THE RITSUMEIKAN ECONOMIC REVIEW Vol. 65 No.

4 Feb 2017 3

論 説

Industrial development and policy :

revisiting Schumpeter in the 21st century

Michael Peneder＊

Abstract

 Joseph Schumpeter characterised economic development by the continuous interplay of

growth and qualitative change. He considered entrepreneurship, venture finance, and com-
petition as three core drivers of the dynamic market process to explain the innovation
driven growth of living standards, fluctuations and crises, continuous structural change, and
even the transformation into a post-capitalist society. This article addresses Schumpeter s
agenda for industrial development and demonstrates its undiminished relevance to econom-
ic education, research and policy from a contemporary perspective.
JEL Codes : L11, L22, L41, M13, O33
Key Words : Schumpeter, entrepreneurship, venture finance, innovation, competition,

１ Introduction

 Scientific theories are not meant to be engraved in stone. The more radical and ground
breaking new ideas are, the more they will be challenged and the more likely they will be
overturned or amended. It is the wealth of competing hypotheses, controversial arguments,
and ongoing debate that signals intellectual success. The present article addresses the
Schumpeterian agenda from such an angle, illustrating its relevance together with the need
to develop a contemporary perspective.
 Given the immense scope of the topic one cannot strive for comprehensiveness or draw
a panoramic picture, not even a survey of the literature. Instead, the aim is to demonstrate
some modern avenues towards Schumpeter s theory of development through selected ex-
amples. If successful, they shall inspire further research in the area.
 The paper is organized as follows. Section 2 briefly sketches the main elements of
Schumpeterian development. In Section 3 we discuss in more detail the varied ideas about

＊Austrian Institute of Economic Research, Arsenal Obj. 20, A ― 1030 Vienna, Austria, Tel. : ＋43 ― 1 ― 798 26
01 480 ; E-mail : Michael.Peneder@wifo.ac.at

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entrepreneurship and its different economic functions. Section 4 picks the case of venture
capital to illustrate the problem of entrepreneurial finance. Section 5 then turns to the en-
dogenous relationship between competition and innovation as well as their joint impact on
productivity. Finally, the concluding section sketches the idea of Schumpeterian economic
policies that focus on an economy s capacity to evolve.

２ Industrial development

 Schumpeter is probably the most famous economist one has never learned about in the
standard economic textbooks. Though regularly credited for influential ideas that he had
contributed to such varied fields as entrepreneurship, innovation research, industrial organi-
zation, finance and growth, business cycles, public choice, or the history of economic
thought, these are mostly received in a very partial manner and often serve as mere
catchwords. In contrast, Schumpeter s（1911）general theory of innovation driven develop-
ment rarely receives its due attention. This is the more surprising, as the basic elements
are rather straightforward and have much intuitive appeal to practitioners in business and
policy alike. They would also be simple enough to become part of our general economics
education.
 In contrast to Schumpeter s own exposition, that is rich in detail and informed by a deep
understanding of history and the heterogenous sources of economic thought, the graphic
representation in Figure 1 is provocatively simple. The purpose is to demonstrate a facile
yet meaningful narrative, which one could easily communicate in elementary classes in eco-
nomics as well as other disciplines（e. g., legal studies, engineering, management, and politi-
cal sciences）
. The focus here is on the overall reasoning. In the later sections we will turn
to selected specific elements of his theory.
 To begin with, the model presumes that there exist no definite boundaries to innovation,
neither from running out of technological opportunities nor an ultimate saturation of de-
mand. On purely logical grounds one cannot preclude either, and the recurrent fear of sec-
ular stagnation is a reasoned possibility. But the historical record on technological change
1）
and the psychological trait of continuously rising aspirations suggest to expect otherwise.
Development will nevertheless pass through prolonged phases of temporary exhaustion and
consequent downturns on top of other causes for the regular business cycle.
 Schumpeter basically depicts the entrepreneurial venture as navigating a turbulent and
uncertain, but also fundamentally sea of opportunities （Figure 1, Panel a）.
 A second premise is that innovation requires deliberate effort to search and exploit op-
portunities by the This in turn depends on the pre-financing of effort, which
refers to the complementary function of providing and allocating purchasing pow-
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 Industrial development and policy : revisiting Schumpeter in the 21st century（Peneder） 5

