In this video we want to talk about the work of Joseph Schumpeter, an Austrian economist back in the 1930s who introduced and focused in on the problems associated with innovation but also highlighted its importance and its role in the economic system. Schumpeter had quite interesting ideas about innovation and it's well worthwhile spending time looking at what his ideas were. He was a minister in government there but also a know-it-all economist and has made a long-term contribution to economic theory and is well worth looking up sometimes if you've got some spare time and looking at his works.
So Schumpeter's theory. Well, he was an Austrian economist, as I said, who introduced his theory on innovation management during the 1930s. Schumpeter emphasised the importance of innovation in organisations.
And the organisations in this case could be industrial or commercial. It was simply looking at the importance of innovation. in the organization. The type of organization was not relevant. Schumpeter's publication on capitalism, socialism, and democracy focused on the concept of what he called creative destruction.
Now, I want to spend a little time talking about this idea of creative destruction and see what it means. Organizations must continue to innovate in order to drive profits. Organizations exist in competitive situations, let's say, and the competitors are constantly looking for angles and different ways of producing their product and altering their product to make it more acceptable to customers. So thereby they will cut their costs and also generate more sales. So the competitors are doing it, this forces the company to do it.
So all the companies are trying to, in a sense, out-innovate each other. They're trying to be more innovative than each other, making products which are more interesting to the customers and therefore giving themselves more opportunity to survive in the market. So the really successful innovators are the ones who are going to lead the market.
The companies that are less successful in innovation may go out of business. Innovation is the driving force which results in economic change causing creative destruction. So we only get economic change if we've got innovation.
Now we know... The world in which we live is typified by economic change. We have new products coming out every day. We have different ways of working and different ways of living.
But all of this is the outcome from the innovative process. The innovative process within companies. Their desire to produce something new that will be a novelty, will be interesting to the consumer.
The consumers will purchase it and thereby the companies will generate more revenue. revenue for themselves. Schumpeter explains economic development and assumes a perfectly competitive economy which is in stationary equilibrium. Now it's difficult to explain this completely without reference to economic theory. In economics in terms of market structure there is one particular one which is quite relevant here which is the theory of perfect competition.
Now perfect competition whether it exists or not does not interest us. It is the state in which there is maximum competition and therefore all the companies who are producing identical products, all the companies have identical cost structures, they're all fighting for their existence and in the long run They will all settle to earning very little profit, just enough profit to keep them in the business. to keep them producing just enough and all of them will make the same profit because all of them are producing essentially the same good it's been sold at the same price so all of them will have roughly the same sales now you really need to have a look at the material on perfect competition that we've put on the web for you to consult to get an understanding of what's going on here but essentially Schumpeter said well the economic development and it assumes that there is a perfectly competitive economy there are no monopolies there's no oligopolistic firms or monopolistically competitive firms this is pure competition so all the issues the other issues are sidestepped Schumpeter was looking purely at the extreme in competition and if that extreme in competition was to come about he called it the stationary equilibrium this is the point where all the companies will produce the same amount sell it at the same price generate the same profits because the profits the the products are identical the consumers cannot decide between one or the other there's an assumption that there's no transport cost or No obstacles to the customers understanding the product or there's no differentiation of the product through advertising, psychic differentiation or physical differentiation of the product.
Because companies can't afford to differentiate their products. So the whole system comes into this competitive equilibrium, which he called the stationary equilibrium. So a stationary economic state is referred to as the perfect equilibrium in which there is no profit, no interest rates, no savings, no investment and no voluntary unemployment. Involuntary unemployment, I should say. In other words, we've got rid of the world in which we know it, the normal commercial world in which we live.
This is an abstraction. This is a purely theoretical point. It's looking at a world where there is pure competition and looking at the effects of this intense competition. And the effects of this intense competition is to drive the prices down and each producer is fighting for its survival, each organization.
It's fighting for its survival. So there's no profit. In fact, there is a profit in terms of economics. It's called normal profit. In other words, it's making enough profit to just keep it in production.
We say no profit. We mean no excess profit. No supernormal profit.
It's just making what economists call normal profit. Normal profit is just enough to keep the business. going just enough to keep it in the market. Anything less and the business will close down. Schumpeter explains this stationary economic state as the circular flow as he called it.
A continuous cycle constantly repeating itself every year. So this system will keep moving in perpetuity because there's nothing to knock it out there's no external force so all the companies are in perfect competition they're all producing identical products they can't differentiate with advertising or physically differentiate because they haven't got the resources to do so all the consumers have good knowledge of the market, they know what the prices are, they know where to get it, they know the attributes of the product. So it's like a cycle and it just continuously rolls around and it's the same all the time from one year to the next. There is nothing knocking it out. Innovation is the force that is considered spontaneous and a disturbance to this Perfect equilibrium.
Schumpeter says creative destruction. So what breaks this cycle, this monotonous cycle of competition and with the same products, the customers get the same products all the time. What breaks it is innovation.
Innovation, according to Schumpeter, is the desire on the part of some producers. to try and find the resources, to try and find the way to improve the product and break out of that cycle. And if they do, then they're going to break the whole cycle. They're going to break that whole market situation.
And this is called creative destruction. Schumpeter explains, creative destruction is the innovative process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old, incessantly creating new ones. So creative destruction is caused by innovation.
It's innovation that breaks this. endless cycle of competition, which is the extreme form of the model that we would now know as perfect competition. And it's well worth spending some time just looking up our material on perfect competition so you will see what the underlying assumptions of that model are. But all of them are really ones I've touched on here.
The producers make normal profit. In other words, They just make enough profit to keep themselves in business. They all produce identical products because they can't afford to differentiate. There's no advertising.
