Independent Innovation in History: Productive Entrepreneurship and the Rule of Law
he was … the entrepreneur extraordinaire, with all the requisite traits for the role: nerve, persistence, dynamic energy, a talent for propaganda, a capacity for deception, imagination.
—A description of Ferdinand de Lesseps
in McCullough, 1977, p. 53
Interviewer: “Why do you rob banks, Mr. Sutton [notorious thief of the mid-twentieth century]?”
Sutton: “Because that’s where the money is.”
It is, as a business proposition, a matter of indifference to the man of large affairs whether the disturbances which his transactions set up in the industrial system help or hinder the system at large, except in so far as he has ulterior strategic ends to serve.
—Veblen, 1904, pp. 29–30
Innovation is a heterogeneous product.
—Baumol’s third tautology
So far, we have stressed two features of the capitalist economy that, arguably, contribute to its unequaled growth record. First and, perhaps, most fundamental is the role of innovation as a primary competitive weapon, and the resulting innovation arms race. Second is the routinization of innovation that transforms it from a sequence of fortuitous occurrences into a businesslike activity that can be relied upon and is reasonably predictable. We have yet to deal with two other very relevant attributes of the free-market economy. One of these, to be studied in the next two chapters, is the profit offered by voluntary dissemination of proprietary technology and its licensing as a normal business activity. The other feature, which is the subject of this chapter, is the contribution of the independent innovator—Schumpeter’s entrepreneur. In particular, this chapter will discuss the incentive that capitalism provides to entrepreneurs to channel their activities in productive directions, rather than, as in many other forms of economic organization, in directions that contribute little to output growth or even impede it.
Because entrepreneurship is hard even to define and therefore impossible to measure statistically, much of this chapter is based on historical anecdote. Yet a good deal of this historical evidence seems to me to be compelling.1
THE REVOLUTIONARY CONTRIBUTIONS OF INNOVATORS OUTSIDE THE ESTABLISHED FIRM
This book’s focus on routinized innovation (which is guided by standard business-decision principles) is not meant to imply that nonroutine innovation (which does not emerge from established firms as part of their regular planning of competitive strategy) has become unimportant. The routine character of many innovation processes is helpful to us because it facilitates their incorporation into standard economic models of investment and other parts of microeconomic analysis. More to the point, it is an activity that was, for all practical purposes, never undertaken in any pre-capitalist economy and that patently contributes considerably to growth in the free-market economies. Routinized innovation is, indeed, of great and probably growing significance, as was suggested earlier by the fact that the bulk of U.S. R&D is now channeled through business firms. But innovation stemming from other sources has also been important and certainly continues to be so. Independent innovators continue to play a crucial role. I have already cited Scherer’s long list of major technical inventions introduced by entrant firms, which were consequently not subject to the pressures for routinization that one expects in large, established enterprises.
One can even offer the plausible conjecture that most of the really revolutionary new ideas have been, and are likely to continue to be, provided preponderantly by independent innovators. But, as already noted, that is usually only the beginning of the tale. Once a new invention proves successful, the inventors or the associated entrepreneurs often provide the product through new firms that in many cases grow large and themselves specialize in routine innovation. Such subsequent innovation, like most innovations produced by routine processes, is primarily devoted to product improvement, increased reliability, enhanced user-friendliness of products, and the search for new uses for those products. Though these routine innovations tend to be less dramatic than the original and strikingly revolutionary idea, both independent and routinized innovation activities undoubtedly contribute significantly to economic growth, as Rosenberg has emphasized (see, e.g., 1976, p. 66). In this process there is no reason to expect independent inventors or innovators to become obsolete any time in the foreseeable future. It is more plausible that this division of the work of technical progress will continue, with the independent entrepreneur providing many if not most of the more revolutionary and heterodox contributions, while the routine innovation activities of the oligopoly corporations take those contributions and improve and extend them, often well beyond what their capabilities could have been imagined to be.
ON THE SIGNIFICANCE OF THE ENTREPRENEUR
The place of entrepreneurs in the process of growth is well recognized and widely accepted, though their general absence from the theoretical literature is noteworthy. Here, I use the word “entrepreneur” in the Schumpeterian sense to mean the bold and imaginative deviator from established business patterns and practices, who constantly seeks the opportunity to introduce new products and new procedures, to invade new markets, and to create new organizational forms.2 In short, the entrepreneur is the independent innovator, in the broadest sense, meaning that the activities of this individual include, but go considerably beyond, technical inventions and their utilization.
For it is important to recognize that the innovating entrepreneur often makes no productive contribution at all, and in some cases even plays a destructive role, engaging in what Thorstein Veblen described as “systematic sabotage” of production (for example, coming up with a new way to enforce output restrictions upon the members of a cartel in order to keep prices high). This does not happen fortuitously, but occurs when the structure of payoffs in an economy is such as to make unproductive activities such as rent-seeking (and worse) more profitable than activities that are productive.