Figure 1 : Embarking the Schumpeterian AdVenture

Capital

Finance
Search &
exploitation

Sea of opportunity

（a）Entrepreneurial ventures

Knowledge spillovers
Innovation Diffusion
Increasing competition

（b）Innovation & diffusion

Capital

Innovation Diffusion

New production Lower prices &

possibilities higher PP

Structural change & growth

（c）Growth & development

er. Both the entrepreneurs and capitalists must invest their respective resources under
2）
conditions of fundamental uncertainty about the ultimate success and later returns to be
earned by the venture. Their creative vision and realization of opportunities makes them
the essential characters of the play. We will discuss them in more detail in Sections 3 and
4. Each impersonates a different function, with the entrepreneurs being the principal agent
of change, and the capitalists occupying its headquarters . They controll the means of pro-
duction and make the ultimate choices about their allocation.
 For Schumpeter, it is only a matter of time until innovations leak and generate positive
spillovers to other firms that learn to adopt new techniques, imitate and may even chal-
lenge the incumbent by their own innovations （Panel b）. As a consequence, competition
increases and the temporary surplus profits are destroyed by new innovations. This in-
volves a fundamental endogeneity of competition and innovation, which we will discuss in
Section 5. In the end it is the widespread diffusion of new productive knowledge, which fu-
els the aggregate growth of per capita income via the associated expansion of goods or
services and decline of prices（Panel c）. The latter is responsible for the rise of real pur-
chasing power that brings the benefits of innovation not only to the pioneering users but
also to the mass of consumers.
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 What can Schumpeter s theory of development tell us about contemporary concerns ?

Let s briefly turn to the current fear of technological unemployment caused by increasing
digital intelligence. To begin with, digitalisation should be discussed in combination with
the fear of secular stagnation. As long as markets are competitive, the foremost impact of
automation is to lower prices and thereby raise real incomes. If demand is not saturated,
the additional income can be spent on other goods and services creating new demand for
labour. This is not to deny severe problems of adjustment, for example, when labour must
acquire higher skills or will inevitably shift towards new tasks, that cannot easily be re-
placed by programmed algorithms. However, by and large these difficulties correspond to
past developments, which the standard model well explains.
 If this time is really different , it must be because the long term prospects for the
growth of demand cannot match that of productivity. In other words, a qualitatively new
problem arises if two popular fears come together : First, the rise and disruptive potential
3）
of robots, progressively displacing human labour in production. And second, the hypothesis
4）
of an ultimately diminishing value of new ICTs and other innovations to consumers. In
such a scenario, labour would indeed be squeezed out. Large scale unemployment, inequali-
ty, and poverty would call for fundamentally new social arrangements that probably lead
the way towards a post-capitalist society.
 Schumpeter was a technology optimist , who believed in undiminished opportunities of
value creating innovations and hence also demand（at least for the foreseeable future）. In
the current situation, he would probably point towards the manifold opportunities for new
products and services that arise in the application of new ICTs. These are systematically
underappreciated by our general perception, which is exactly what makes them a business
opportunity for the visionary entrepreneur. Though acknowledging that historic events are
unique, he probably would not consider the current situation that much different from past
waves of technological change.
 However, Schumpeter（1942）also offered a supply-side reason, why entrepreneurial capi-
talism may eventually run out of steam. This one may bear even more relevance to the
long-term scenarios of the digital age. Instead of the saturation of demand, he pointed at
economies of scale, especially in the large R & D labs of industries that were rapidly grow-
ing in importance at his time（e. g., chemicals or defense）and the consequent tendency of
industry to become more concentrated. What he feared was a general tendency of routini-
zation of innovation itself. The consequent concentration of industry would in the end lead
society to take over the headquarters and socialise the means of production.
 Historically, at least two developments lead to the rebuttal of Schumpeter s bleak predic-
tion on the future of capitalism. Both relate to structural change and the emergence of
new industries. First, in many industries with high economies of scale rivalry remained
largely intact. To a considerable degree this was owed to growing global competition. Low-
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er prices thus transferred the productivity gains towards consumers instead of the incomes
earned by industry. As a consequence, their importance relative to the growing services
sectors, typically characterised by less economies of scale, smaller firm size, many start-ups,
and mostly local competition, has actually declined.
 To this process of tertiarisation one must add the digital revolution, which brought about
many new and innovative enterprises in the ICT related sectors. There have always been
certain large and dominant firms, but their relative fortunes easily shifted and have be-
come especially colourful illustrations of Schumpeterian creative destruction. Overall, the
ICT revolution has so far strengthened entrepreneurialism.
 But in contrast to popular perception, the digital revolution is coming of age and the ap-
5）
parent commodification of many ICTs indicates that the industry has entered a certain
stage of maturity. Growing network economies create ever more powerful advantages to
incumbents such as Google or Amazon. With rising barriers for new contenders, Schumpet-
er s process of creative destruction may again be at stake. Paraphrasing a popular quest,
6）
society may start to ask, s and controls the rising digitial intelli-
gence ?
 To conclude, Schumpeter provided an original, straightforward, and intuitively appealing
narrative, which still captures essential elements of the dynamics of innovation driven
growth and development. It is high time to admit it the due place in the introductory
courses and textbooks of our discipline. To demonstrate its relevance also for contempo-
rary research, the following examples add some detail to selected elements of his theory.

