The free-market innovation machine : analyzing the growth miracle of capitalism

319 Pages·2004·2.53 MB·English

by  Baumol

The Free-Market Innovation Machine
The Free-Market Innovation
Machine
Analyzing the Growth Miracle of
Capitalism
WILLIAM J. BAUMOL
PRINCETON UNIVERSITY PRESS
PRINCETON UNIVERSITY PRESS
Princeton, New Jersey
Copyright © 2002 by Princeton University Press Published by Princeton University Press,
41 William Street, Princeton, New Jersey 08540
In the United Kingdom: Princeton University Press, 3 Market Place, Woodstock,
Oxfordshire OX20 1SY
All Rights Reserved
Fourth printing, and first paperback printing, 2004
Paperback ISBN 0-691-11630-X
THE LIBRARY OF CONGRESS HAS CATALOGED THE CLOTH EDITION OF THIS BOOK AS
FOLLOWS
Baumol, William J.
The free market innovation machine : analyzing the growth miracle of
capitalism / William J. Baumol.
p. cm.
Includes bibliographical references (p. ) and index.
ISBN 0-691-09615-5
1. Capitalism. 2. Economic development. 3. Technological innovations—
Economic aspects. I. Title.
HB501 .B38 2002
330.12'2—dc21 2001056044
British Library Cataloging-in-Publication Data is available This book has been composed
in Stone Serif by Princeton Editorial Associates, Inc., Scottsdale, Arizona Printed on acid-
free paper. ∞
pup.princeton.edu
Printed in the United States of America
10 9 8 7 6 5 4
CONTENTS
Preface vii

CHAPTER 1 Introduction: The Engine of Free-Market Growth 1
PART I THE CAPITALIST GROWTH MECHANISM
The “Somewhat Optimal” Attributes of Capitalist Growth:
CHAPTER 2
Oligopolistic Competition and Routinization of Innovation 19
Oligopolistic Rivalry and Routinization to Reduce
CHAPTER 3
Uncertainty 30
Oligopolistic Rivalry and Routine Innovation Spending:
CHAPTER 4
Theory of the Engine of Unprecedented Capitalist Growth 43
Independent Innovation in History: Productive
CHAPTER 5
Entrepreneurship and the Rule of Law 55
Voluntary Dissemination of Proprietary Technology: Private
CHAPTER 6
Profit, Social Gain 73
CHAPTER 7 Oligopolistic Rivalry and Markets for Technology Trading 93
Tradeoff: Innovation Incentives versus Benefits to Others
CHAPTER 8
(Distributive Externalities) 120
PART II INTEGRATION OF INNOVATION INTO THE
MAINSTREAM OF MICROTHEORY
Oligopolistic Competition, Pricing, and Recoupment of
CHAPTER 9
Innovation Outlays 151
Microeconomic Theory of Industrial Organization in the
CHAPTER 10
“Innovation-Machine” Economy 161
Recouping Innovation Outlays and Pricing Its Products:
CHAPTER 11
Continued 183
CHAPTER 12 Models of Optimal Timing of Innovation 199
CHAPTER 13 Licensing for Profit: Efficiency Implications 215
PART III ON THE MACRODYNAMICS OF CAPITALISM
Capitalism’s Unique Innovation Machine: Historical
CHAPTER 14
Evidence 245
Macroeconomic Models and Relationships That May Limit
CHAPTER 15
Growth 262
CHAPTER 16 Feedback: Innovation as a Self-Nourishing Process 284

Bibliography 299
Index 307
PREFACE
If the past century of economic policymaking has taught us
anything, it is that achieving strong long-term growth often has less
to do with macroeconomic policies than with good microeconomics,
including fostering competitive markets that reward innovation and
restricting government to only a limited role.
—The Economist magazine,
7 October 2000, p. 21
The unifying framework is the characteristic of knowledge as a
semipublic good, with non easily enforceable property rights. Its
diffusion, in principle, is good for social well being, but bad for
private returns: No one wants to invest in the creation of new
knowledge, if the rents generated are not, at least partly,
appropriable. Institutions that govern the creation and the diffusion
of knowledge have invariably been molded by this tradeoff.
—Navaretti, Dasgupta, Mäler,
and Siniscalco, 1998, p. 1
Much like the professor who never changed the questions on his
examinations—only the answers—some of the content of this book is a
1
repetition of material in an earlier volume, but the focus is quite
different. In that book, which was also related to growth issues, I was
concerned primarily with the entrepreneur, and the apparently
mysterious propensity of the supply of that factor of production suddenly
to dry up, braking the economy’s growth, or to expand unexpectedly, by
some unspecified process of spontaneous generation, leading the
economy to take off. I concluded that much of the explanation for such
swings is to be found in the way in which the market mechanism—
together with institutional arrangements—influences, not the creation,
but the allocation of entrepreneurship between productive and
unproductive (rent-seeking) pursuits. It was my contention that
entrepreneurs as a group do not just appear or disappear in some
primordial ooze. Rather, they can be and are reallocated by economic
conditions and circumstances into (or out of) activities that appear not
to be entrepreneurial because of the preconception that enterprising
activity is necessarily productive. But entrepreneurs, like many others,
are motivated primarily by prospects of wealth, power, and prestige,
and, like people in any other occupation, entrepreneurs range widely in
the degree to which morality and concern over the public welfare
constrain their activities. Consequently, when institutional arrangements
happen to offer greater rewards to enterprising rent-seeking or to
destructive activities such as warfare or organized crime than they offer
to productive entrepreneurial activity, we can expect an economy’s
entrepreneurial effort to be allocated away from the more productive
undertakings. In the earlier book, I concluded that the most promising
way for a society to stimulate productive entrepreneurial activity is to
reduce the rewards to unproductive or destructive rent-seeking. I also
went beyond this generalization and provided some concrete
illustrations of such policy measures.
The orientation of this book is very different. Here, my purpose is to
begin to analyze what may well be the most critical attribute of the free-
market economy (the type of economy in which we live): its ability to
produce a stream of applied innovations and a rate of growth in living
standards far beyond anything that any other type of economy has ever
been able to achieve for any protracted period. My central contention
here is that what differentiates the prototype capitalist economy most
sharply from all other economic systems is free-market pressures that
force firms into a continuing process of innovation, because it becomes a
matter of life and death for many of them. The static efficiency properties