The entrepreneur is at once one of the most intriguing and one of the most elusive in the cast of characters that constitutes the subject of economic analysis. In the writings of the classical economists the appearance of this important figure was frequent, but shadowy, without clearly defined form and function. In the literature of formal theory, at least until very recently, only Schumpeter and, to some degree, Frank Knight (1921) succeeded in infusing this character with life and in assigning to entrepreneurs a specific area of activity to any extent commensurate with their acknowledged importance.3 But, to do so, these writers were forced to sacrifice analytic tractability and substantive mathematical representation. In more recent years, although economic events continue to underscore the significance of their role, entrepreneurs have nonetheless virtually disappeared from the mainstream theoretical literature. There is a good reason why entrepreneurship should elude the theorist, because by its very nature we cannot describe exactly what entrepreneurs do. An innovation, by definition, is something that has never been carried out before, or at least never in exactly the same way. It is a heterogeneous product par excellence. Anything done a second time is no longer an innovation. How, then, can generalized statements be made about it? This chapter will nevertheless suggest what I consider a promising direction for further work on the theory of entrepreneurship. But the discussion will have to be based more on history than upon mathematics.
There are important reasons why we cannot simply give up and ignore the behavior of entrepreneurs. If we are interested in explaining what Trygve Haavelmo has described as the “really big dissimilarities in economic life,” and in accounting for the extraordinary growth performance of the capitalist economies in particular, we cannot overlook the role of the entrepreneur. Recent empirical evidence as well as experience indicate that the entrepreneurial function is a vital component in the process of growth of output and productivity. For example, most empirical studies on the nature of the production function have concluded that sheer capital accumulation and expansion of the labor force leave unexplained a substantial proportion of the historical growth of the nation’s output. This is suggested, for example, in one of Robert Solow’s seminal papers (1957, p. 320). He observes, on the basis of American data for the period 1909–49, that “[g]ross output per man-hour doubled over the interval, with 87½ percent of the increase attributable to technical change and the remaining 12½ percent to increase in the use of capital.”4 But much of technical change, that is, innovation, presumably required entrepreneurial initiative. Thus, if we ignore the entrepreneur we cannot fully explain a very substantial proportion of the historic growth of the West.
The literature of development policy has also emphasized the importance of the entrepreneur, both in the Schumpeterian sense and as the creator of new enterprises of any sort. Discussions seeking to explain the success of some economies and the failure of others emphasize differences in the availability of entrepreneurial talent and in their motivational mechanisms. Plans to stimulate development include provisions for the training of entrepreneurs and for the encouragement of their activities. The absence of entrepreneurs is sometimes cited as a significant obstacle to growth. Whether or not they are assigned the starring role, they are clearly not considered minor characters.
THE ENTREPRENEUR AS ALLOCATED RESOURCE
In line with these views, it is sometimes asserted, as an explanation for the slowdown of growth of an economy, that, for some mysterious reason, the spirit of entrepreneurship and with it the entrepreneurs themselves have disappeared. Or when an economy takes off, the (unexplained) emergence of a cadre of entrepreneurs is given at least part of the credit. My position, in contrast, is that this is implausible. Entrepreneurs are not suddenly created in profusion by spontaneous generation and their ranks are not suddenly decimated by some undescribed plague. Rather, it is my belief that the explanation for this rise and fall of entrepreneurial activity is grounded in simple dollars and cents—in the changes in the economy’s structure of payoffs. Baldly put, the activities that promise the greatest monetary (or other) returns lead to a reallocation of entrepreneurs from one sector of the economy to another, and this reallocation can take forms that give the appearance of the vanishing or emergence of entrepreneurs as a group.
As an input, entrepreneurship, like any other input, can be reallocated from one task to another by a change in the relative profit prospects offered by the available alternative uses to which entrepreneurship can be put. The efforts of entrepreneurs are reallocated by shifts in the sectors of the economy and the lines of activity where profit seems most easily to be earned. Perhaps not for all entrepreneurs, but surely for many of them, the identity of the line of endeavor that offers the most promising prospect of profits is a matter of great moment. Toward the beginning of his Capital, Marx suggests that, in the profit-making production process, chairs and tables lose their distinctive attributes as usable items of furniture. Rather, both are transformed into abstract embodiments of value, into prospective sources of financial gain, and are in that sense homogenized. The same is true of the alternative occupations available for the efforts of the entrepreneur. All become homogenized into abstract opportunities for the acquisition of wealth, power, or prestige, and the pricing arrangements that determine prospective profitability therefore can have a profound influence on the pattern of allocation of the economy’s entrepreneurial resources. When an industry reaches a stage at which the opportunities for further innovation seem, perhaps temporarily, to be exhausted, it is not surprising to find entrepreneurial effort flowing out of that field and into others where the opportunities for the profitable introduction of change seem brighter. The propensity of entrepreneurs to redirect their efforts in this way has long been recognized and its contribution to the dynamism of the economy accepted.
