Preliminary List - Part I 1) Schumpeter is considered as one of the pioneers who recognized the importance of innovation for understanding the dynamics of wealth creation. Can you briefly describe some of his main ideas? Do you consider them still relevant today? Argue why (not) and/or to what extent.
2) Baumol claims that innovation can be understood as the engine behind free market growth. Briefly explain his ideas. Do you agree? Why (not)? Do you think his account provides a complete perspective on innovation dynamics within market economies? Argue why (not)?
Once capitalism was in place and fully operational, a flow of innovation and the consequent rise in productivity and per capita gross domestic product were to be expected. The greed where A. Smith refers to in the economical sentence translated into continuously searching for profits. Companies therefore do not battle any more only on prices but on the flow of innovations.
More growth has to be expected when these 5 conditions are more in the market:
Rule of law stand in for enforceability of contract between partner)
Possible: Technology selling and trading (sell vs. license)
Not only big but also small firms contribute to technology and science. Large firms are important for incremental innovations; providing the customers more product reliability.
Small firms are important for major breakthroughs.
Baumol claims that innovation flows could be enhanced by the cooperation of the government (active and passive) and the universities.
Passively by providing a good Intellectual Property Right protection to the firms.
Actively by spendin’ money into basic research (done by universities)
Baumol also states that there is an important trade-off: getting monopoly power by heavily investing into R&D but knowing that power is just for a while (until new technique has made his way to the top, very fast nowadays).
This however is not a problem: firms engage into R&D cooperation hereby reducing risk of uncertainty and also may block new entrant. This is due to the fact that the entrant is not admitted to the possible technique antitrust?
He also stated that foreign innovation is also extremely important. The government should for example contribute to the smoothly integration of skilled foreign engineers.
Agree on Baumol findings however did not mention about certain aspects of innovation dynamics:
What about the market failures? Also important for innovation?
Differentiation problem: he mentioned that innovations should be adapted to the customers need however he did not told that this could impede the R&D cooperation
Did not mentioned that an option is that the government can grant a firm a possible patent hereby assuring that a company will engage into R&D.
What about moral hazard problems when cooperating between firms?
Baumol believes that innovative activity is mandatory for firms in free market economies to survive. Also, the new technologies spread much faster in capitalistic industries (or free market economies) than in other types of economies. The primary product of capitalism (or free market) is economic growth, which will appear automatically by itself and without any planning or decision making. This capitalist economies have competitive pressures which are not present in other economies that force companies to invest in innovation and provide incentives for a fast dissemination (=spread) and exchange of improved technologies throughout the industry.
Following features are typically available in free-market economies or capitalist economies that are most innovative:
Oligopolistic competition in capitalist free-markets: innovation has replaced price as being the most important competitive weapon
Routinization of innovative activities: this makes innovation a regular ordinary component of the firm’s activities; uncertainty is minimized
Productive entrepreneurship: entrepreneurs prefer productive innovation to innovative rent-seeking (=the non-productive pursuit of economic profit)
Rule of law
Technology selling and trading
These features are crucial for the extraordinary growth of free-markets. They are fundamentally different from other types of economies. Other economic systems may produce some inventions, but only capitalism produces innovation in the Schumpeterian sense: making technological progress itself in an industry that provides inputs to others
In most literature, free market firms are characterized by a tendency towards static efficiency (=use the most economical of the available methods of production and supply the marketing mix adapted to the demand). This however implies that there would be a level of innovation far below the optimal level, because of spillover effects to other firms. Nevertheless, Baumol argues that in capitalistic economies, there is still high innovation because of competitive market pressures that force the firm to integrate innovation into their routine decision processes and activities. Baumol says that there is too little attention for innovation in standard microeconomics, which is currently focusing on prices and its related variables. Routine innovation is at least that important as price in the competitive process. The competitive pressures have forced companies to systemize innovation processes to a accustomed and predictable controlled procedure (routinized). Moreover, innovation stimulates innovation, so innovative activities can be considered to be a cumulative process, in which there is feedback from one innovation to the next: once innovation is launched in an industry, it will spread and cause new innovations. It is often most profitable for an owner of an innovation to spread the technology to competing firms since the financial rewards help to internalize the externalities of the innovation process.
Do you agree? Why/Why not?
Although some of Baumol’s statements are very informative, his theory should be handled with care.
For example, not all free market economies in which people were more or less free to chase their economic interests ended up being equally technologically creative and innovative. Moreover, the author's enthusiasm for routinized research by oligopolies leads to underestimate the importance of preserving not only competition among those large firms but also competition from "the inspired innovator." Can a search for the unknown really be routinized? Can one conclude that the nineteenth century discoveries in the fields of for example electricity were driven by free market capitalism?
Furthermore, I don’t think that innovation is more important than price in the competitive process. It is not that evident that the benefits of innovation would be passed on to consumers if price competition is not dominant.
C. Do you think his account provides a complete perspective on innovation dynamics within market economies? Argue why/why not?
No, he doesn’t offer a complete perspective.
The selection of new techniques in "free" markets in capitalist economies also have a large component of political decision-making in them.
The theory doesn’t say how the spending norm of firms on innovation should be determined. What is the equilibrium?
Another concern is the possibility of winner-take-all patent races: the highest bidder wins, but every bidder has to pay. In such circumstances, collusion to reduce duplicative efforts might be socially desirable.
