The Free-Market Innovation Machine

The Free-Market Innovation Machine: Analyzing the Growth Miracle of Capitalism

Copyright Date: 2002
Edition: STU - Student edition
Pages: 336
  • Cite this Item
  • Book Info
    The Free-Market Innovation Machine
    Book Description:

    Why has capitalism produced economic growth that so vastly dwarfs the growth record of other economic systems, past and present? Why have living standards in countries from America to Germany to Japan risen exponentially over the past century? William Baumol rejects the conventional view that capitalism benefits society through price competition--that is, products and services become less costly as firms vie for consumers. Where most others have seen this as the driving force behind growth, he sees something different--a compound of systematic innovation activity within the firm, an arms race in which no firm in an innovating industry dares to fall behind the others in new products and processes, and inter-firm collaboration in the creation and use of innovations.

    While giving price competition due credit, Baumol stresses that large firms use innovation as a prime competitive weapon. However, as he explains it, firms do not wish to risk too much innovation, because it is costly, and can be made obsolete by rival innovation. So firms have split the difference through the sale of technology licenses and participation in technology-sharing compacts that pay huge dividends to the economy as a whole--and thereby made innovation a routine feature of economic life. This process, in Baumol's view, accounts for the unparalleled growth of modern capitalist economies. Drawing on extensive research and years of consulting work for many large global firms, Baumol shows in this original work that the capitalist growth process, at least in societies where the rule of law prevails, comes far closer to the requirements of economic efficiency than is typically understood.

    Resounding with rare intellectual force, this book marks a milestone in the comprehension of the accomplishments of our free-market economic system--a new understanding that, suggests the author, promises to benefit many countries that lack the advantages of this immense innovation machine.

    eISBN: 978-1-4008-5163-8
    Subjects: Economics

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-vi)
    (pp. vii-xiv)
  4. CHAPTER 1 Introduction: On the Engine of Free-Market Growth
    (pp. 1-16)

    Under capitalism, innovative activity—which in other types of economy is fortuitous and optional—becomes mandatory, a life-and-death matter for the firm. And the spread of new technology, which in other economies has proceeded at a stately pace, often requiring decades or even centuries, under capitalism is speeded up remarkably because, quite simply, time is money. That, in short, is the tale told in this book—an explanation of the incredible growth of the free-market economies. The capitalist economy can usefully be viewed as a machine whose primary product is economic growth. Indeed, its effectiveness in this role is unparalleled....

    • CHAPTER 2 The “Somewhat Optimal” Attributes of Capitalist Growth: Oligopolistic Competition and Routinization of Innovation
      (pp. 19-29)

      The phrase “somewhat optimal” appears to be an oxymoron, but actually describes the growth processes of capitalism effectively. Indeed, there is no foundation for a claim that free-enterprise economies automatically tend to satisfy the requirements of ideal economic efficiency in the growth process. Yet there are substantial reasons to conclude that the patently extraordinary growth record of the free-enterprise form of economic organization is hardly accidental, and that it is in large part attributable to the pressures of the free market upon the business firm, which force it to spend liberally and continually on the innovation process and to make...

    • CHAPTER 3 Oligopolistic Rivalry and Routinization to Reduce Uncertainty
      (pp. 30-42)

      This chapter discusses the transformation of the innovation process in response to competitive pressures, a transformation that has changed a major portion of the activity from an entrepreneurial to a managerial affair.¹ It offers some evidence that firms have increasingly taken over the process of technical change, transforming it from a fitful and uncertain discovery process into something closer to a routine internal matter governed by the bureaucratic and managerial procedures that also control many of the other activities of the large corporation. This is yet another consequence of the role of innovation as one of the primary weapons of...

    • CHAPTER 4 Oligopolistic Rivalry and Routine Innovation Spending: Theory of the Engine of Unprecedented Capitalist Growth
      (pp. 43-54)

      In this chapter we come to what, in my view, is the main influence explaining why the growth performance of the capitalist economy continues to be so different from that of all other economic forms. Using tools not much beyond the elementary textbook level, I will focus on a feature of free competitive markets to which I ascribe much of the extraordinary growth of the market economies. That feature is the process by which oligopolistic competition determines the level of innovation expenditure and its trajectory over time. That is, we turn now to the free-market economy’sproductionof innovation. I...

    • CHAPTER 5 Independent Innovation in History: Productive Entrepreneurship and the Rule of Law
      (pp. 55-72)

      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...

    • CHAPTER 6 Voluntary Dissemination of Proprietary Technology: Private Profit, Social Gain
      (pp. 73-92)

      The previous chapter dealt with the market’s offsets to one major impediment to productivity and growth—the diversion of entrepreneurial effort and ability to unproductive activities, such as rent-seeking. In this chapter, I will examine the way in which the free-enterprise mechanism alleviates another major impediment to growth. Because firms gain competitive advantage from their possession of products and processes that are unavailable to rivals, we might expect them to do whatever they can to impede or prevent the spread of this proprietary technology. However, if every firm is denied access to the innovations that are currently employed by others,...

    • CHAPTER 7 Oligopolistic Rivalry and Markets for Technology Trading
      (pp. 93-119)

      I turn now to a second mechanism that encourages and facilitates voluntary dissemination of new technology. The previous chapter discussed the profit incentive offered by the market mechanism for the licensing of proprietary technology. It also described the resulting consequences for efficiency in the use of innovations and for the rate of economic growth, arguing that the effect is generally beneficial. In the current chapter I will discuss the trading by competitors of the right to use one another’s technology, rather than the unilateral sale of such a right via licenses. It may appear at first glance that there should...