However, sometimes the productivity consequences of such a reallocation are more questionable. For example, a change in the laws in a less developed country that greatly increases the hazards faced by entrepreneurs in directly productive lines of activity may induce them to turn their efforts to activities such as accumulation of land or advance in the government bureaucracy. And that may not just change the directions of the economy’s productive efforts, but can also reduce its output and impede its growth. This sort of reallocation of entrepreneurial effort, too, can be induced by changes affecting the relative returns to more productive and less productive exercises of entrepreneurship.
Thus, there is a variety of roles among which entrepreneurs’ efforts can be reallocated. And some of those roles do not follow the constructive and innovative script that is conventionally attributed to them.5 How entrepreneurs act at a given time and place depends heavily on the prevailing “rules of the game”—i.e., the reward structure in the economy. My central hypothesis is that it is this set of rules, and not the supply of entrepreneurs, that undergoes significant changes from one period to another, and helps to dictate the ultimate effect on the economy via the allocation of entrepreneurial resources.
UNPRODUCTIVE, RENT-SEEKING, AND DESTRUCTIVE ENTREPRENEURSHIP
A key part of my story is the contention that the entrepreneur’s activity can be, and as a matter of fact sometimes is, innovative and yet nevertheless makes little or no contribution to the real output of the economy. The activity can sometimes even reduce output or restrain its growth. “Rent-seeking,” a concept introduced by Gordon Tullock, refers, of course, to any activity whose objective is the acquisition of some of the monopoly profit or the other economic rents currently generated or potentially available in the economy. For example, consider a regulated industry that is a bilateral monopoly. Suppose one of the monopolists finds a new way to persuade the regulatory agency to readjust prices so that a larger share of the industry’s total monopoly profits flows into the coffers of its enterprise. Then it will have engaged in a successful act of rent-seeking. Such an activity can clearly be innovative. A novel legal principle may, for example, be thought of and used by the rent seeker to persuade the regulatory agency to intervene in its favor. But the activity need not contribute anything at all to economic production or productivity. Indeed, it can constitute an effective impediment to both of these, through misallocation of valuable resources into pursuits that, from the viewpoint of the economy, are useless and by forcing the targeted firm to redirect its activities into unproductive directions for the sake of self-defense.
At the extreme end of the spectrum, enterprising violence has also occurred throughout history, and continues today. The leaders of medieval mercenary armies and the early twentieth-century warlords in China were clearly businesspeople, engaged in the sale of a service as a final product or an intermediate good. Their activities were marked by innovations in strategy and technology. In short, some of them were undoubtedly entrepreneurs. But it is at least arguable that their activities reduced production and even destroyed some of the economy’s capacity to produce. So, too, is modern organized crime businesslike or entrepreneurial. Thus, unlike rent-seeking, which may merely contribute nothing to production but not actually harm it except in the sense of the opportunity cost of such activity, there is entrepreneurship whose result is substantial destruction of both output and the capacity to produce.
It is clear, then, that entrepreneurship should not be taken as a synonym for contributions to productivity and growth. Schumpeter had already drawn attention to some types of entrepreneurial innovation whose productive contributions are questionable. He included in his list of the activities of the entrepreneur “[t]he carrying out of the new organization of any industry, like the creation of a monopoly position (for example through trustification)” (1911, 1936, p. 66).
The obvious fact that entrepreneurs engage in such a variety of tasks suggests that theory can usefully consider what determines the allocation of entrepreneurial inputs among them. Presumably the reason no such line of inquiry was pursued by Schumpeter or his successors is that any reallocation of entrepreneurial resources among the items in his basic list of entrepreneurial activities, with the exception of the creation or destruction of a monopoly, does not seem very significant. All the other activities in his list are normally beneficial to production, so that the general implications of such a shift for economic welfare are unlikely to be substantial.
More substantive results from an analysis of the allocation of entrepreneurial resources require expansion of Schumpeter’s list, to include the unproductive and destructive activities that have attracted enterprising and innovative individuals throughout history. That is the approach I adopt, and I will argue that the free-market economy does a far from perfect job of attracting entrepreneurial activity into productive channels. Nevertheless, it appears to have performed far better in this role than any other type of economy.
ENTREPRENEURSHIP UNDER CAPITALISM AND ALTERNATIVE SYSTEMS: HOW PRODUCTIVE ACTIVITY BECAME RESPECTABLE
Despite the evident continuation on a substantial scale of rent-seeking and other forms of wasteful entrepreneurship under capitalism, never before has productive activity been so effective and prestigious as a method for the attainment of wealth, power, and prestige. These three goals are clearly the primary objectives of most entrepreneurs, and history indicates that many entrepreneurs are not particularly choosy about the means they utilize to achieve these ends. They, like those engaged in any other occupation, span the range of morality and dedication to virtue. So one can expect that there will be many entrepreneurs who will choose whatever activities offer the greatest promise of attaining those objectives, whatever the social consequences.
