Theories of Entrepreneurship: Innovation Theory of Schumpeter:

 Theories of Entrepreneurship

Economic Entrepreneurship Theory

This theory was proposed by Richard Cantillon who considered the economy as one of the fields affected by entrepreneurship. According to Cantillon, an entrepreneur acts as both ‘producers’ and ‘exchangers’. An entrepreneur’s action greatly affects the supply chain of raw products being collected, to become an end product for consumers. Cantillon included everyone as an entrepreneur from their little actions starting from a beggar to restaurant owners as they also have their source of unfixed income; this counts as a unique factor and made his theory stand out from other entrepreneurship theories.

Sociological Entrepreneurship Theory

Yes, you are right! This theory talks about the social aspects of entrepreneurship. If an entrepreneur considers all the social aspects such as social taboos, customs, culture, and other religious beliefs, they might have a well-established business that is up to mark with every consumer’s expectation. Max Weber propounded the sociological entrepreneurship theory and stated that entrepreneurs should accept the system of a society for the development of themselves as well as their startup.

Psychological Entrepreneurship Theory

Psychological theories are of three sections. They are based on the personal characteristics of a typical entrepreneur.

1. Locus of control:- Any entrepreneur’s success can be an outcome of internal locus of control as well as the outer locus of control i.e., his or her Inside abilities and support from outside.
2. Theory of personality traits: The inborn qualities of an individual are the one that naturally makes them an entrepreneur.
3. Theory of need for achievement:- Entrepreneurs are driven by a need for achievement and it eventually makes them succeed.

Now, these three characteristics distinguish various types of entrepreneurs based on psychological entrepreneurship theories.

3.1 Innovation Theory of Schumpeter: 

A dynamic theory of entrepreneurship was first advocated by Schumpeter (1949) who considered entrepreneurship as the catalyst that disrupts the stationary circular flow of the economy and thereby initiates and sustains the process of development. Embarking upon ‘new combinations’ of the factors of production - which he succinctly terms, innovation - the entrepreneur activates the economy to a new level of development.

 

Schumpeter introduced a concept of innovation as key factor in entrepreneurship in addition to assuming risks and organising factor of production. Schumpeter defines entrepreneurship as “a creative activity”. An innovator who brings new products or services into economy is given the status of an entrepreneur. He regards innovation as a tool of entrepreneur, The entrepreneur is viewed as the ‘engine of growth’, He sees the opportunity for introducing new products, new markets, new sources of supply, new forms of industrial organization or for the development of newly discovered resources. The concept of innovation and its corollary development embraces five functions: 

• The introduction of a new product with which consumers are not yet familiar or introduction of a new quality of an existing product, 
• The introduction of new method of production that is 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, 
• The opening of new market that is a market on to which the particular branch of manufacturer of the country in question has not previously entered, whether or not this market has existed before, 
• Conquest of a new source of supply of raw material and 
• The carrying out of the new organisation of any industry. 

Schumpeter is the first major theorist to put the human agent at the centre of the process of economic development. He is very explicit about the economic function of the entrepreneur. The entrepreneur is the prime mover in economic development; his function, to innovate or carry out new combinations. Schumpeter makes a distinction between an innovator and an inventor. An inventor discovers new methods and new materials. On the contrary, an innovator is one who utilises or applies inventions and discoveries in order to make new combinations. An inventor is concerned with his technical work of invention whereas an entrepreneur converts the technical work into economic performance. An innovator is more than an inventor because he does not only originate as the inventor does but goes much farther in exploiting the invention commercially.

Wilken had added the concept of the changes that an entrepreneur brings: 

• Expansion of goods, products. 
• Productivity of factors of production such as finance, labour, material. 
• Innovation in production such as, technology, process changes and increase in human resource productivity. 
• Innovation in marketing area such as the composition of the market, size of the market and new markets. 

To Schumpeter, entrepreneurs are individuals motivated by a will for power; their special characteristic being an ­inherent capacity to select correct answers, energy, will and mind to overcome fixed talents of thoughts, and a capacity to withstand social opposition. The factors that contribute to the development of entrepreneurship would essentially be a suitable environment in grasping the essential facts. 

