The Economist's Blindspot

"I suddenly realized that Keynes and all the brilliant economic students in the room were interested in the behavior of commodities, while I was interested in the behavior of people." Peter Drucker

What is entrepreneurship? It’s a question that’s surprisingly difficult to answer. The problem is intrinsic: How do you define something that is always re-defining itself??

Over the last 10 years, as I’ve worked to expand my own understanding of the question and its complexities, I’ve started reading economics. Reading economics is something that is best left to economists themselves. They don’t make many accommodations for the layperson. Their writings are dense and contain a lot of impenetrable math that may seem like Greek because mostly it is written in Greek.?

Turning to the economists for answers about entrepreneurship and innovation leads to a surprising discovery: It’s stumped them as well. Despite the massive volumes of theory on everything having to do with the economy, economics has been uncharacteristically tightlipped about entrepreneurship.

Nonetheless, understanding what economists have had to say on the matter can shed a lot of light on our own understanding and assumptions. It can also explain a bit about why our approaches to entrepreneurship take the form that they do. After all, as Edmund Phelps has said, our economies tend to mirror our economics. By better understanding economics, we can better understand economies—including what new possibilities for entrepreneurship might exist beyond what we currently believe and expect.??

A world in balance??

We get the word economics from the ancient Greek: it’s the "way (nomos) to run a household (oikos)”. Political economy—which is really what we mean when we talk about economics—is the way to run a polis or state.?

Adam Smith, one of the most influential economists of all time, considered economics to be “an inquiry into the nature and causes of the wealth of nations". His book, The Wealth of Nations, which was published in 1776, marks the beginning of economics as a discipline.?

Since the time of Smith, classical economics, and later neoclassical economics, have focused on creating tools to model and analyze economies in order to then make predictions about them and prescriptions for better managing them.?

Economies are incredibly complex—they combine human behaviors and decisions, firms of all sizes, innumerable financial transactions, products and services, pricing dynamics, and demographics. The project of modeling them to make predictions and management decisions is ambitious to say the least. But the models that have been developed over the last 250 years do a surprisingly good job.?

However, in doing this job economics has largely sidestepped the question of entrepreneurship. Most economics relegate entrepreneurship and innovation to the realm of exogenous forces—things that impact and shape the economy but occur outside of it. This puts entrepreneurship in the same category as the weather, war, politics, acts of God, and technology.?

In mapping the economy, economists focus only on what already is. Their models can be validated, but they have no way to account for the introduction of new goods and services into a changing economy.??

Entrepreneurial economics

While most economists skirt the question of entrepreneurship, there have been some notable exceptions.?

The first to make a formal study of entrepreneurship was the French economist and businessman, Jean-Baptiste Say, who coined the word entrepreneur around the year 1800.?

For Say, entrepreneurs were essential intermediaries in the production process of an economy. They combined productive capacities of land, capital, and labor in order to better meet consumer demands. In playing this coordinating role, the entrepreneur would “shift economic resources out of an area of lower and into an area of higher productivity and greater yield”. The resources at the entrepreneur’s disposal were fixed. The entrepreneur might recombine and redeploy resources but they could not create new ones.?

It wasn’t until 100 years after Say’s death that another major economist proposed a theory of entrepreneurship. Joseph Schumpeter was born in Austria in 1883 and moved to the United States in 1919 where he taught at Columbia before moving to Harvard.

In Schumpeter’s theory, entrepreneurs were the creative force driving economic development. Their role was “doing of new things or the doing of things that are already being done in a new way”. (Schumpeter, The Creative Response in Economic History)

By coming up with new ideas and implementing them, entrepreneurs would sweep aside what had come before. Schumpeter described this process of innovation as unleashing a storm of “creative destruction”; an evolutionary process in which the creation of the new and the replacement of the old were two sides of the same coin.?

Schumpeter’s world would have been filled with examples of such displacements; as electric lightbulbs replaced candles and kerosene lanterns, and automobiles replaced horse-drawn carriages, and airplanes replaced steamships and railroads.?

Most economists, including Schumpeter’s contemporary John Maynard Keynes, designed their theories around movement towards states of equilibrium. In a state of equilibrium, there is perfect balance of competition; supply meets demand, allowing for prices to be set and transactions to occur.?

Schumpeter was skeptical of equilibrium models. Instead, he believed that healthy economies could actually be better defined as being perpetually thrust into states of “dynamic disequilibrium”. These disruptions were caused by entrepreneurial innovation which destroyed the status quo and replaced it with something better.?