More than that, moral standards surely are not immutable. They tend to adapt themselves to current opportunities and practices, so that activities that today would be considered beyond the pale in terms of their ethics may in an earlier time have been accepted as normal and even commendable (and vice versa). As I will describe in greater detail in chapter 14, in ancient Rome and medieval China,6 with their abundance of military and nonmilitary inventions, the pursuit of wealth and power was considered as acceptable, and even as desirable, as it is in the most greed-driven of capitalist societies. But the ideas about the means that were proper for attainment of these goals were very different from today’s. Methods of wealth accumulation that were considered laudable in one or both of these societies included military aggression, ransom, bribery, and usury. Some of the great figures of Roman history, for example, were respected for having acquired vast riches by these means. The Chinese mandarins, having been appointed to powerful positions, were expected to recoup in the form of bribes the heavy expenses they incurred in preparing for the difficult imperial examinations that were requisites for such positions. No hint of scandal or disapproval attached to these means of accumulation.
But in both Roman and Chinese societies there were two types of activity that incurred unambiguous disgrace: participation in commerce or in productive activity (with the possible exception of some gentlemanly agricultural undertakings). In Rome, for example, such disgraceful endeavors were left to freedmen—to manumitted slaves and their sons. And these individuals, too, strove to accumulate sufficient means so that they could afford to leave their degrading occupations, or at least make it possible for later generations in their families to achieve respectability. It is little wonder, then, that there was not much productive entrepreneurship in these societies. Even though the Chinese, in particular, produced an astonishing abundance of inventions, there was little innovation, in the sense of the application and distribution of the inventions. Most such inventions were put to little productive use and often soon disappeared and were completely forgotten.
In the Middle Ages, similar ideas about honorable and dishonorable means to wealth and power prevailed among the nobles, though some cracks in the edifice appeared when several monastic orders adopted the idea that labor, including productive toil, was a most virtuous activity. Still, the preferred medieval ways to wealth were the public and private wars carried on by kings and nobles alike. Also in line with the orientation of the times were the occupations of the robber barons and of the leaders of private armies whose services were for hire and who undertook aggression on their own initiative when market demand for their services was poor. In the same period, rent-seeking was also a respectable avenue to wealth. The king’s friends at court who helped him against his enemies, who entertained him, and who provided him with various forms of amusement could hope for rich rewards in the form of generous grants of land, castles and other privileges. We may note again that these military activities were not merely unproductive—they were clearly destructive. They destroyed infrastructure and crops, they took into the armies people who would otherwise have engaged in fruitful labor, and they undermined production in other ways, frequently leaving poverty, misery and disease in their wake.
Destructive wars and rent-seeking activities as means to enhance wealth and power, of course, continued through the Renaissance7 and, indeed, they manifestly continue today. The idea that productive activity is disgraceful continued to guide continental European nobility well into the nineteenth century. But at least in Italy, the Low Countries, and England things began to change, roughly in the thirteenth to fifteenth centuries. As capitalistic activity rose in these countries, the relative ease of wealth attainment through banking, commerce, and production seems to have become irresistible.
The attractiveness of such pursuits also grew as the constant and urgent need for funds by the royal houses made increasingly common the sale of positions of nobility to those who could afford the steep prices. As armies grew in size and arms and ammunition became more expensive, the kings found themselves repeatedly threatened with inability to finance their wars and with bankruptcy when they could not repay their vast loans. Philip II (of Spanish Armada fame) underwent bankruptcy many times because the Cortes (the bodies of nobles whose assent for additional taxes was required) proved reluctant to levy additional tax payments on themselves. The same was true of Parliament in England, where there was instituted, during the centuries following the Magna Carta, the principle of no taxation without representation (of the nobles and the gentry, of course), an issue finally settled in the seventeenth century in the battles between Parliament and the Stuarts. Edward IV, the Yorkist king, had earlier used many devices to get out of the resulting financial difficulties. For us, it is most noteworthy that among the means he employed was entry into commerce:
Edward IV has some claim to be regarded as the first ‘merchant king’ in English history. From the beginning of his reign he sought to improve his finances by indulging in personal trading ventures, an example followed by many of his great men. Already by the spring of 1463 he was actively engaged in the wool trade. Soon after he was exporting a variety of other merchandise, notably cloth and tin, and by 1470, if not before, he was active as an importer. … In February 1470 no fewer than twenty-five ships entering or leaving the port of London contained goods of the king. … This activity continued throughout the reign. In his later years he also made use of the royal ships, when not engaged on other business, as commercial charter vessels. (Ross, 1974, p. 351, emphasis added)