    • CHAPTER 8 Tradeoff: Innovation Incentives versus Benefits to Others (Distributive Externalities)
      (pp. 120-148)

      The central conclusion of this chapter will be that, despite the substantial spillovers (externalities) of innovation, expenditure on R&D in the free-market economies may nevertheless be quite efficient. There is a tradeoff between the welfare contribution of the spillovers and the welfare gain forgone because of the resulting limitation of the payoffs to innovators. Such a tradeoff has already long been recognized from the Dupuit (1853)/Samuelson (1954) analysis of public goods, and its implication that any nonzero price for the use of such a good is inefficient if it decreases such use. This is so because an additional user of...

    • CHAPTER 9 Oligopolistic Competition, Pricing, and Recoupment of Innovation Outlays
      (pp. 151-160)

      Part II will, to some extent, look further into the growth process of the free-enterprise economy. Notably in chapter 13, I will return to the discussion of licensing and the voluntary dissemination of proprietary technology, considering the magnitude of license fees, deriving necessary conditions for consistency of this price with economic efficiency, and obtaining an explicit pricing formula. That chapter will also consider whether market forces lead to the adoption of such efficient licensing prices, and will conclude that the market does provide such incentives, though perhaps not always sufficiently powerful, in reality, to lead to prices that approximate optimality....

    • CHAPTER 10 Microeconomic Theory of Industrial Organization in the “Innovation-Machine” Economy
      (pp. 161-182)

      This chapter provides an overview of the way in which the “invention-machine” economy requires us to modify our vision of the microeconomy, in particular of the firm and of industry. I will show that the differences from the traditional scenario are profound.

      Although no one has claimed that the world is perfectly competitive in the textbook sense, traditional microeconomic theory implies that the depiction provided by the perfect competition model is sufficiently pertinent to enable us to understand the workings of real-world market forces.¹ And that modelisarguably pertinent to the world of the early nineteenth century, when a...

    • CHAPTER 11 Recouping Innovation Outlays and Pricing Its Products: Continued
      (pp. 183-198)

      This chapter continues with analysis of the financing of innovation, treating expenditure for this purpose as just another of the firm’s portfolio of investments. It focuses on the intertemporal pattern of final-product prices that returns the investment in a manner compatible with economic efficiency. The analysis will illustrate once again the ways in which our theoretical work becomes easier when we recognize that decisions on routine investment in innovation are very similar to those on other types of business investment; indeed, many parts of those decisions are formally identical. In particular, this is because the grand budgeting decisions of the...

    • CHAPTER 12 Models of Optimal Timing of Innovation
      (pp. 199-214)

      This chapter provides another illustrative application of the standard tools of microeconomic analysis to innovation—this time to timing issues. In particular, it focuses upon the optimal length of time a product or process undergoing continued improvement via research and development (R&D) should continue to be kept in the firm’s R&D facilities before it is released to the market. Unlike the previous two chapters, the issues raised here are not at the heart of mainstream microtheory. But the discussion shows that the standard microeconomic tools can offer concrete results that are far from obvious and that may have substantial applications....

    • CHAPTER 13 Licensing for Profit: Efficiency Implications
      (pp. 215-242)

      In this chapter, I provide a final illustration of the ways in which innovation and growth theory can be adapted to standard microeconomic analysis. But this case will not involve mainstream value theory, and the related theory of the firm will be used only toward the end of the chapter. Rather, I will use another well-developed body of analysis—the theory of the economic regulation of business firms. This material deals with what is referred to as “parity pricing” of bottleneck inputs (see, e.g., Laffont and Tirole, 2000).¹ These are inputs owned by a single proprietor firm, which uses them...

    • CHAPTER 14 Capitalism’s Unique Innovation Machine: Historical Evidence
      (pp. 245-261)

      This third part of the book takes a preliminary look at the bottom line of our discussion: What does it all add up to for the economy as a whole? Part I and portions of part II have sought to contribute some analysis of the free-enterprise growth process, viewed from the microeconomic side. I have contended that this is where onemustlook to discover the critical attributes of the capitalist growth process that account for its unparalleled accomplishments. But that is not enough. Even if we were to prove that each of the components, individually, works in the right...

    • CHAPTER 15 Macroeconomic Models and Relationships That May Limit Growth
      (pp. 262-283)

      This chapter differs from the materials in parts one and two of this book in two main ways. First, its analysis is macroeconomic rather than microeconomic. Secondly, and more substantially, it examines some of the forces that may conceivably bring the unprecedented growth performance of the capitalist economies to an end, slowing it to the pace of progress of earlier eras.

      The question, then, is, how may such an ending come about? Of course, if the end of spectacular growth is sufficiently far in the future it is almost the same, as a practical matter, as never-ending advance. And such...

    • CHAPTER 16 Feedback: Innovation as a Self-Nourishing Process
      (pp. 284-298)

      The previous chapter ended on a rather inauspicious note, showing at least one course of events that could end up with the incentives for routine invention activity attenuated, and the rising trajectory of resources devoted to R&D petering out or ceasing altogether. But that scenario was meant primarily to represent a possibility that by no means constitutes an immediate threat or even one for the foreseeable future. Chapter 15 was not meant to draw attention to any imminent crisis but, rather, to call attention to the dangers of the fallacy of composition, which, in this case, involved generalizing from the...

    (pp. 299-306)
  9. INDEX
    (pp. 307-318)