Baumol also puts much more emphasis on the incremental improvements to innovations than to the original innovations themselves. In this routinized R&D that is essential for firms to survive, where do good ideas come from?
Baumol underestimates the entrepreneurial element in bringing the results of R&D to the market. How do good ideas get into the marketplace? The apparently small step between R&D and a marketable product is entrepreneurship, but this is neglected by Baumol.
3) Several authors claim that innovation is a field characterized by the presence of market failures. What is understood by this notion? Would you agree that such market failures are indeed present? And if so, does this apply for all types of innovative activity?
Roberts and Frohman told that there has to be a tolerance of false foundations can prove to be challenging new starts. Therefore we should accept market failures.
Arrow: uncertainty involved in technological & development process cause market failures.
A solution could be:
Like stocks, having a big portfolio (only by big firms possible).
Having an insurance averse selection could take place no insurance anymore (too high problem).
Investing in basic research by government in universities split commercialisation and science.
Market failures are widely common in every industry. These market failures could enhance the future developments. However in industries where there are no or few process innovations (in the model of Abernathy & Utterback) (like in bulk chemicals) these market failures are do not contribute to product development
4) Is it justified to support R&D activities with public money? Why (not)?
5) Briefly explain what is understood by the notion of ‘innovation system’. What does it add to our understanding of innovation dynamics? What could be the role of universities or research institutes within such a system?
6) Briefly explain what is understood by the notion of ‘innovation system’. What does it add to our understanding of innovation dynamics? From an innovation system perspective, what should you recommend the EC in order to meet the Lisbon targets?
7) What is the difference between ‘market pull’ and ‘technology push’? Does this distinction hold any relevance for a firm’s innovation strategy? Argue why (not)?
8) Innovation dynamics are not time-invariant. Briefly explain what is meant by this idea. How can this idea be useful for guiding innovation related decisions (both on the policy and the firm/managerial level)?
Innovation dynamics are not time-invariant. Briefly explain what is meant by this idea.
In the past, models were static in nature, meaning they considered the factors affecting innovation under a fixed perspective. The following models include the innovation “dynamics”, in a time-variant approach. Three relevant models are discussed. However the explanation should be briefly, just to give you a better overview of the dynamics the three models are explained more in detailed lower.
When explained briefly, it can be stated that the innovation models have become more dynamic in time. Meaning that factors affecting innovation are variable, instead of with a fixed perspective.
In the S-Curve model, in the early stage, large amounts of resources have small effects on innovation improvements. During time the innovation technology accumulates, till it in the end is faced with physical limitations.
The Abernathy-Utterback Model adds that when there is an innovation, three phases are detected in time. In the “fluid phase”, there is a high product innovation (e.g. product design, operational characteristics), with much less attention given to the processes by which products are made. Secondly, innovation will evolve to the “transitional phase”. Standard optimal product designs become settled, not the product innovation but the process (e.g. efficient production) innovation is important in this time stage. Finally, in the “specific stage”, innovations for product and process decreases, now the industries become extremely focused on cost, volume and capacity.
The disruptive models shows the difference between sustaining in or disruptive in time. Sustaining innovations are the incremental year-by-year improvements or breakthroughs, where established competitors almost always win the battles of sustaining technology. Disruptive innovation do not attempt to bring better products to established customers in existing markets. They disrupt and redefine that trajectory by introducing products and services that are not as good as currently available products. However, they offer other benefits, for example they are simpler, more convenient and less expensive products that appeal to new or less-demanding customers. Resulting in a new cycle. In time, this “not-good-enough” technology will improve, till it intersects with the needs of more demanding customers. When that happens, the disruptors are on their way to defeating the incumbents
Models more in detail:
S-Curve: In the innovation management field the S-Curve illustrates the introduction, growth and maturation of innovations as well as the technological cycles that most industries experience. In the early stages large amounts of money, effort and other resources are expended on the new technology but small performance improvements are observed. Then, as the knowledge about the technology accumulates, progress becomes more rapid. As soon as major technical obstacles are overcome and the innovation reaches a certain adoption level an exponential growth will take place. During this phase relatively small increments of effort and resources will result in large performance gains. Finally, as the technology starts to approach its physical limit, further pushing the performance becomes increasingly difficult, as the figure below shows.
When a product reaches its limit, new technologies can expand the S-curve. This innovation creates a new S-curve, if it is shifted to the right compared to the original one, it can reach a higher performance limit.
Abernathy-Utterback Model: As the figure indicates, the rate of product innovation in an industry or product class is highest during its formative years. During this period, called the ‘fluid phase,’ considerable experimentation with product design and operational characteristics takes place. This phase is characterized by high product innovation, with much less attention given to the processes by which products are made.
The period of fluidity, according to the model, typically gives way to a ‘transitional phase’ in which the rate of major product innovation slows down and the rate of major process innovations speeds up. At this point, product variety is superseded (or outdated) by standard designs that have proven themselves in the market as best satisfying user needs, or designs that have been dictated by accepted industry protocols or regulations. As the form of the product becomes settled, the pace of innovation in the way it’s produced quickens.
Finally, some industries into what Abernathy and Utterback call the ‘specific phase’ in which the rate of major innovation dwindles for both product and process. These industries become extremely focused on cost, volume and capacity; product and process innovation appears in small, incremental steps.
Not all industries or products pass through these phases, but the model has proven durable over the years as a way of explaining the pace of innovation as a competitive advantage.