside profits and employment.
Since most new start-ups fail (another topic deserving of its own entire blog post in the future), America must be able to educate its youth to be innovators or the capable employees for innovators. Supportive public policies and a well-maintained infrastructure will not guarantee growth if America does not possess the correct human capital.
Politicians in Washington must set aside their ideological differences and take action to support the entrepreneur. Through his or her ingenuity and creativity, massive amounts of intangible wealth can boost the gross domestic product for decades to come. In order to achieve this, we must abandon the policies of old, the Neo-classical equilibrium models, the monetarism and outrageous public spending. Instead, we must adopt a model that invests in infrastructure  education and governance to create favorable conditions for new start-ups to succeed. The future of America depends on it.

Much of this piece was inspired directly by the teachings and power-points of Dr. Don Hicks from the University of Texas at Dallas. He is a leader in the field of innovation and entrepreneurship.