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Joseph A. Schumpeter

Entrepreneurship as Innovation

Entrepreneurship as Innovation

Joseph A. Schumpeter

To produce means to combine materials and forces within our reach. To produce other things, or the same things by a different method, means to combine these materials and forces differentiy. In so far as the "new combination" may in time grow out of the old by continuous adjustment in small steps, there is certainly change, possibly growth, but neither a new phenomenon nor development in our sense. In so far as this is not the case, and the new combinations appear discontinuously then the phenomenon characterising development emerges. For reasons of expository convenience, henceforth, we shall only mean the latter case when we speak of new combinations of productive means. Development in our sense is then defined by the carrying out of new combinations.

This concept covers the following five cases: (I) The introduction of a new good—that is one with which consumers are not yet familiar—or of a new quality of a good. (2) The introduction of a new method of production, that is one not yet tested by experience in the branch of manufacture concerned, which need by no means be founded upon a discovery scientifically new, and can also exist in a new way of handling a commodity commercially. (3) The opening of a new market, that is a market into which the particular branch of manufacture of the country in question has not previously entered, whether or not this market has existed before. (4) The conquest of a new source of supply of raw materials or half-manufactured goods, again irrespective of whether this source already exists or whether it has first to be created. (5) The carrying out of the new organisation of any industry, like the creation of a monopoly position (for example through trustification) or the breaking up of a/monopoly position.

/ Now two things are essential for the phenomena incident to the carrying out of such new combinations, and for understanding of the problems involved. In the first place it is not essential to the matter—though it may happen—that the new combinations should be carried out by the same people who control the productive or commercial process which is to be displaced by the new. On the contrary, new combinations are, as a rule, embodied, as it were, in new £ffns which generally do not arise our of the old ones but start producing beside them; to keep to the example already chosen, in general it is not the owner of stage-coaches who builds railways. This fact not only puts the discontinuity which characterises the process we want to describe in a special light, and" creates so to speak still another kind of discontinuity in addition to the one mentioned above, but it also explains important features of the course of events. Especially in a competitive economy, in which new combinations mean the competitive elimination of the old, it explains on the one hand the process by which individuals and families rise and fall economically and socially and which is peculiar to this form of organisation, as well as a whole series of other phenomena of the business cycle, of the mechanism of the formation of private fortunes, and so on. In a non-exchange economy, for example a socialist one, the new combinations would also frequently appear side by side with the old. But the economic consequences -of this fact would be absent to some extent, and the social consequences would be wholly absent. And if the competitive economy is broken up by the growth of great combines, as is increasingly the case to-day in all countries, then this must become more and more true of real life, and the carrying out of new combinations must become in ever greater measure the internal concern of one and the same economic body. The difference so made is great enough to serve as the water-shed between two epochs in the social history of capitalism.

We must notice secondly, only partly in connection with this element, that whenever we are concerned with fundamental principles, we must never assume that the carrying out of new combinations takes place by employing means of production which happen to be unused. In practical life, this is very often the case. There are always unemployed workmen, unsold raw materials, unused productive capacity, and so forth. This certainly is a contributory circumstance, a favorable condition and even an incentive to the emergence of new combinations; but great unemployment is only the consequence of non-economic events—as for example the World War—or precisely of the development which we are investigating. In neither of the two cases can its existence play a fundamental role in the explanation, and it cannot occur in a well balanced circular flow from which we start. Nor would the normal yearly increment meet the case, as it would be small in the first place, and also because it would normally be absorbed by a corresponding expansion of production within the circular flow, which, if we admit such increments, we must think of as adjusted to this rate of growth.¹ As a rule the new combinations must draw the necessary means of production from some old combinations—and for reasons already mentioned we shall assume that they always do so, in order to put in bold relief what we hold to be the essential contour line. The carrying out of new combinations means, therefore, simply the different employment of the economic system's existing supplies of productive means—which might provide a second definition of development in our sense. That rudiment of a pure economic theory of development which is implied in the traditional doctrine of the formation of capital always refers merely to saving and to the investment of rhe small yearly increase attributable to it. In this it asserts nothing false, but it entirely overlooks much more essential things. The slow and continuous increase in time of the national supply of productive means and of savings is obviously an important factor in explaining the course of economic history through the centuries, but it is completely overshadowed by the fact that development consists primarily in employing existing resources in a different way, in doing new things with them, irrespective of whether those resources increase or not. In the treatment of shorter epochs, moreover, this is even true in a more tangible sense. Different methods of employment, and not saving and increases in the available quantity of labor, have changed the face of the economic world in the last fifty years. The increase of population especially, but also of the sources from which savings can be made, was first made possible in large measure through the different employment of the then existing means.