Note from this passage that the king’s example was quickly followed by the nobles (the king’s “great men”). The royal example and the practice of the elite soon dissipated the shame of such activities. By the time of Adam Smith—that is, the birth of the Industrial Revolution—many members of the higher nobility were avidly engaged in canal-building projects and in other productive and innovative pursuits. And one can surmise that it was the abundance of promising wealth-accumulation opportunities offered by the emerging free market in commerce that drew the king and his nobles into the field.8
Thus, it is arguably capitalism itself that brought with it the respectability of the entrepreneur’s productive activity. Marx observed that it imparted an aura of virtue to the capitalist’s saving: “he thus forces the development of the productive powers of society. … Only as personified capital is the capitalist respectable. As such, he shares with the miser the passion for wealth as wealth. But that which in the miser is a mere idiosyncrasy, is, in the capitalist, the effect of the social mechanism, of which he is but one of the wheels” ([1867] 1906, p. 649). Two implications of this passage should be noted here. The first, as Marx also emphasized elsewhere, is the change in the standards of respectable behavior brought about by capitalism. What in another society would constitute despicable miserliness becomes in a capitalist world an in-escapable mode of behavior, and one that contributes materially to growth of productivity. Second, Marx asserts that this form of economy leaves no choice to the capitalist entrepreneur. He is required by social forces to expand the productive powers of society and is driven, moreover, “ruthlessly [to force] the human race to produce for production’s sake” ([1867] 1906, p. 649). Thus, “[t]he bourgeoisie cannot exist without constantly revolutionizing the instruments of production, and thereby the relations of production. … Conservation of the old modes of production in unaltered form, was, on the contrary, the first condition of existence of all earlier industrial classes” (Marx and Engels, 1847).
It is noteworthy how different from such capitalistic behavior was the role of the entrepreneur in the former Soviet economies, which allegedly sought to follow Marxian guidelines. In the controlled economies of the old Soviet Union, entrepreneurship was driven back to its rent-seeking orientation, with gains to be sought by becoming bureaucrats and Communist Party officials.9 Managers of economic enterprises were in effect penalized for undertaking any innovative steps that increased productivity. This happened in at least two ways. First, a manager’s reward depended on the firm’s success in meeting an assigned “production norm” for the year. But any disruption caused by the retooling necessary to carry out an innovation would threaten failure to meet that current production target. Second, if an innovation were carried out and promised to increase productivity, that was all too likely to lead to the assignment of a higher production target in future years, making the manager’s task that much more difficult. These were just two of the obstacles to the exercise of productive entrepreneurship in the Soviet economies.10
These are handicaps generally absent from the free-market economies. It is true that in market economies there remains an abundance of opportunities for profit through legal rent-seeking or through outright criminal activity, much of it an impediment to growth. But the free market also offers rich rewards to the entrepreneur who successfully introduces productive innovation. And, simultaneously, it changes the standards of commendable behavior, making a role model of billionaire innovators, particularly if their earnings stem from contributions to production. For the rising wealth and power of the capitalist entrepreneurs enable them to purchase respectability, both through their impressive productive and accumulative accomplishments, and via good works they subsequently undertake with their wealth. In short, the free-market economy offers encouragement to productive entrepreneurship such as no other form of economy has ever provided. This is, then, plausibly, another crucial component underlying the dramatic growth performance of capitalism.
ENTREPRENEURSHIP UNDER CAPITALISM: THE RULE OF LAW AND SANCTITY OF PROPERTY
I have sometimes asserted that that there is no occupation whose total economic product is greater than that of lawyers; and none whose marginal contribution is smaller. But it is the total contribution that matters most. A strong case can be made for the conclusion that without the rule of law, including the rights of property and the enforceability of contracts, the growth miracle of capitalism, indeed capitalism itself, might not have been possible.11
To discuss the significance of the rule of law and provide some indications of its origins, it is appropriate to return, once again, to a bit of history. In many earlier societies there was no such thing as the right of private property. At least in theory, all property belonged to the monarch, who was entitled to requisition any of it whenever it suited his purposes. This was notably true in ancient China, where not only money and physical property were subject to expropriation, but even innovations themselves were likely to be taken over by the state. For example, it is reported that “frequently … during the course of Chinese history … the scholar officials … gathered in the fruits of other people’s ingenuity. … Three examples of innovations that met that fate [are] paper, invented by a eunuch; printing, used by Buddhists as a medium for religious propaganda; and the bill of exchange, an expedient of private businessmen” (Balaszs, 1964, p. 18. For more of the quotation, see chapter 13, below). Even the Church was not immune from royal takings, sometimes on a massive scale, as in the expropriation of the Templars12 by Philip IV of France (Philip the Fair) in 1307 or that of the monasteries by Henry VIII of England, more than two centuries later.