３ Entrepreneurship

 Different from mere growth, Schumpeter characterized development by the ongoing

qualitative transformations that drive the expansion of an economic system. The creative
agent and prime mover of these changes is the entrepreneur, who fuels the process by
own innovation. These innovations are not confined to technological change but must be
understood very broadly, ranging from the introduction of new products or processes to
the use of new resources, finding new markets, or changing the industrial organization of a
market. The distinctive feature is the creation of novelty, by which entrepreneurs upset
the current configuration of competitive advantages.
 Inspired by his teachers from the early Austrian School, Schumpeter s definition of entre-
preneurship was a radical break from the received theories of the classical and Marxist
traditions as well as other marginalist schools. These had pictured entrepreneurs as mere
undertakers, or managers, if considered at all, and focused on capital and labour as the two
central factors of production. In contrast, technological change was assumed to be exoge-
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nous and thus placed outside the economic system.

 Once described as an intriguing but elusive （Baumol, 1968） concept, entrepreneurship
research has since become a flourishing discipline. Engaging scholars from diverse fields of
economics, business strategy, and organisational behaviour, it still confronts us with a puz-
zling plethora of theoretical approaches and definitions（Davidsson et al., 2006）
. Compared
to these, Schumpeter s concept exhibits a clear definition and purpose, but also a rather
narrow scope. Practically, it is interchangeable with the notion of innovation.
 Most important among alternative explanations are those by the later Austrian School
from Hayek（1945）to Kirzner（1979）. Instead of innovation, their focus is on the function
of alert entrepreneurs to co-ordinate demand and supply by the discovery and exploitation
of exogenously given imbalances in prices. Another influential alternative concept is the hu-
man capital theory of entrepreneurship by Theodore Schultz （1975）, who emphasised the
adoption and implementation of new technologies as the main characteristic of most entre-
preneurs.
 All three theories share a disequilibrium view of the economy. However, there are im-
portant differences. While Schumpeter s entrepreneur is the source of disequilibrium, itself
unsettling and transforming the system, the two other theories treat disequilibrium as ex-
ogenous, and characterise entrepreneurs by their adaptation to a constantly changing busi-
ness environment and thus as an equilibrating force. The difference is most pronounced
when we contrast Schumpeter s focus on innovation, and Schultz, who stresses imitation.
Essentially, the three approaches are complementary, each pointing at different entrepre-
neurial functions that are invariable important for the working of the economic system.
 Going beyond Schumpeter s narrow definition of entrepreneurship, Table 1 starts from a
general behavioural definition. It then distinguishes between its different economic func-
7）
tions, occupational categories, and characteristic capabilities or skills. In short, the generic
definition emphasizes the opportunity seeking nature of entrepreneurship, under which a
large portion of the contemporary entrepreneurship literature can be summarized. It states
in general terms, what is unique about that entrepreneurs do : the pursuit and exploitation
of opportunities.
 The notion of entrepreneurship originates in economics and therefore the traditional fo-
cus has been on entrepreneurs, who pursue and exploit opportunities to make a
pecuniary profit. This is also how Schumpeter used the term. In addition, the contempo-
rary literature increasingly applies the concept also to other agents of change, e. g. in poli-
tics or the civil society, who pursue and exploit opportunities for social change（ en-
8）
trepreneurs）or for environmental conservation（ entrepreneurs）.
 For a comprehensive perspective, we must distinguish between two occupational catego-
ries that may both be the locus of entrepreneurial activity : First, independent entrepre-
neurs are opportunity-seeking in the sense of the general behavioural definition, but simul-
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 Industrial development and policy : revisiting Schumpeter in the 21st century（Peneder） 9