The next step in our argument is also self-evident: command over means of production is necessary to the carrying out of new combinations. Procuring the means of production is one distinct problem for the established firms which work within the circular flow. For they have them already procured or else can procure them currently with the proceeds of previous production (as was explained in the first chapter). There is no fundamental gap here between receipts and disbursements, which, on the contrary, necessarily correspond to one another just as both correspond to the means of production offered and to the products demanded. Once set in motion, this mechanism works automatically. Furthermore, the problem does not exist in a non-exchange economy even if new combinations are carried out in it; for the directing organ, for example a socialist economic ministry, is in a position to direct the productive resources of the society to new uses exactly as it can direct them to their previous employments. The new employment may, under certain circumstances, impose temporary sacrifices, privations, or increased efforts upon the members of the community; it may presuppose the solution of difficult problems, for example the question from which of the old combinations the necessary productive means should be withdrawn; but there is no question of procuring means of production not already at the disposal of the economic ministry. Finally, the problem also does not exist in a competitive economy in the case of the carrying out of new combinations, if those who carry them out have the necessary productive means or can get them in exchange for others which they have or for any other property which they may possess. This is not the privilege of the possession of property per se, but only the privilege of the possession of disposable property, that is such as is employable either immediately for carrying out the new combination or in exchange for the necessary goods and services.² In the contrary case—and this is the rule as it is the fundamentally interesting case—the possessor of wealth, even it if is the greatest combine, must resort to credit if he wishes to carry out a new combination, which cannot like an established business be financed by returns from previous production. To provide this credit is clearly the function of that category of individuals which we call "capitalists." It is obvious that this is the characteristic method of the capitalist type of society—and important enough to serve as its differentia specified—for forcing the economic system into new channels, for putting its means at the service of new ends, in contrast to the method of a non-exchange economy of the kind which simply consists in exercising the directing organ's power to command.

It does not appear to me possible to dispute in any way the foregoing statement. Emphasis upon the significance of credit is to be found in every textbook. That the structure of modern industry could not have been erected without it, that it makes the individual to a certain extent independent of inherited possessions, that talent in economic life "ride to success on its debts," even the most conservative orthodoxy of the theorists cannot well deny. Nor is the connection established here between credit and the carrying out of innovations, a connection which will be worked out later, anything to take offence at. For it is as clear a priori as it is established historically that credit is primarily necessary to new combinations and that it is from these that it forces its way into the circular flow, on the one hand because it was originally necessary to the founding of what are now the old firms, on the other hand because its mechanism, once in existence, also seizes old combinations for obvious reasons. First, a priori: borrowing is not a necessary element of production in the normal circular flow within accustomed channels, is not an element without which we could not understand the essential phenomena of the latter. On the other hand, in carrying out new combinations, "financing" as a special act is fundamentally necessary, in practice as in theory. Second, historically: those who lend and borrow for industrial purposes do not appear early in history. The pre-capitalistic lender provided money for other than business purposes. And we all remember the type of industrialist who felt he was losing caste by borrowing and who therefore shunned banks and bills of exchange. The capitalistic credit system has grown out of and thrived on the financing of new combinations in all countries, even though in a different way in each (the origin of German joint stock banking is especially characteristic). Finally there can be no stumbling block in our speaking of receiving credit in "money or money substitutes." We certainly do not assert that one can produce with coins, notes, or bank balances, and do not deny that services of labor, raw materials, and tools are the things wanted. We are only speaking of a method of procuring them.

Nevertheless there is a point here in which, as has already been hinted, our theory diverges from the traditional view. The accepted theory sees a problem in the existence of the productive means, which are needed for new, or indeed any, productive processes, and this accumulation therefore becomes a distinct function or service. We do not recognise this problem at all; it appears to us to be created by faulty analysis. It does not exist in the circular flow, because the running of the latter presupposes given quantities of means of production. But neither does it exist for the carrying out of new combinations,³ because the productive means required in the latter are drawn from the circular flow whether they already exist there in the shape wanted or have first to be produced by other means of production existing there. Instead of this problem another exists for us: the problem of detaching productive means (already employed somewhere) from the circular flow and allotting them to new combinations. This is done by credit, by means of which one who wishes to carry out new combinations outbids the producers in the circular flow in the market for the required means of production. And although the meaning and object of this process lies in a movement of goods from their old towards new employments, it cannot be described entirely in terms of goods without overlooking something essential, which happens in the sphere of money and credit and upon which depends the explanation of important phenomena in the capitalist form of economic organisation, in contrast to other types.