It can be noted that this theory’s main figure, the “innovating entrepreneur” has played an important role in the rise of modem capitalism. The entrepreneur has been the prime mover - for economic development process. On the criticism side, this theory seems one-sided as it puts too much emphasis on innovative functions. It ignores the risk taking and organizing aspects of entrepreneurship. An entrepreneur has not only to innovate but also assemble the resources and put them to optimum use. 

While stressing upon the innovative function of the entrepreneur, Schumpeter ignored the risk-taking function, which is equally important. When an entrepreneur develops a new combination of factors of production, there is enough risk involved.

In spite of these lacking, the theory supports the “enterprising spirit” of entrepreneur to innovate. It is the act that endows resources with a new capacity to create wealth. Drucker says, “Innovation, indeed, creates a resource. It endows it with economic value.” Schumpeter’s views are particularly relevant to developing countries where innovations need to be encouraged. The transformation of an agrarian economy into an industrial economy required a great deal of initiative and changes on the part of businessmen and managers.

3.1.1 Key Elements of Schumpeter's Theory of Entrepreneurship

1. Role of the Entrepreneur:

Schumpeter's theory places the entrepreneur at the center of economic development. According to him, the entrepreneur is not just a business owner but a change agent who introduces new products, services, production methods, or business models. Entrepreneurs are characterized by their ability to take risks, innovate, and break away from routine economic activities.

The entrepreneur is a visionary who identifies new opportunities and takes advantage of them to create new combinations of resources, which leads to economic growth.

1. Innovation as the Key Driver:

The core of Schumpeter's theory is the concept of "innovation." He defines innovation as the introduction of a new product, a new method of production, the opening of a new market, the conquest of a new source of supply, or the carrying out of a new organization of any industry.

Schumpeter identified five types of innovation:

1. New Products: Creating a new product that has never been introduced before.
2. New Methods of Production: Introducing a new technology or a new way of producing goods.
3. New Markets: Finding new markets for existing products.
4. New Sources of Supply: Discovering new sources of raw materials or semi-finished goods.
5. New Organizations: Developing new organizational structures or business models.

1. Creative Destruction:

Schumpeter introduced the concept of "creative destruction," which describes the process by which new innovations replace outdated technologies, products, or business models. This process of creative destruction is essential for economic development because it leads to continuous improvement and adaptation in the economy.

While creative destruction may lead to short-term disruption, loss of jobs, or the failure of firms that cannot adapt, it ultimately results in more efficient resource allocation, higher productivity, and long-term economic growth.

1. Discontinuous Economic Development:

Schumpeter argued that economic development is not a smooth, continuous process but rather occurs in cycles of "boom and bust." The introduction of innovations leads to economic booms, while the saturation or obsolescence of innovations causes economic downturns or recessions. This cyclical pattern is a natural part of the capitalist economy.

1. The Role of Credit and Capital:

According to Schumpeter, access to credit and capital is crucial for entrepreneurship and innovation. Entrepreneurs need financial resources to invest in new ideas and bring innovations to market. Banks and financial institutions play a critical role in providing the necessary funds for entrepreneurial ventures.

1. Entrepreneurial Motivation:

Schumpeter emphasized that entrepreneurs are not primarily driven by profit alone. Instead, they are motivated by the joy of creating something new, the desire for success, and the challenge of overcoming obstacles. Entrepreneurs seek to distinguish themselves and gain personal satisfaction from their achievements.

1. Monopoly and Temporary Profits:

Schumpeter argued that innovation can create temporary monopolies, allowing the innovating entrepreneur to earn above-normal profits. However, these profits are not permanent because, over time, competitors will imitate the innovation, reducing the profit margins. Thus, continuous innovation is necessary to maintain a competitive edge.

3.1.2 Implications of Schumpeter's Theory

1. Economic Policy:

Schumpeter's theory suggests that economic policies should focus on fostering an environment that encourages innovation, risk-taking, and entrepreneurship. Policies that reduce barriers to entry, provide access to credit, protect intellectual property rights, and promote education and skills development can help in this regard.

1. Corporate Strategy:

Firms must recognize the importance of innovation as a key driver of competitiveness and growth. Businesses should invest in research and development (R&D), encourage a culture of innovation, and be prepared to adapt to market changes brought about by creative destruction.