Table 1 : Integrating different concepts of entrepreneurship

General behavioural definition

Entrepreneurship is the pursuit and exploitation of opportunities
for …profit（ entrepreneurship）
…social change（ entrepreneurship）
…conservation of the natural environment
（ entrepreneurship）
Economic functions
  Adaptive（equilibrating） Market co-ordination（Hayek, 1945 ; Kirzner, 1997）
Technology adoption/diffusion（Schultz, 1975）
  Creative（disequilibrating） Innovation（Schumpeter, 1911）
Occupational categories
  Independent entrepreneurs Owner-managers running a businesses
  Corporate entrepreneurs Managers pursuing opportunities within the
organisational context of a firm（Burgelman 1983a, b）
Special skills & capabilities
  Cognitive leadership（Witt, 1998）
  Judgemental decisions（Knight, 1921 ; Casson, 1982）
  New means, ends, or means-ends relationships（Venkataraman, 1997 ; Shane, 2004）
   Jacks-of-all-trades （Lazear, 2004, 2005）

Adapted from Peneder（2009）

.

taneously perform the functions of risk-bearing （ownership） and managing their own
business. Alternatively, in firms with separate ownership and control the share-holders del-
egate the opportunity-seeking functions to its management. The locus of entrepreneurship
9）
is then with salaried employees, or corporate entrepreneurs.
 Furthermore, entrepreneurship research has given rise to a number of different charac-
terizations of specific entrepreneurial capabilities and skills, which are in principle indepen-
dent from the occupational status and can apply to independent owner managers just as
well as to salaried managers. Among them, Table 1 lists the selected tasks of cognitive
leadership , judgmental decisions , creation of new means, ends, or means-ends relation-
ships , or the multifaceted and balanced portfolio of skills（ jacks-of-all-trades ）.
 Finally, to understand how entrepreneurial behaviour contributes to the economic pro-
cess, it is necessary to distinguish at least three particular economic functions. As a dis-
equilibrating force, entrepreneurship creates new opportunities by means of innovation.
As an equilibrating force, the alert discovery and exploitation of given opportunities im-
proves market co-ordination through the detection and elimination of imbalances in the
price/quantity relationships ; and incites technology diffusion through the adoption of
novel practices and techniques. Some firms simultaneously conduct all the three functions
at a time, whereas some may specialise in exploiting opportunities of a particular kind, and
others may experience the three modes at different times.
 Each of the three functions of market co-ordination, technology diffusion, and innovation
originate in the entrepreneurial motive to pursue and exploit profit opportunities.
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While the discovery of an opportunity is the appropriate characterization of the two former
functions, the latter implies the creation of an opportunity. Since the notions of pursuit and
exploitation of an opportunity encompass both, this general characterization identifies the
only attribute that is both comprehensive and unique to the nature of entrepreneurship.
 The important point to keep from this discussion is that all the three functions of entre-
preneurship are essential and complementary forces of economic development. The eco-
nomic system needs creative entrepreneurs for innovation as much as it needs adaptive
entrepreneurs, who propel the diffusion of new technologies by imitation, or those who help
to co-ordinate demand and supply by means of processing the price signals from the mar-
ket. By increasing the overall efficiency of the system they contribute in important ways
to the rise of a population s overall purchasing power.
 In short, industrial development depends on all three entrepreneurial functions, common-
ly rooted in the pursuit and exploitation of profit opportunities. Without violating any of
the essential mechanisms in Schumpeter s initial argument, acknowledging the related and
yet distinct nature of these forms of entrepreneurship would be an important step towards
a more comprehensive theory of development.