The resulting uncertainty was surely a major discouragement to saving and to innovative activity alike. Wealth was best rapidly consumed, lest it serve as a temptation to government acquisitiveness, and it may be conjectured that this contributed to the propensity of the nobility in a number of societies to be perpetually in debt. Productive innovation, aside from receiving little recognition, much less admiration, was rarely worth the required effort. Without the rule of law, clearly, enormous obstacles prevented economic growth of any substantial magnitude.
Capitalism itself, even more clearly, was precluded by absence of the rule of law. Capitalism requires markets in which the participants can have confidence in any agreements arrived at. It is driven by the pursuit of accumulated and retainable wealth and opportunities to expand that wealth by devoting it to the production process. Sanctity of property and contract, and institutions that can be relied upon to enforce them both, are necessary conditions for the creation of capitalists and for effective execution of their role. That is why, without the contribution of the lawyers, the free-market economies might never have evolved. And even if they had, it is unlikely that their unprecedented growth could have occurred. It is on these grounds that I base my evaluation of the enormous total contribution of lawyers to the performance of the industrial economies.
But how was the rule of law introduced? A key to the answer arguably lies in economic pressures, together with the limited power of the kings. At various times these rulers were forced to grant (and reconfirm) privileges and protections to their subjects either under direct compulsion (as at Runnymede in the case of Magna Carta) or in exchange for needed favors. For it must be understood that the term “absolute monarchy” was always a misrepresentation of the facts. Even the most powerful kings and emperors held absolute sway only over limited geographic areas and over those subjects who were not too remote in location or too elevated in station. Primitive means of transportation, an absence of standing armies (rather than mercenaries or troops provided by powerful subjects under traditional arrangements), perpetual shortage of funds, and tiny administrative bodies meant that the medieval and Renaissance kings possessed only very limited power. They had no effective tax collection agencies, a gap, as we know, that prevailed in France until the Revolution. The kings also found it difficult to borrow, and had to pay higher interest rates than many other borrowers because there was no way they could make an enforceable commitment to repay. After all, there existed no court in which a debtor could sue the ruler.
The consequence was that in order to carry out their prime occupational duty—warfare—the kings (some historians have called them the “pauper kings”) were frequently driven to beg for funds from the parliament, the Spanish Cortes, or the other bodies that held the power to tax. And those bodies frequently demanded and often received concessions in return. The century after Magna Carta inaugurated the process of conceding the sanctity of property, including immunity from taxation without representation, a process carried to its conclusion in England in the struggle between Charles I and his parliaments. In effect, the rule of law can to some degree be ascribed to the low productivity of the medieval economy, which kept even the kings in poverty in terms of what one expects of the financial circumstances of a monarch. Certainly they were constantly hampered by lack of resources for the activity on which they were expected to focus—aggressive warfare. Underpaid troops deserted and mutinied, and kings underwent repeated bankruptcies in wartime, as I have already noted. Under such pressures, and with their own nobility often themselves aggressive and unruly, the kings were forced, time after time, to agree to grant protections to various groups of subjects against certain arbitrary royal actions. The beneficiaries included not only the nobles but also the towns, which early began to acquire their traditional “liberties.” As these protections evolved and accumulated, they grew into a body of law. Driven by economic forces—the low medieval productivity and the resulting royal poverty—they became the legal foundation for a free-market economy in which entrepreneurship could flourish and production could explode.13
CAPITALISM AND INDEPENDENT INNOVATION: OUTLINE OF THE SEQUENCE OF DEVELOPMENTS
The conclusion of this discussion is that entrepreneurs—that is, independent innovators—have played a critical role in the growth performance of the capitalist economy. They were indispensable at its inception, introducing new business methods and other innovations without which the free-enterprise system could not have prospered. They adopted new processes, ranging from the use of better ships provided by the Venetians, the Genoese, and the Dutch, to financing innovations such as the introduction of equity as a supplement to debt in the financing of business ventures,14 and procedures such as double-entry bookkeeping. This was centuries before the Industrial Revolution in eighteenth-century England.
The conditions for the rise to economic importance of the independent entrepreneur can perhaps be ascribed to historical accident. We have seen how the emergence of the rule of law, the sanctity of property, and the evolving respectability of commercial activity grew out of the antagonism between the nobility and their monarchs and were solidified in the religious disputes of the seventeenth century. The kings, pursuing their own interests, did what they could to bring free-enterprising violence under control, thereby foreclosing this easy avenue for unproductive entrepreneurship. Then the upper classes, in their turn, did what they could to limit the powers of the king by restricting his ability to offer rich rewards to rent seekers.
