Posted by: Dirk | January 15, 2008

Innovation and Productivity Growth in the US

Brad DeLong recently reviewed Thomas McCraw’s Prophet of Innovation: Joseph Schumpeter and Creative Destruction. Let’s use his review to show Schumpeter’s ideas on innovation:

In a later book, Capitalism, Socialism, and Democracy, Schumpeter wrote that the traditional view of competition must be abandoned. “Economists,” he said, “are at long last emerging from the stage in which price competition was all they saw. … However, it is still competition within a rigid pattern of invariant conditions, methods of production and forms of industrial organization … that … monopolizes attention. But in capitalist reality as distinguished from its textbook picture, it is not that kind of competition which counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organization — competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives.”

Baumol et al. (2007) finds that the race for innovation has transformed the US:

The conventional wisdom is that the surge in productivity growth which has surged in the United States over the past 15 years has been attributed almost wholly to advances in the production and use of information technology. While this is certainly evident from the statistics, a driving force behind the IT revolution has been the development and growth of new firms. Indeed, the U.S. economy has achieved a remarkable transformation over the last several decades from an economy characterized by large, bureaucratic firms into one increasingly powered by entrepreneurial innovation.

This is a very interesting development. I think it is pretty obvious that the IT revolution changed the landscape of firms in that sector. Just think of Microsoft, eBay, Amazon, Yahoo, Google, Intel and so on (and remember Compuserve, AOL and other dropouts). But will these companies powered by entrepreneurial innovation stay the way they are or will the become large, bureaucratic firms themselves? If we look at older firms like Microsoft and Intel it is clear that these firms benefitted a lot from having a monopoly (well, Intel still had AMD at its heels). Microsoft definitely turned large and bureaucratic. eBay also enjoys a kind of monopoly, having established a large market. Google is still very innovative, but their strategy also seems directed at establishing one or more monopolies. The more applications you need, the more you benefit if they wotk together. If Google can deliver everything you need (and all applications are interlinked), why look somewhere else?

The IT revolution is still in progress, and I think it is to early to judge if firms are of a new innovative type, or whether they are just like the old firms: Innovating at the beginning, and then settling with their monopolies. This is something they can do only if technical progress slows. And I don’t see that happen anytime soon. In the end, even though I am not sure whether we see new firms in the US powered by entrepreneurial innovation, I think it is a good idea to enhance the policies directed at innovative entrepreneurs. Even though some say otherwise (and produce journalism at its worst) the good old German universities are jumping on this train.



  1. From the perspective of indivudual firms, innovation and competiton are means not ends. Firms compete because they have no alternative. Bureaucracies naturally emerge when management believes risks outweigh potential gains. Of course, they can be mistaken and over time most firms are (cf. Arie de Geus, Schumpeter and Claton Christensen). The primary beneficiaries of the “IT revolution” were and are IT companies.

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