All the prices are the same. Each firm will produce the same amount of output. Competition will pull all of them in that direction. And what breaks the cycle... is some of them will make this extreme effort, despite the lack of resources, will make this extreme effort to innovate, to introduce something new.
And when they introduce something new, then they've got a different product. In fact, they're the only ones with that product. So in a sense, they become monopolists.
They're the only ones producing that product. They've broken the cycle. They've broken away.
But now the others... see that company making abnormal profits as they're called or supernormal profits and they want to copy so they will also try to innovate and this is how the this idea of the circular flow will break down this is the essence of creative destruction so what is innovation well Schumpeter defines innovation as you New product introduction, like I just described. Companies have an incentive to make new products and to introduce new products, to try to generate more sales, to become at least temporary monopolists.
They're the only ones selling this particular product that has this particular set of attributes. So it's new product introduction. It's also new production methods and processes trying to cut the costs within the business and thereby making more profits available and those extra profits could then be used of course for innovation. Innovation looking for further cost cutting measures within the business or innovating the product. Looking for new market opportunities, looking for alternatives to try and break out of that cycle of competition that I just described, which is that fierce competitive model with emphasis totally on competition, ignoring customers'lack of choice.
the fact that the product is very standardized and ignoring the monotony of the whole situation looking for new market opportunities trying to introduce new products or introduce something new into the market to try and break away from that endless cycle of competition. A new approach for sourcing and supplying raw materials or semi-manufactured goods. So trying to get raw materials by negotiating discounts or trying to do some sort of deal with the suppliers and with the shippers, trying to negotiate terms for semi-manufactured goods from other producers and working in collaboration, building alliances, doing, in a sense, anything to escape that cycle of competition.
All of this is leading to innovation. The Schumparian view is that innovation is extremely important in the economy. I mentioned earlier the creation of a monopoly. As soon as a company is almost in that perfectly competitive situation, if only they can modify their product to some extent.
then their product will be different from the others, and therefore, by definition, they will have a monopoly. The monopoly will enable them to generate abnormal profits, and the monopoly will enable them to break away from that cycle. And companies would like to make abnormal profits, or supernormal profits, rather than just eking out a living, eking out an existence. trying to survive.
Schumpeter believes or believed all organizations must innovate to sustain growth, market position and competitiveness. So heavy emphasis on innovation as a way of bringing about economic growth, the growth of businesses, customers getting new products. buying more, the business is growing.
Companies can sustain themselves in the market. They can improve their market position. Their long-term viability is improved by virtue of more sales. And they're more competitive because they're able to engage in marketing and product redesign.
So there is an incentive to innovate. Schumpeter explains the key role entrepreneurs play in the development and deployment of new inventions. They are the ones that drive growth, creative destruction and economic development. So they are the ones who bring about creative destruction, economic development and economic growth. It's the entrepreneurs who have the ideas.
the ideas for change and if the ideas for change are good and reap the rewards of extra profits then that leads to business growth it leads to more companies trying to follow and innovate so they will try to grow as well creative destruction moving away from that that cycle of competitiveness that we described which if it were to continue would mean utter monotony for the consumers who would get the same product continuously and for producers who could not break away and have to experience low levels of profit just surviving an inability to finance anything which is new So it's the entrepreneurs who bring about creative destruction. But of course, all of this means we have economic development. The entrepreneur is motivated to innovate due to the need to specialize and dominate a new industry.
So entrepreneurs, they've come up with a good idea, let's say, for a product or a service. but really what they want is rewards they want to be rewarded with greater profitability for themselves they don't want to set up a business that's just surviving they want to set up a business that's highly successful that will grow and will further finance their ambitions to bring in even further products perhaps so entrepreneurs are motivated to develop businesses which that have the capacity to grow. There's also the need to showcase their skills and capabilities in order to demonstrate their superiority. Entrepreneurs like to be seen as entrepreneurs.
They're the ones who have changed the market. They're the ones who have brought about the products that the rest of us buy. They're the ones who are responsible for the way we live.
And some entrepreneurs like to take credit for that and show themselves as the ones who have led the changes in society and have changed the way we all live. The enjoyment of working on activities or hobbies which ultimately provide an economic growth. Entrepreneurs like the challenge, or so the literature would say.
They like the challenge of what they're doing. They like the idea of coming up with a new idea and then working on it and bringing it to market and seeing it succeed. There is a sense of achievement, not just the profits and the economic rewards. There is a personal sense of achievement, and that is part of the reward that they experience.
So, in this video, what we've done is we've looked at Schumpeter, we've looked at the idea of creative destruction, we've talked about the circular flow as put forward by Schumpeter, we've looked at the economic model that underpinned it, a perfectly competitive model, and there are videos about that available on the course. We've moved away in the end towards... Looking at innovation as the destructive force, that the force is going to bring about change, economic development and a higher standard of living and a better life because we are getting new products, we're getting changing products and they're making our lives better. And we finally isolated the... This is all down to the entrepreneur.
It's the entrepreneur who brings about the innovation, brings about the changes. It's the entrepreneur who's got the idea, the idea for the change. And having championed the idea gets it introduced. And if the idea is good and acceptable, the reward is higher profits for the business, but also for the entrepreneur. And.
sense of achievement for the entrepreneur and that's all we're going to deal with in this video and that's the the famous book if you're passing the library sometime just have a look at it and just brush through it and see it it's written in a very nice style it is accessible and at some stage on your personal reading list perhaps in years to come when you have less pressure, you might want to return and have a look at it. But that's all we're going to deal with. So let's leave it at that and say thank you for watching.