Entrepreneurship: The Source of All Innovation

Economist Israel Kirzner described the typical entrepreneur as displaying “vision, boldness, determination and creativity” and alertness to available opportunities for profit. Economist Joseph Schumpeter wrote of the “creative destruction” that resulted from the activities of entrepreneurs. Both considered these roles essential to economic growth – the one citing the innovations that make positive changes to the lives of consumers, and the other the manner in which such innovations necessarily make redundant already existing income-earning products and services.

The creative and destructive functions of the entrepreneur are the two sides of the entrepreneurial coin, simultaneously creative and destructive. Whenever consumers switch their preferences from one product to another, they cast a vote in favour of the new and withdraw support from the one they might have favoured for many years. They might find that they prefer the old favourite after all, and shift their vote back again, thus dismissing the new product, and continue to buy the old. Sometimes ‘brand loyalty’ delays the overthrow of the old product by the new, but this depends on many factors of which functionality and price are but two. When consumers are sovereign, as they should be in a free society, they are the force that determines what goods and services should be produced or provided, where and how and by whom they are to be delivered, and at what price.

While this ‘voting’ behaviour of consumers might appear inconsequential to the casual observer, the consequences for the creators of the new product and the producers of the old can be either highly satisfactory or totally devastating. At any time, a new product or method of delivery can drive another out of the market and even cause a long-established business to close down.

New products or methods of delivery seldom capture and continue to hold the votes of consumers for a decade or more. It does occur, though, when the innovations are revolutionary and change people’s lives so dramatically that they can never be the same again.

The Industrial Revolution, which occurred in the UK and the US in the late 18th and early 19th centuries, was a period filled with such innovation. James Watt built a steam engine (1775) that could power mills, spinning machines and looms, and transformed the lives of Britons. Mass produced cotton cloth made cheap clothing available to people who previously did not enjoy the luxury of having a change of clothing. Innovations in steel production by Henry Bessemer and the Martin brothers took steel production in England from 60,000 tons in 1851 to 3,637,000 tons in 1899. The discovery of oil in the US in 1859 and methods of utilising it provided a new source of energy, while coal production increased four hundredfold in the 150 years from 1785. Alexander Graham Bell registered his patent for the telephone in 1847, and Orville and Wilbur Wright made the first successful powered flights in 1903 (12 seconds) and 1904 (5 minutes).

Great entrepreneurial discoveries of the last 200 years are taken for granted. A discovery is made, life changes hardly or dramatically, people adapt, and then press on. Often ignored is the huge amount of accumulated knowledge that enables every single innovation to be constantly reproduced, applied and improved upon.

Consumers with the freedom to choose and the means to purchase innovative products and services, and the entrepreneurs who have the freedom and essential capital to research, experiment, develop and produce such products and services are the vital cogs in the wheels of our current civilisation. But it is the freedom to choose that makes the process possible and allows it to function, renew and advance. If consumers are prevented from making their choices freely, entrepreneurs are deprived of the information they need to make innovations of interest to potential customers. And innovation is also stifled if entrepreneurs are shackled by regulation from responding to the demands of consumers or are not allowed to profit from their innovations.

Israel Kirzner in his book How Markets Work: Disequilibrium, Entrepreneurship and Discovery described what drives and motivates the entrepreneur:
Of course, in order to sense the possibility of pure profits in a particular line of production, through having a ‘nose’ for price differences, it is most helpful for the entrepreneur to have a keen sense (or, at least, a keen sense of where to hire employees with this keen sense) both for technical production possibilities and for future consumer preferences in this line of production. But ultimately it is his sense for the possibility of pure profit (because of differences between resource prices and product prices) which drives his activity and motivates his alertness to technical production possibilities and to future consumer preferences. It is the law of the single price which, working through the process of entrepreneurial discovery, powerfully redirects the pattern of capitalist production into more, rather than less, allocatively efficient channels.

Bill Gates of Microsoft undoubtedly fits Kirzner’s description of the entrepreneur. He had the keen sense to identify the potential of the personal computer when IBM first produced it. He followed through on his discovery of the “pure profit” that lay in producing software that would make the PC accessible to individuals with no training in computers. He also had the “keen sense of where to hire employees with this keen sense both for technical production possibilities and for future consumer preferences in this line of production”. His entrepreneurial sense has allowed him in 35 years of doing business to become, reputedly, the richest man in the world. His wealth has been derived from serving consumers, changing their lives by playing an important role in allowing them to become more efficient, gain more knowledge and communicate better – all valuable capabilities and attributes.

AUTHOR Eustace Davie is a director of the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author's and are not necessarily shared by the members of the Foundation.

FMF Feature Article / 30 November 2010