1. Economic Growth and Development:

Schumpeter's theory highlights the dynamic nature of capitalism and its ability to drive economic growth through innovation. It underscores the need for continuous change and adaptation to sustain long-term economic development.

3.1.3 Assumptions of Schumpeter's Theory of Entrepreneurship

1. Capitalist Economy Framework:

The theory is based on a capitalist economy where private ownership, profit motive, and competitive markets are the primary drivers. It assumes that entrepreneurship and innovation flourish best under capitalism.

1. Presence of Entrepreneurial Talent:

The theory assumes that there is always a pool of talented individuals capable of acting as entrepreneurs, possessing the vision, creativity, and risk-taking abilities needed to introduce innovations.

1. Availability of Credit and Capital:

It assumes that entrepreneurs have access to credit and capital, which are crucial for financing innovative activities. Banks and financial institutions are presumed to support entrepreneurs by providing the necessary funds.

1. Profit as a Primary Incentive:

Although Schumpeter mentions non-monetary motivations like personal satisfaction and achievement, the theory largely assumes that profit remains a significant driving force for entrepreneurs.

1. Dynamic Market Conditions:

The theory presumes that markets are dynamic and ever-changing, providing continuous opportunities for new combinations, innovations, and creative destruction.

1. Economic Agents Act Rationally:

Schumpeter’s theory assumes that economic agents (entrepreneurs, firms, and consumers) act rationally in making decisions that maximize their utility, whether it is profit maximization for firms or satisfaction maximization for consumers.

1. Temporary Monopolies:

It is assumed that innovative entrepreneurs can create temporary monopolies through their innovations, which allows them to enjoy above-normal profits until competitors catch up.

3.1.4 Criticisms of Schumpeter's Theory of Entrepreneurship

1. Overemphasis on Innovation:

Critics argue that Schumpeter’s theory overly emphasizes innovation as the sole driver of economic development and ignores other factors like managerial efficiency, labor productivity, and market expansion. Not all economic development comes from radical innovation; sometimes, incremental improvements or efficient management also contribute significantly.

1. Neglect of Imitation and Incremental Innovation:

The theory tends to overlook the role of imitation and incremental innovation. While Schumpeter focuses on radical, groundbreaking innovations, most real-world innovations are incremental and build on existing technologies and processes.

1. Idealization of Entrepreneurs:

Schumpeter’s portrayal of entrepreneurs as heroic figures and agents of change is considered idealistic. In reality, not all entrepreneurs are driven by innovation or the desire to create; many are motivated by profit, survival, or risk aversion.

1. Lack of Emphasis on External Environment:

The theory does not sufficiently account for the impact of external environmental factors such as government policies, cultural influences, market structures, or global economic conditions, which can significantly affect entrepreneurial activity.

1. Overlooks the Role of Large Firms:

Schumpeter initially focused on individual entrepreneurs, but later recognized the role of large firms in driving innovation through research and development (R&D). Critics argue that innovation is often driven by established firms with substantial resources rather than individual entrepreneurs.

1. Assumption of Perfect Knowledge and Rationality:

The theory assumes that entrepreneurs have perfect knowledge of market conditions and act rationally. However, in reality, uncertainty, bounded rationality, and imperfect information significantly affect decision-making processes.

1. Simplistic View of Credit and Capital Availability:

While Schumpeter emphasizes the role of credit, he does not fully address the complexities and challenges associated with obtaining financing, especially for small or new entrepreneurs. The theory assumes that credit is readily available to those who seek it, which is not always the case.

1. Neglect of Social and Cultural Factors:

Schumpeter’s theory does not take into account the social, cultural, and psychological factors that can influence entrepreneurship. Entrepreneurial activity is often shaped by cultural norms, societal values, and individual backgrounds, which the theory overlooks.

1. Insufficient Focus on the Broader Economic Impact:

While Schumpeter discusses economic growth driven by innovation, critics argue that he does not adequately address the broader socio-economic consequences, such as income inequality, job displacement, and social welfare impacts caused by creative destruction.

1. Lack of Specificity in Policy Guidance:

The theory is more descriptive than prescriptive. It explains the process of economic development through innovation but does not provide specific guidance on policies or strategies to promote entrepreneurship or manage creative destruction.