４ Venture finance

 While Schumpeter is best known for his theory of innovation and entrepreneurship, ven-
ture finance occupied an enigmatic and much underrated place in his intellectual and per-
sonal life. As a theorist, he placed a unique emphasis on entrepreneurial finance, which he
considered to be the constitutive and foremost function of the money and capital markets.
In his view, credit and interest are created by and feed on the phenomenon of innovation-
driven development. When money was generally accepted to be a mere veil , affecting
only the price level but without a lasting impact on real production, Schumpeter connected
the monetary system to innovation, economic growth, and crises. He showed that beyond
the mere facilitation of exchange, venture finance can enable and its lack obstruct certain
trajectories of development. Thereby, he explicitly related the temporary entrepreneurial
rent from innovation to Hilferding s concept of the promoter s profit , which is the capital-
ized gains from founding, expanding, or restructuring a business and realized by selling
new shares. It bears much similarity to what we today broadly call private equity, and
with particular regard to early stage investments, venture capital.
 Schumpeter pursued such profits actively during his brief and unfortunate history as a
venture investor. After WWI, when still in Vienna, he invested on a grand scale in the
foundation of new firms. Given the poor condition of industrial sites after years of war
economy, the changed economic conditions due to the dissolution of the Habsburg Empire,
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and the excess demand for goods, the economic rationale appeared sound, but the financial
10）
scheme, timing and practical execution were not. Having built up large leverage, he was
unable to refinance short-term loans when Austria was hit with its major banking crisis in
1924. As a consequence, the factories failed before they could produce a significant cash
flow.
 There is also an intriguing third chapter to Schumpeter s relationship with venture fi-
nance. When he was a celebrated professor of economic theory at Harvard University, the
Boston area became the birthplace of modern institutional venture capital. Although
Schumpeter was not directly involved, his venture theory contributed an intellectual stimu-
lus to some of the creative new leaders in finance. One was Georges Doriot, the acknowl-
edged father of institutional venture capital, who displayed a strong affinity to Schumpet-
erian ideas. Another was David Rockefeller, who repeatedly acknowledged Schumpeter s
11）
influence as teacher on his career as creative banker . In short, Schumpeter was a cre-
ative venture investor already in the 1920s. But he failed, because of being overoptimistic,
unexperienced, and struck by a banking crisis at the worst possible time. He also lacked
the supportive institutional environment of the modern venture capital industry. Last but
not least, he did not yet have a theoretical understanding of the agency problems involved
comparable to that of contemporary corporate finance.
 How does the rise of institutional venture capital affect our contemporary appreciation
and relevance of Schumpeter s theory ? For example, Kenney（2016）refers to venture cap-
ital as the purest incarnation of the Schumpeterian perspective . It targets precisely the
creative Schumpeterian kind of entrepreneurship at the right tails of the firm growth dis-
tribution. Even though it directly concerns only a very small fraction of the firm popula-
tion, Schumpeter s model reveals its bigger impact on the entire economy : when venture
capital helps innovative start-ups to rapidly expand their operations, these initiate imitation,
capital accumulation and growth in other companies as well.
 Schumpeter clearly understood that capital markets have to channel financial resources
to their most profitable uses. Thereby, investment decisions are based on expectations
about future returns ; they rely on incomplete information describing possible future out-
comes and thus involve uncertainty. In this situation, the accuracy of the allocation of re-
sources depends on two critical factors : the availability of and the ability to
