A Dearth of Exit Strategies

Image courtesy of Flickr user Sergei Golyshev.

While governments deliberate responses to the financial crisis of 2008 and its aftermath, one important question should not be overlooked: What will be the long-term impact of the crisis on technological innovation? As part of the fallout from the financial crisis, funds for many types of economic activity have become far more scarce—and that includes research and development.

As economists know, innovation is a key driver of economic growth. Any significant decline in the rate of invention would have a much bigger impact on growth over the next 10 to 20 years than whatever few percentage points of GDP we may lose during the next couple of years because of recession. Thus, we need to be concerned about the impact of the financial crisis on the system of innovative activity in the United States and elsewhere.

The notion that a recession is problematic for the rate of innovation is a controversial one. No less a figure than economist Joseph Schumpeter welcomed downturns because he thought that they weeded out old processes and products in the economy. Schumpeter’s conception of the innovative process held that successful entrepreneurs are the generators of economically productive ideas and that over time they transform their businesses into larger enterprises. Those larger enterprises, Schumpeter argued, become more conservative and seek to protect their hard-won market positions. To the next generation of entrepreneurs, the established companies represent a barrier to competing successfully in the marketplace. By shaking out less efficient established enterprises, recessions create opportunities for entrepreneurs once again, Schumpeter thought. He coined the phrase “creative destruction” to describe the phenomenon and saw the cycle of boom and bust as necessary for economic progress.

Two Pathways for Entrepreneurial Start-Ups

We are, however, no longer in the economy of the early- to mid-20th century, when Schumpeter wrote. The fact that new ideas must in some sense displace old ones remains true—but, in today’s economy, the mechanisms of entrepreneurial innovation are somewhat different. In particular, entrepreneurship in some critical technology sectors is dependent upon the activities of larger enterprise in new ways. What is troubling is that the financial crisis poses a risk to that relationship.