The Austrian School also emerged to explain growth and its determinants. Among key proponents are Schumpeter (1934) and Kirzner (1973). The
56 Austrian School breaks away from the traditional thinking of right policy and right environment to introduce the entrepreneur as a key driver of growth. While Schumpeter’s work was at the time of neo-classical economists, not much attention was given to his views. Entrepreneurship is captured in recent attempts to find the reasons for sustained growth.
The debate on growth in recent years has moved away from purely economic policy to include among other factors like entrepreneurship, social capital and governance. The World Bank’s emphasis on social capital and governance is a point into this direction. (World Bank Report, 1995; Collier, 1997).
a) The Schumpeterian growth model
The break from pure economics to other factors was spearheaded by Schumpeter. Schumpeter (1934) moved away from the basic economics when he proposed that growth is attributable to a phenomenon known as entrepreneurship. Schumpeter argued that economic development was not a gradual harmonious process but was characterized by periodic bursts and downturns. These bursts were created by entrepreneurs who seized opportunities and exploited them as new ideas or inventions leading to growth.
Schumpeter, sometimes referred to as the father of modern entrepreneurial thought (Campbell and Wilson, 1976), argued that an entrepreneur was an
57 innovator unlike managers or industrialists who operated business. According to him, an entrepreneur distinguished himself by carrying out new combinations of productive forces. The entrepreneur is the innovator and causes innovations by introducing new goods or services, introduces new raw materials or a new method of production or opens a new market or re-organizes an industry (Schumpeter, 1959).
According to Schumpeter, the existence of innovation possibilities is a necessary but not sufficient condition for development. Entrepreneurship sparks off development by innovating. Therefore, it is the entrepreneur who is responsible for growth/development. Schumpeter assumes that the starting point is a purely competitive economy which is in a stationary state. There is neither net investment nor population growth and full employment prevails. The economy is in equilibrium. Opportunities for new combinations, however exist and entrepreneurs through their activities perceive them and exploit them. This exploitation causes disequilibrium in the economy and leads to increased production and growth.
Schumpeter’s theory assumes a perfectly competitive economy which is in stationary equilibrium. In stationary equilibrium, there is no interest, no savings, no investment and no involuntary unemployment. According to Schumpeter, this equilibrium is characterized by a circular flow which continues to repeat itself in the same manner year after year. The same
58 products are produced every year in the same manner. For every supply, there awaits somewhere in the economy, a corresponding demand.
Figure 2.1: Schumpeter’s model of growth
Development, according to Schumpeter (1959), is the spontaneous and discontinuous change in the channel of this circular flow. Disturbance of the equilibrium alters and displaces the equilibrium state previously existing. This is the role of the entrepreneur through perceptions of innovations and exploiting them through business start-ups.
Changes arise from within the economy. Endogenous development consists of carrying out new combinations for which possibilities exist in a stationary state. These new combinations come from innovation.
Land
Labour
Capital
Organization Production Growth
Entrepreneurship Activity
Innovation
59 Innovation is introducing a new product or a new process, new market, new raw materials, and/or new administrative arrangements.
Schumpeter says development is a result of the introduction of newness and he assigns the role of innovation to the entrepreneur, somebody who introduces something entirely new. The entrepreneur is motivated by a variety of factors including the joy of creating something new, the joy of getting things done, the will to concur and prove superiority besides the desire to form a commercial kingdom. Schumpeter advanced the paradox that economic progress de-establishes the world. As new innovations come up, they bring in their wake new products and/or new services or new firms and processes. New products kill off old ones and as old products die, so do jobs. Economic progress is thus accompanied with job destruction. This is the dynamic process Schumpeter called creative
destruction or what is today known as the business churn. It is new
businesses starting, it is business expanding, contracting, relocating and closing. It creates new businesses and new jobs with a multiplier effect, leads to job losses as businesses close.
Criticism of the theory
Schumpeter’s theory is based on the innovator whom he regards as an instigator. These were the persons who led the growth in the 18th and 19th centuries through their innovations. Schumpeter (1939) did not consider the possibility of organizations innovating. But now innovations form part
60 of the functions of a corporation, for this reason, the individual who is the entrepreneur is not necessarily the innovator. Innovations are regarded as the routine of industrial concerns and do not require an innovator as such. This view is however challenged by Storey (1994) and Baumol (2002) who argue that important innovations still come from not only small firms but individuals. In their view Schumpeter’s view is still valid.
Another criticism leveled against Schumpeter is that economic development is not the result of the cyclical process as he proposed. The downswings and upswings are not essential for economic development. Schumpeter’s contention that cyclical changes are due to innovations only is also not entirely correct. As a matter of fact, cyclical fluctuations may be due to psychological, natural and financial causes, thus other factors may influence change.
Again, Schumpeter (1939) regards innovations as the main cause of economic development. But this is far from reality because economic development not only depends on innovations but also on many economic, social and political changes.
Meier and Baldwin (1964) argued that while Schumpeter’s broad social economic analysis of capitalist process was generally admired few people accepted its conclusions. They argued that his arguments are stimulating but not completely convincing.
61 b) Kirzner’s growth model
Kirzner (1973) is the other economist who departs from classical and neo- classical economists to give an entrepreneur a role in development. Kirzner, like Schumpeter, assumes an equilibrium state in an economy where there is perfect competition and where decision making is not important. The classical economists assume that information for decision making is available to everybody, however, Kirzner shows that there is no perfect knowledge and that in any economy, there are always unexploited gains and these are not recognized by everybody. The ignorance about unexploited gains results in mistakes and missed opportunities leading to failure.
Kirzner (1979) argues that there are some people who see a little more clearly than others. They see these gains, these are the entrepreneurs. Those who notice what has hitherto been overlooked are alert. The entrepreneur is alert to opportunities and thus has superior knowledge and uses that knowledge to profit from the market. However, Kirzner argues that, knowledge does not last. Entrepreneurs who perceive the gains act to exploit it. However, their actions evoke competition, which limits their gains.
62 In the absence of further disturbance, the process of exploiting the gains will run its course until full knowledge and an equilibrium are simultaneously achieved. Kirzner’s arguments are essentially those of arbitrage. Arbitrage in the market may arise where there is a cheaper alternative of producing goods or services or a cheaper raw material that may be used to produce an existing product or where there is a disparity between prices of products and services.
For Kirzner therefore, entrepreneurship is not an introduction of new products or new techniques of production, but is the ability to see that new products have become more valuable to consumers or new methods of production have become feasible, unknown to others.