Thus, the conditions for the flowering of productive entrepreneurship seem, ironically, to have emerged out of the struggle for power between the kings and their nobility, each side seeking to ensure its unhampered ability to pursue its natural occupation—destructive warfare. The monarchs, to succeed in their purpose, had to foreclose the route to independent military entrepreneurship by their unruly barons. The nobles, in turn, required the protection of rules such as those embodied in Magna Carta. In the seesaw battle between these two antagonists, when the power of the barons was in the ascendant, commitments such as the sanctity of property, assent to taxation by the taxpayers, and the rule of law were adopted (for themselves, of course). In a later period of ascendancy of the upper classes, they reduced the opportunities for rent-seeking by limiting the power of the king to grant monopolies and other sources of rents to his friends and others who served his purposes. When it was the king’s turn as victor, it was the destructive entrepreneurship of the nobles that was curbed, foreclosing violence and aggression as an easy avenue to wealth and power. The ultimate winner was a third party, apparently not concerned in this struggle—those whom Marx had dubbed the “bourgeoisie.” But the beneficiaries also included those nobles who were induced to participate in bourgeois undertakings such as commerce and production by the more restricted availability of wealth from rent-seeking and violence. From this group, whose activities were made possible by the evolving political rearrangements and by the guarantees of the rule of law, there arose the productive entrepreneurs who brought the free-enterprise economy into existence.15
But once the conditions that nurtured capitalist entrepreneurship emerged, economic forces took over. The success of earlier innovators in commercial and productive activities encouraged other innovators to follow their lead, both by showing how it could be done and by publicizing the rewards. But it also brought political power to this class and to the capitalists who helped to finance their activities. This power was used to strengthen the rule of law and the rights of property, and to encourage other governmental measures that solidified and improved the environment’s hospitality to productive entrepreneurial activity.
At the same time, in a number of industries, innovation expanded the scale of the firm required for economic efficiency. Canal building, railroad construction, steel manufacturing, and other such activities could not be carried out efficiently by the minuscule enterprises of an earlier era. These large enterprises evolved into oligopolies and their rivalry forced them to employ whatever weapons promised to preserve and perhaps enhance their market position. New products and processes were obvious tools for the purpose. Then, as described in earlier chapters, the pressures of competition forced these firms to do what they could to reduce the uncertainties of innovation. They did so by taking over much of the process as part of the routine operation of the firm.
Today we are left with an economy that derives innovations from both sources—from the routine activities of giant firms and from independent inventors and their entrepreneur partners (who are sometimes the same person).16 But, as already observed, these are not purely substitute activities. Rather, there has been a predictable tendency toward specialization: the entrepreneurs providing the more heterodox, breakthrough innovations, and the R&D establishments of the larger firms creating the enhancements to those breakthroughs that contribute considerably to their usefulness. Thus, there is superadditive complementarity between the roles of the two types of innovating enterprise, and growth is arguably enhanced by this division of their labor.
In sum, growth in the free-market economy, from its inception (and still today), has served as a stimulus to entrepreneurship. But entrepreneurship has returned the favor, making a constant and major contribution to capitalist growth.
___________
1. As that noted economic historian David Landes once remarked, “One good anecdote is worth more than a number of questionable statistical tables.” (This statement was made orally at a conference, and is reproduced here from memory, but with permission.)
2. Thus, I do not use the term to refer to anyone who creates a new firm, however conventional and insignificant. This more common usage, incidentally, is probably closer to the original interpretation of the term when it was introduced into English in the nineteenth century. For an example of the insight that can be brought by rigorous analysis to the entrepreneur as firm creator, see Sharon Gifford (1998). Professor Gifford takes off from Israel Kirzner’s observation that alertness and attention to opportunities are crucial attributes of the entrepreneur. Gifford then points out that limits upon entrepreneurs’ available time raise the issue of the allocation of their attention between the management of their established enterprises and the formation of newer enterprises. On this basis, Gifford derives a variety of illuminating results.
3. For more on the entrepreneur in the history of economic ideas, see Mark Blaug (1999).
4. Solow’s article has, understandably, led to an enormous literature, some of it critical. For example, Solow’s quantitative estimate was challenged in an article by Jorgenson and Griliches (1967). However, none of the revisions proposed there and elsewhere seems to have denigrated the role of the entrepreneur. Jorgenson and Griliches (1967) reevaluated the magnitude of the role of technical change as a residual, estimating the remaining contributions to labor productivity directly in terms of expansion in the quantities of inputs measurable by conventional methods. It is undoubtedly true that growth in output contributed by entrepreneurship and innovation often requires corresponding increases in input quantities, but that does not mean that the entrepreneur has played little or no role in the generation of such output increases. It merely means that, since the amount of entrepreneurial activity is difficult to quantify, the correlation between that activity and the quantities of conventional outputs makes the role of the enterpreneur even more difficult to measure.
Moreover, more recent work by Jorgenson, Gollop, and Fraumeni (1987), which, on the basis of highly sophisticated econometric analysis, assigns a primary role to the capital stock in the remarkable postwar rise in U.S. labor productivity, nevertheless attributes more than one-third of the annual growth rate in labor productivity to innovation (pp. 1–2).