As Schumpeter put it, “the process of industrial mutation…incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.” (Schumpeter, Capitalism, Socialism and Democracy pp. 82–83).

It’s worth noting that Schumpeter didn’t invent the notion of creative destruction—he was riffing on Karl Marx who half a century before had said that capitalism contained the “seeds of its own destruction” and that its destructiveness was a “condition of its self-preservation” (Marx, Karl, Grundrisse: Foundations of the Critique of Political Economy). Unlike Marx, however, Schumpeter saw this destructive impulse not for its ruthlessness but for its creativity.?

For Schumpeter the creative impulse that led to the destruction and replacement of the old was an act of entrepreneurial will. It was the spirit of the entrepreneur—for which he coined the word Unternehmergeist or “entrepreneur-spirit”—that would first conceive of the new before organizing and coordinating the investments and work to make it real.?

However, the thing that made new opportunities possible, came not from the entrepreneur, but from “scientists and navigators” discovering new scientific truths and driving technological progress. While the entrepreneur operated within the economy, scientific and technological discoveries that made new things possible were exogenous—they came from outside of the economy. Once they were known, the opportunities for new products and businesses that they’d enable would become obvious to all.?

This last point is critical. It means that for neoclassical economics, the rate of innovation and growth is limited to the rate of technological progress. In other words, the economy can grow no faster than new science or new technologies are either discovered or imported from other countries.

This bias towards scientific discovery and technological advance as prerequisite, is the defining characteristic of economists’ views of innovation and entrepreneurship. It’s no wonder that this bias is so widely shared in our common understanding of what makes innovation possible.?

The rediscovery of dynamism

By placing entrepreneurship outside of the economy—or tethering it to science and technology—economists have placed it outside of the norm of economic activity. Because it did not—could not—fit into their models, they’ve conveyed upon it an alien status. This status is reflected in all aspects of how we view and approach it—from policy, to education, to popular culture.?

However, there is a new theory of innovation and entrepreneurship emerging that has the promise of expanding our understanding of how new things come to be and greatly broadening our conception of what might be.?

Edmund Phelps won the Nobel Prize in 2006 for work he had done in the late 1960s on the relationship between inflation and unemployment. However, over the course of the last 15 years, Phelps has turned his attention to a new theory of innovation and entrepreneurship—one that holds the keys for a new conception of what an economy is and how people may come to participate deeply within it.?

In his 2013 book, Mass Flourishing, Phelps describes a bold, contrarian vision of “what the prosperity of nations is”. He offers “prosperity on a national scale—mass flourishing—comes from the broad involvement of people in the processes of innovation: the conception, development, and spread of new methods and products—indigenous innovation down to the grassroots.” (Phelps, Mass Flourishing, p.vii)

Phelps’ conception is radical—a direct assault on Schumpeterian assumptions about innovation that have dominated economics—and our economies—for nearly 100 years.?

For Phelps, this idea is not a mere hypothesis of what might be, but an historical description of what was during the years of massive growth and economic expansion that occurred, beginning in England and the United States between the 1820s and 1960s.?

The innovations that drove this unprecedented expansion were not solely, or even primarily, the result of scientific discovery, as is almost universally assumed. Instead, they were economies that were made dynamic because they enabled people with modern values, from all backgrounds and walks of life, to participate in the act of imagining and building new things within “a vast imaginarium… space for imagining new products and methods imagining how they might be made, imagining how they might be used.” (Phelps, Mass Flourishing, p27)?

This experience of the modern economy was one of broad inclusion. It afforded all people, including those without educations or particular skills to find new ways prosper. But beyond just making them richer, it also enabled them to flourish by giving them richer experiences of the deep satisfactions of work and the good life. These would have included opportunities to pursue new ideas, solve problems, build new skills, try new approaches, and ultimately create new things.??

In his follow-up book, Dynamism (2020), Phelps and his co-authors test this theory against the standard theories of innovation—to prove that this new kind of economy is not only desirable but achievable.?

The need is pressing. “Economics will not point us to the road we need to take and may point us to wrong roads if we misunderstand the roots of innovation.” (Phelps, Dynamism p.xi)

Economics models have painted a picture of a bloodless economy that mechanically and robotically amasses new wealth without ever stopping to consider why or what the effect may be on the people who make up these economies. They focus only on productivity and consumption—they have no place for the fundamentally human impulses of imagination and creativity.?

Our economies, managed by these narrow economic perspectives, have come to mirror them. But we can choose otherwise.?

Please note: I’m going to be heading out of town for some R+R starting next week. Brand New World will be back May 30th. Thanks for reading.?