Finally one more step in this direction: whence come the sums needed to purchase the means of production necessary for the new combinations if the individual concerned does not happen to have them? The conventional answer is simple: out of the annual growth of social savings plus that part of resources which may annually become free. Now the first quantity was indeed important enough before World War I—may perhaps be estimated as one-fifth of total private incomes in Europe and North America—so that together with the latter sum, which it is difficult to obtain statistically, it does not immediately give the lie quantitatively to this answer. At the same time a figure representing the range of all the business operations involved in carrying out new combinations is also not available at present. But we may not even start from total "savings," For its magnitude is explicable only by the results of previous development. By far the greater part of it does not come from thrift in the strict sense, that is from abstaining from the consumption of part of one's regular income, but it consists of funds which are themselves the result of successful innovation and in which we shall later recognise entrepreneurial profit. In the circular flow there would be on the one hand no such rich source, out of which to save, and on the other hand essentially less incentive to save. The only big incomes known to it would be monopoly revenues and the rents of large landowners; while provision for misfortunes and old age, perhaps also irrational motives, would be the only incentives. The most important incentive, the chance of participating in the gains of development, would be absent. Hence, in such an economic system there could be no great reservoirs of free purchasing power, to which one who wished to form new combinations could turn—and his own savings would only suffice in exceptional cases. All money would circulate, would be fixed in definite established channels.

Even though the conventional answer to our question is not obviously absurd, yet there is another method of obtaining money for this purpose, which claims our attention, because it, unlike the one referred to, does not presuppose the existence of accumulated results of previous development, and hence may be considered as the only one which is available in strict logic. This method of obtaining money is the creation of purchasing power by banks. The form it takes is immaterial. The issue of bank-notes not fully covered by specie withdrawn from circulation is an obvious instance, but methods of deposit banking render the same service, where they increase the sum total of possible expenditure. Or we may think of bank acceptances in so far as they serve as money to make payments in wholesale trade. It is always a question, not of transforming purchasing power which already exists in someone's possession, but of the creation of new purchasing power out of nothing—out of nothing even if the credit contract by which the new purchasing power is created is supported by securities which are not themselves circulating media—which is added to the existing circulation. And this is the source from which new combinations are often financed, and from which they would have to be financed always, if results of previous developmental did not actually exist at any moment.

These credit means of payment, that is means of payment which are created for the purpose and by the act of giving credit, serve just as ready money in trade, partly directly, partly because they can be converted immediately into ready money for small payments or payments to the non-banking classes—in particular to wage-earners. With their help, those who carry out new combinations can gain access to the existing stocks of productive means, or, as the case may be, enable those from whom they buy productive services to gain immediate access to the market for consumption goods. There is never, in this nexus, granting of credit in the sense that someone must wait for the equivalent of his service in goods, and content himself with a claim, thereby fulfilling a special function; not even in the sense that someone has to accumulate means of maintenance for laborers or landowners, or produced means of production, all of which would only be paid for out of the final results of production. Economically, it is true, there is an essential difference between these means of payment if they are created for new ends, and money or other means of payment of the circular flow. The latter may be conceived on the one hand as a kind of certificate for completed production and the increase in the social product effected through it, and on the other hand as a kind of order upon, or claim to, part of this social product. The former have not the first of these two characteristics. They too are orders, for which one can immediately procure consumption goods, but not certificates for previous production. Access to the national dividend is usually to be had only on condition of some productive service previously rendered or of some product previously sold. This condition is, in this case, not yet fulfilled. It will be fulfilled only after the successful completion of the new combinations. Hence this credit will in the meantime affect the price level.

The banker, therefore, is not so much primarily a middleman in the commodity "purchasing power" as a producer of this commodity. However, since all reserve funds and savings to-day usually flow to him, and the total demand for free purchasing power, whether existing or to be created, concentrates on him, he has either replaced private capitalists or become their agent; he has himself become the capitalist par excellence. He stands between those who wish to form new combinations and the possessors of productive means. He is essentially a phenomenon of development, though only when no central authority directs the social process. He makes possible the carrying out of new combinations, authorises people, in the name of society as it were,; to form them. He is the ephor of the exchange economy.

We now come to the third of the elements with which our analysis works, namely the "new combination of means of production," and credit. Although all three elements form a whole, the third may be described as the fundamental phenomenon of economic development. The carrying out of new combinations ' we call "enterprise"; the individuals whose function it is to carry them out we call "entrepreneurs." These concepts are at once broader and narrower than the usual. Broader, because in the first place we call entrepreneurs not only those "independent" businessmen in an exchange economy who are usually so designated, but all who actually fulfil the function by which we define the concept, even if they are, as is becoming the rule, "dependent" employees of a company, like managers, members of boards of directors, and so forth, or even ^: if their actual power to perform the entrepreneurial function has any other foundations, such as the control of a majority of shares. As it is the carrying out of new combinations that constitutes the entrepreneur, it is not necessary that he should be permanently connected with an individual firm; many "financiers," "promoters," and so forth are not, and still they may be entrepreneurs in our sense. On the other hand, our concept is narrower than the traditional one in that it docs not include all heads of firms or managers or industrialists who merely may operate an established business, but only those who actually perform that function. Nevertheless I maintain that the above definition does no more than formulate with greater precision what the ^: traditional doctrine really means to convey. In the first place our definition agrees with the usual one on the fundamental point of distinguishing between "entrepreneurs" and "capitalists"—irrespective of whether the latter are J regarded as owners of money, claims to money, or material goods. This I distinction is common property to-day and has been so for a considerable time. It also settles the question whether the ordinary shareholder as such is an ^: entrepreneur, and disposes of the conception of the entrepreneur as risk bearer.⁴ i Furthermore, the ordinary characterisation of the entrepreneur type by such | expressions as "initiative," "authority," or "foresight" points entirely in our \ direction. For there is little scope for such qualities within the routine of the circular flow, and if this had been sharply separated from the occurrence of I changes in this routine itself, the emphasis in the definition of the function of entrepreneurs would have been shifted automatically to the latter. Finally there are definitions which we could simply accept. There is in particular the well known one that goes back to J. B. Say: the entrepreneur's function is to combine the productive factors, to bring them together. Since this is a performance of a