5. A very similar viewpoint, stressing the allocability of persons with innovative talent among productive and less productive activities is taken by Murphy, Shleifer, and Vishny (1991) in a very illuminating theoretical and empirical analysis. The same general idea, albeit in more specialized terms, appears in the writings of Leijonhufvud (1983).
6. For a very penetrating discussion of the case of medieval China, see Landes (2001).
7. During the Renaissance, an ecclesiastical career could be a source of fantastic rents. A spectacular example is provided by the payoffs by the Borgia Pope, Alexander II, to those cardinals who had voted for his elevation: “Alexander set about making good his promises. … such practices had become common over the years in the conclaves. … First in line was Cardinal Sforza, the leading voter for the Pope, who became vice-chancellor. He was given the castle of Nepi, the bishopric of Erlau in Hungary, Rodrigo’s annuities from the bishoprics, monasteries, and churches of Sevilla and Cádiz, and the legations of Bologna, the Romagna, and the exarchate of Ravenna. Before the election, four mules laden with sacks of silver had been seen wending their way from the Borgia palace toward Sforza’s home … Cardinal Orsini received the cities of Monticelli and Soriano, the legation of the Marches and the bishopric of Cartagena, valued at 7,000 ducats, as well as a bonus of 20,000 ducats. For his part, Cardinal Collona was given the abbey of Subiaco with the twenty-two castles belonging to it, and an income of 2,000 ducats, to which the Pope added a bonus of 15,000 ducats. Cardinal Savelli received Civitá Castellana and the bishopric of Mallorca, worth 6,000 ducats, with a bonus of 30,000 ducats [etc., etc.] ….” (Cloulas, 1989, p. 71). It should be noted as a suggestive standard of comparison that any person with assets of 20,000 ducats was considered extremely wealthy at that time.
8. Still, it is difficult for us in the twenty-first century to imagine the degree of dependence of the economy in the late medieval England of Edward IV and his successor, Richard III, upon rent-seeking and granting of such “rents” by the king to secure the seekers’ services and their loyalty (an activity replicated by the great nobles in dealing with their own affinities). The primary components of this form of compensation were land and offices in the royal household and elsewhere. A curious feature of this arrangement stemmed from the fact that, because the amount of land and number of available offices were limited, the king often gained power from the resources he acquired and was able to give away after unsuccessful rebellion, as the traitors were attainted and their properties and positions forfeited. Notable examples followed the death of Warwick, the kingmaker, in battle under Edward IV and the execution of the King’s brother, Clarence, after repeated acts of treason, and the execution of Buckingham under Richard III. For a detailed description of the rent-seeking structure of the society in the period, see Rosemary Horrox (1989).
9. Of course, this happens in market economies as well, but there is a substantial difference in degree.
10. After this passage was written, I came across a much more careful and detailed analysis by Maurizio Iacopetta, a Ph.D. student at New York University (“Techological Diffusion in Market vs. Planned Economies,” unpublished) that reaches essentially the same conclusion, but is based on far more sophisticated analysis than mine. Iacopetta provides clear evidence that invention was quite abundant in the Soviet Union, but what was missing was innovation, that is, the dissemination and widespread utilization of the inventions.
11. See Rosenberg and Birdzell (1986) and de Soto (2001) on this subject.
12. The fact that the bulk of what Philip obtained from the Templars went to the Order of the Hospitalers rather than to the royal treasury does not matter here. Philip seems quite clearly to have been seeking a new source of funds, having run out of such conventional sources as the Jews, who had just been expelled from France (Strayer, 1980, p. 287).
13. Landes (1998, p. 590) writes: “Why this peculiarly European … cultivation of invention—or what some have called ‘the invention of invention?’ … In the last analysis … I would stress the market. Enterprise was free in Europe. Innovation worked and paid, and rulers and vested interests were limited in their ability to prevent or discourage innovation. Success bred imitation and emulation.”
14. It has been argued that the invention of equity was at least to some degree stimulated by the desire to evade the Church’s prohibition of usury, on the argument that equity investors are actual participants in the venture and their earnings, consequently, are not merely a return on the provision of money, with no personal contribution by the investor.
15. In discussing “Why Europe?” [why Britain?] for the origins of the growth economy, Landes (1998, pp. 217–18) also stresses the institutional attributes that I emphasize in this chapter: secure private property to encourage saving and investment, secure rights of personal liberty, and enforced rights of contract, as well as stable, honest, and responsive government. See also his remark, “In despotisms, it is dangerous to be rich without power. So in [such regimes] capital accumulation proved an attractive nuisance. It aroused cupidity and invited seizure” (p. 398).
16. Of course, the universities and the government also make very substantial contributions.