Modern approaches

Classical approaches were developed before the terms “trust” or “corporation” entered the economic lexicon and do not speak to the role of market power on innovation. Alfred Marshall began writing on innovation following the wave of mergers in the late nineteenth and early twentieth centuries. His Principles of Economics, published in eight editions between 1890 and 1920, outline important features of innovation and firm growth. He writes:

Corresponding to this steadily increasing economy of skill, the growth of his firm brings with it similar economies of specialized machines and plants of all kinds; every improved process is quickly adopted and made the basis of further improvements; success brings credit and credit brings success; success and credit help to retain old customers and to bring new ones; the increase of his trade gives him great advantages in buying; his goods advertise one another and thus diminish his difficulty in finding a vent for them.

(Marshall 1890/2009,315)

For Marshall, innovation became more accessible as a business became more profitable. One could learn and master a trade, and as the business developed from this expertise grew, so did the access to capital. Eventually the business owner, the entrepreneur, could take on others with extensive knowledge of the field, reaping the rewards of a division of labor to develop new specialized machinery or production methods.

Marshall demonstrates a notable similarity to Schumpeter. An environment where improved processes are adopted and made the basis of further improvements reflects the competitive nature of Schumpeter’s innovation. A product could be successful and generate market power for a time. But eventually success in the market would drive competitors and upstart companies to imitate and to innovate new advancements in the market.To Marshall, innovation happens once an individual has mastered a skill, grown a business, absorbed astute knowledge in the industry, and then uses this combined knowledge to create new machines or new production methods. Innovation requiring combined knowledge speaks to the role of social coordination. This process is far less focused on the individual. Indeed, Marshall would argue that the greater the wealth of knowledge obtained among many people, the greater the ability to advance existing technologies. Instead of being a process focused on the individual artisan, Marshall’s innovation is a product of combined knowledge.

At the same time, Marshall’s theory of innovation does seem to draw upon Adam Smith. The process by which innovation stems from combined knowledge is similar to the role of Smith’s philosopher who connects seemingly unrelated ideas in order to advance technology. But in Marshall’s world, especially as markets age and more people have access to existing technologies and production methods, it becomes harder for the individual to innovate. On this point, Schumpeter disagrees. Once this knowledge has been aggregated, and a powerful market position built, the large company no longer focuses on innovation. Where in Marshall, the fire of innovative spirit waxes as companies grow and are able to hire specialized labor, in Schumpeter the innovating spirit wanes.

Along the same lines as Marshall, J.K. Galbraith takes the position that advancements in industry have made it much more difficult for the individual or artisan to be a chief source of innovation in an economy. While Galbraith viewed the entrepreneur as having played an important role during the industrial revolution, he thought developed economies had since evolved beyond the small entrepreneur to a state that was managerially driven (Audretsch 2008). The New Industrial State carefully explains that the long-term planning required by modern technological production processes shifts the focus of developed markets away from entrepreneurial innovation.The entrepreneur

is a diminishing figure in the planning system. Apart from access to capital, his principal qualifications were imagination, capacity for decision and courage in risking money, including not infrequently, his own. None of these qualifications is especially important for organizing intelligence or effective in competing with it.

(Galbraith 1967/2007,61)

Galbraith believed, perhaps erroneously, that most of the useful and easy inventions had already been made and integrated into markets by the entrepreneurs of yesteryear. Having served his/her purpose, the entrepreneur was dying off, replaced by the corporate giant. Nonetheless, it is important that Galbraith’s result differs drastically from Schumpeter’s. In Capitalism, Socialism, and Democracy, Schumpeter concludes:

Since capitalist enterprise, by its very achievements, tends to automize progress, we conclude that it tends to make itself superfluous—to break into pieces under the pressure of its own success. The perfectly bureaucratic giant industrial unit not only ousts the small- or medium-sized firm and “expropriates” its owners, but in the end also ousts the entrepreneur and expropriates the bourgeoisie as a class which in the process stands to lose not only in its income but also, what is infinitely more important, its function.

(Schumpeter 1942/1976, 134)

For Schumpeter, the transition toward trustified capitalism would be unstoppable. Ultimately, the benefits of monopolization would be so strong that individual markets would consolidate, and eventually the individual markets would be, themselves, consolidated into one firm, a system of complete socialism. Galbraith made no such predictions about socialism as a result of market concentration and, in fact, was quite optimistic about the economy. “In American Capitalism, Galbraith did not argue that socialism was replacing capitalism, but rather that a type of institution structure was emerging that was more nuanced and complicated than had been typically characterized in economists’ models of perfect competition” (Audretsch 2008, 204). Most importantly, we see that Galbraiths innovation in the corporate world requires collective knowledge, which is a social process.

Despite elements of monopolistic or oligopolistic behavior, the performance of the American economy had been quite good in the immediate post-war period. A shift toward innovation as a product of bureaucracy and corporate management would suggest a shift away from the artisanal process of innovation as suggested by Schumpeter and many of the classical economists. Keeping to Schumpeters tradition of using biology' references to explain the life cycles of economics, Galbraith writes “The great entrepreneur must, in fact, be compared in life with the male Alpis mellifera (bumble bee). He accomplishes his act of conception at the price of his own extinction” (Galbraith 1967/2007,93).

On this question of the extinction of the entrepreneur, there have been several notable attempts to measure the source and extent of innovation. For example, Horowitz and Clemens (1962), Hamberg (1964), and Comanor (1967) found that R&D intensity and the ratio of R&D to firm size increased weakly with size. Mansfield (1964), however, found little evidence of such a relationship, and Scherer (1992) suggests that the relationship between firm size and innovation is only positive up to a threshold (Cohen and Levin 1989). More recently, Acs and Audretsch (1987) found that the total number of innovations is negatively' related to concentration and unionization, and positively related to R&D, skilled labor, and market share. These determinants have disparate effects on small and large firms. Specifically, in an industry' composed primarily' of large firms, innovation is an important competitive strategy of smaller firms. Decreased concentration in an industry is associated with increased innovation.This conclusion falls in line with Galbraith’s prediction, that as markets concentrate, the role of the individual entrepreneur is reduced. Instead of using innovation as a strategy to dominate the market, markets are dominated by vertically' integrated bureaucracy and innovation, one of the only' means by which a small firm can compete. Innovation in complex markets requires combined knowledge. Yet, while the large firms dominate markets, most of the innovation is still attributed to small firms, supporting Schumpeter’s romantic view of the entrepreneur.

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