special kind only when the factors are combined for the first time—while it is merelv routine work if done in the course of running a business—this definition coincides with ours. When Mataja (in Unternehmergewinn) defines the entrepreneur as one who receives profit, we have only to add (see conclusion of the first chapter) that there is no profit in the circular flow, in order to trace this formulation too back to ours.⁵ And this view is not foreign to traditional theory, as is shown by the construction of the entrepreneur faisant ni benefice ni pate, which has been worked out rigorously by Walras, but is the property of many other authors. The tendency is for the entrepreneur to make neither profit nor loss in the circular flow—that is he has no function of a special kind there, he simply does not exist; but in his stead, there are heads of firms or business managers of a different type which we had better not designate by the same term.

It is a prejudice to believe that the knowledge of the historical origin of an institution or of a type immediately shows us its sociological or economic nature. Such knowledge often leads us to understand it, but it does not directly yield a theory of it. Still more false is the belief that "primitive" forms of a type are also ipso facto the "simpler" or the "more original" in the sense that they show their nature more purely and with fewer complications than later ones. Very frequently the opposite is the case, amongst other reasons because increasing specialisation may allow functions and qualities to stand out sharply, which are more difficult to recognise in more primitive conditions when mixed with others. So it is in our case. In the general position of the chief of a primitive horde it is difficult to separate the entrepreneurial element from the others. For the same reason most economists up to'the time of the younger Mill failed to keep capitalist and entrepreneur distinct because the manufacturer of a hundred years ago was both; and certainly the course of events since then has facilitated the making of this distinction, as the system of land tenure in England has facilitated the distinction between farmer and landowner, while on the Continent this distinction is still occasionally neglected, especially in the case of peasant who tills his own soil.⁶ But in our case there are still more of such difficulties. The entrepreneur of earlier times was not only as a rule the capitalist too, he was also often—as he still is to-day in the case of small concerns—his own technical expert, in so far as a professional specialist was not called in for special cases. Likewise he was (and is) often his own buying and selling agent, the head of his office, his own personnel manager, and sometimes, even though as a rule he of course employed solicitors, his own legal adviser in current affairs. And it was performing some or all of these functions that regularly filled his days. The carrying out of new combinations can no more be a vocation than the making and execution of strategical decisions, although it is this function and not his routine work that characterises the military leader.^; Therefore the entrepreneur's essential function must always appear mixed up • with other kinds of activity, which as a rule must be much more conspicuous than the essential one. Hence the Marshallian definition of the entrepreneur, which simply treats the entrepreneurial function as "management" in the widest meaning, will naturally appeal to most of us. We do not accept it, simply because it does not bring out what we consider to be the salient point and the only one which specifically distinguishes entrepreneurial from other activities.

Nevertheless there are types—the course of events has evolved them by degrees—which exhibit the entrepreneurial function with particular purity. The "promoter," to be sure, belongs to them only with qualifications. For, neglecting the associations relative to social and moral status which are attached to this type, the promoter is frequently only an agent intervening on commission, who does the work of financial technique in floating the new enterprise. In this case he is not its creator nor the driving power in the process. However, he may be the latter also, and then he is something like an "entrepreneur by profession." But the modern type of "captain of industry"⁷ corresponding more closely to what is meant here, especially if one recognises his identity on the one hand with, say, the commercial entrepreneur of twelfth-century Venice—or, among later types, with John Law—and on the other hand with the village potentate who combines with his agriculture and his cattle trade, say, a rural brewery, an hotel, and a store. But whatever the type, everyone is an entrepreneur only when he actually "carries out new combinations," and loses that character as soon as he has built up his business, when he settles down to running it as other people run their businesses. This is the rule, of course, and hence it is just as rare for anyone always to remain an entrepreneur throughout the decades of his active life as it is for a businessman never to have a moment in which he is an entrepreneur, to however modest a degree.