interpret information properly, i.e. To this, Schumpeter added the investor s
ability to envision future opportunities for profit, as a counterpart to the entrepreneurial in-
novation.
 In the meantime, corporate finance has developed an intricate understanding of financing
constraints and their causes. For example, Schumpeter s emphasis on the role of the
12）
must be irritating to the modern reader. In contrast, the contemporary litera-
ture suggests that it is precisely the small, young and innovative firms, which are most
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exposed to financing constraints on traditional capital markets. They are also the most like-
ly to seek venture finance.
 Some enterprises generally are more affected by financing constraints than others. For
small firms, transaction costs can be prohibitively high relative to the required volume of
finance. Additional problems arise for young companies, which have not accumulated a
steady cash-flow and typically lack collateral or a track record among creditors. Finally, the
13）
burden of being small and new is aggravated when the investment is on innovation. One
reason is the expensive expert knowledge needed to assess technologically complex proj-
ects. Another reason is the confidential nature of innovation that renders entrepreneurs
more reluctant to disclose information. Both aggravate problems of adverse selection. Moral
hazard increases, if investors have difficulties to distinguish between lacking effort and in-
herent risk as a cause of failure. Finally, innovative firms tend to have fewer tangible as-
sets for collateral.
 As a consequence, the optimal capital structure typically changes over time as firms
grow and mature（Berger and Udell, 1998 ; Myers, 2001）
. Due to the high degree of infor-
mational opacity, young and small start-up companies initially rely most on insider funds.
Access to intermediated funds increases as firms grow, successfully strengthening their
reputations and accumulating other tangible assets. With a growing number of options
available, the conventional posits that firms prefer internal fi-
nancing from their own cash-flows and retained earnings in favour of external financing
and issuing debt before equity, in the case that internal funds are exhausted. Internal
financing is the cheapest method, because it avoids the problems of governance linked to
asymmetric information. Debt financing is generally the favoured source of external financ-
ing, thanks to lower issuing costs and the entrepreneur s preference to maintain ownership
and control.
 Financial markets repeatedly create new means of overcoming inherent limitations and
restrictions, when it comes to backing potentially profitable businesses. Thereby they follow
the above logic of Schumpeterian development（Perez, 2002）. Venture capital is one of its
most remarkable examples. What makes it so special, is not only the focus on firms with
high growth potential, but also the intense commitment in terms of the selection and moni-
toring of projects, which helps to mitigate the above problems of asymmetric information.
Equally important, cash-flow is consistently reinvested, thus building-up company value
rather than paying out dividends. Even though investments are of limited duration and in-
vestors must ultimately reap their returns through divestment, the episode of venture
backed financing is the time, when an innovative entrepreneur can best pursue first-mover
advantages and raise the scale of operations.
 To conclude, offering specialised teams of active investors, venture capital operates at
lower marginal cost of screening, contracting, monitoring or advise, and can thus mitigate
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problems of moral hazard and adverse selection. It is itself a consequence of the Schumpe-
terian process of development. At the same time, it propells its further dynamics by over-
coming traditional deficiencies in the financing of young and innovative firms that embark
on his particular kind of entrepreneurial adventures. It provides a foremost example of the
continuing relevance and further evolution of the Schumpeterian model of development.

