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William J. Baumol is professor of economics and academic director of the Berkley Center for Entrepreneurial Studies at New York University. His many books include The Free-Market Innovation Machine: Analyzing the Growth Miracle of Capitalism and The Invention of Enterprise: Entrepreneurship from Ancient Mesopotamia to Modern Times (both Princeton).

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"Even as innovative entrepreneurship has emerged as the goal for policymakers around the globe, economists have struggled to find its proper place in microtheory. No more. In this pathbreaking new book, William Baumol provides the blueprint for understanding the crucial role of entrepreneurship and its contribution to innovation and ultimately economic growth. This lively and thoughtful book highlights the distinct role entrepreneurs play in the economy and reveals why the entrepreneur can no longer remain the invisible man in economic theory."--David B. Audretsch, author of The Entrepreneurial Society

"Baumol is one of the giants in the entrepreneurship field. The Microtheory of Innovative Entrepreneurship will be widely read, discussed, and debated, and is likely to have a significant impact on the scholarly conversation."--Peter G. Klein, University of Missouri

"This book is a timely and valuable contribution to the economics of entrepreneurship. Baumol's ambitious goal is to give the entrepreneur his rightful place in economic theory. He demonstrates that, contrary to conventional thinking, the elusive figure of the entrepreneur is indeed amenable to logical economic analysis."--Simon C. Parker, University of Western Ontario

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The Microtheory of Innovative Entrepreneurship

PRINCETON UNIVERSITY PRESS

Contents

List of Figures and Tables................................................................................................................................ixPreface The Innovative Entrepreneur in Dynamic Microtheory...............................................................................................xiINTRODUCTION Bringing Entrepreneurship and Innovation into the Theory of Value...........................................................................1CHAPTER 1 Entrepreneurship in Economic Theory: Reasons for Its Absence and Goals for Its Restoration.....................................................9CHAPTER 2 Toward Characterization of the Innovation Industry: The David-Goliath Symbiosis................................................................25CHAPTER 3 Entrepreneurship, Invention, and Pricing: Toward Static Microtheory............................................................................36CHAPTER 4 Oligopolistic "Red Queen" Innovation Games, Mandatory Price Discrimination, and Markets in Innovation..........................................57CHAPTER 5 Optimal Innovation Spillovers: The Growth-Distribution Trade-off...............................................................................77CHAPTER 6 Enterprising Technology Dissemination: Toward Optimal Transfer Pricing and the Invaluable Contribution of "Mere Imitation".....................101CHAPTER 7 The Entrepreneur and the Beneficial Externalities of Creative Destruction......................................................................128CHAPTER 8 Economic Warfare as a "Red Queen" Game: The Emergence of Productive Entrepreneurship...........................................................139CHAPTER 9 On the Origins of Widespread Productive Entrepreneurship.......................................................................................152CHAPTER 10 The Allocation of Entrepreneurship Does Matter................................................................................................165CHAPTER 11 Mega-enterprising Redesign of Governing Institutions: Keystone of Dynamic Microtheory..........................................................172CHAPTER 12 Summing Up: Yes, the Theory of Entrepreneurship Is on Its Way.................................................................................188Notes.....................................................................................................................................................197References................................................................................................................................................225Index.....................................................................................................................................................237

Chapter One

Man is not the only animal who labors; but he is the only one who improves his workmanship. —Abraham Lincoln, "First Lecture on Discoveries and Inventions," 6 April 1858

The direction of all economic affairs is in the market society a task of the entrepreneurs. Theirs is the control of production. They are at the helm and steer the ship. A superficial observer would believe that they are supreme. But they are not. They are bound to obey unconditionally the captain's orders. The captain is the consumer. —Ludwig Von Mises (1940, 270)

If we are interested in explaining what Trygve Haavelmo once described as the "really big dissimilarities in economic life," we must be prepared to concern ourselves with entrepreneurship. For the really big differences are usually those that correspond to historical developments over long periods of time, or to the comparative states of various economies—notably, those of the developed and the underdeveloped areas. It has long been recognized that the entrepreneurial function is a vital component in the process of economic growth. Thus, we are led to suspect that if we ignore the entrepreneur, we are prevented from explaining a very substantial proportion of historic growth in developed countries and its distinction from that of other lands. Those who concern themselves with development policy have apparently been driven to similar conclusions. If we seek to explain the degree of success of those economies that have managed to grow significantly in comparison to those that have remained relatively stagnant, we find it difficult to do so without taking into consideration differences in the availability of entrepreneurial talent and in the motivational mechanism that drives them on. Those who design plans to stimulate development devote a substantial proportion of their energies to providing the means for training and encouraging entrepreneurs. The entrepreneurs also are present in institutional and applied discussions of a number of economic arenas other than development. For example, their absence is sometimes cited as a significant source of the difficulties of a declining industry, and a balance-of-payments crisis is sometimes discussed in similar terms. Thus, those who study either macro or micro problems reserve a substantial place for innovative entrepreneurship within their analyses.

Whether or not they are assigned star roles in such discussions, entrepreneurs, in practice, play no minor role. In fact, the innovative entrepreneurs are among the most intriguing and elusive characters in the cast of characters that constitute economic analysis. They have long been recognized as occupants of the apex of the hierarchy that determines the behavior of the firm and, thereby, bears a heavy responsibility for the vitality of the free enterprise society. This is no recent phenomenon: in the writings of the classical economists, entrepreneurs appeared at least occasionally, though they remained a shadowy entity with no clearly distinguished form or function. Only Schumpeter, and to some degree, Say, succeeded in infusing entrepreneurs with life, assigning them the task of innovation as a specific area of activity that is commensurate with their acknowledged importance. In more recent years, the accumulating facts underscore the significance of their role, but, at the same time, they have disappeared from the theoretical literature. In discussions of the doctrinal history of entrepreneurship theory, the consensus view now seems to be that there once was a theory of entrepreneurship found in the writings of the classical economists, but with the advent of neoclassicism, the entrepreneur was exorcised from that literature.

However, a review of the literature should lead to some modification of these views, particularly those about the earlier period. First, the set of authors who constitute the "usual suspects" hardly includes all of the superstars of the classical arena. Neither Smith nor Ricardo typically is listed as a significant contributor on the subject. Instead, they frequently are replaced in this role by Cantillon and Say. Second, careful perusal of what these early authors have written on the subject should lead to the conclusion that, as far as theory—particularly of the neoclassical variety—is concerned, "There is no there, there." The writings offer us brief descriptions of the activities of the entrepreneur, such as...