５ Competition and innovation

 Following the previous discussions of entrepreneurship and venture finance, this section
briefly addresses a third pillar of Schumpeter s theory : the nature of competition and its
endogenous relationship to innovation. One question in particular has attracted much atten-
tion in the field of industrial organization : Is competition conducive or an impediment to
innovation ?
 Schumpeter （1911） raised the issue by pointing at an uneasy, almost paradoxical rela-
tionship : the process of economic development is driven by the ongoing competition for
monopoly profits from innovation （Metcalfe, 1998）. Thus, innovation feeds on the rivalry
for monopoly power. However, if successful, innovation earns the biggest surplus by elimi-
nating competition. As a consequence, incentives and effort for innovation will be largest,
the more one can expect to monopolize the market. One may say, that if innovation is the
motor of development, a variety of competitors is its fuel. But how can development be
sustained, if the motor in full swing consumes all the fuel ?
 Schumpeter s solution to the dilemma is twofold. First, he argues that innovation is logi-
cally inconsistent with a situation of perfect competition, where all firms are identical and
new technologies are immediately available to all. Competition reduces the payoff to innova-
tion. But when the firm can earn no（or less）surplus profit, there is no（or less）incentive
14）
to invest effort （ n）. Second, monopoly power from innovation is only tempo-
rary ― that is, markets must be contestable in order to trigger a competitive race for the
next innovation. This brings us back to the first assumption in the discussion of Schumpet-
er s model of development. As long as that sea of opportunities is open, incumbents face
the threat of being displaced by entrants with a new technology or a better business mod-
el, etc.（ ）
.
 Arrow（1962）acknowledged the impossibility of perfect competition in a knowledge pro-
ducing industry and considered Schumpeter s case of a contestable monopoly as a competi-
tive situation. In his model, he compared it with a legally protected monopoly, demonstrat-
ing that the latter has less incentives to invest in innovation. The reason is that in a
protected market the incumbent s innovation would foremost replace the rent which he
previously held, leaving only incremental gains to be made, e.g., from reducing cost or rais-
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ing the consumers willingness to pay. However, in a contestable market the whole innova-
tion rent is at stake（ ）
. This considerably raises the incentives to invest
in innovation for both the contender, who wants to gain the rent, and for the incumbent to
defend it.
 Different from how they are portrayed in the literature, Arrow and Schumpeter thus of-
fer complementary answers to our question. Even though one highlights a negative and
the other a positive impact of competition on innovation, their reasoning applies exactly to
the opposite ends of possible initial conditions. Taken together, they make a strong case
that neither perfect competition nor uncontested monopolies are conducive to innovation.
This suggests a non-linear function that would be consistent with the contemporary inter-
est in an inverted-U shaped relationship.
 Scherer（1976a, b）was the first to observe an inverted-U shape empirically. Kamien and
15）
Schwartz （1976） were the first to provide an analytic solution. They modeled an innova-
tion race, where firms choose the level of effort which maximizes the expected present
value of an innovation. The firm faces a trade-off : a longer development period reduces the
cost of innovation but also the expected stream of revenues. Maximizing the expected net
return of innovation effort, more intense rivalry increases the risk of preemption and hence
incites more R&D for low to intermediate ranges of that hazard. However, when the risk
of rival preemption becomes sufficiently large, firms start to reduce their effort. The invert-
ed-U relationship results from the fact that increasing competition raises the risk of pre-
emption by rivals, but also the cost of winning the race.
 Aghion et al.（2005）initiated the recent surge of interest in the inverted-U relationship.
They extend the Schumpeterian growth model by distinguishing between the firms pre-
and post-innovation rents and relating them to the relative proximity of firms to the tech-
nological frontier. The rent dissipation effect captures the negative impact of competition
on post-innovation rents. It occurs when competition is expected to be high even if the
firm successfully innovates ― that is, when the rents of the innovation are difficult to appro-
priate. In contrast, a positive escape competition effect dominates, if the innovation can give
the firm a competitive edge over its rivals. More precisely, it occurs if competition affects
the pre-innovation rents more than the post-innovation rents, thereby raising the incremen-
tal returns to the effort. The key prediction is that the positive escape effect of competition
on innovation dominates at low levels of initial competition, while the negative dissipation
effect dominates at high levels of competition. Of course, the precise trade-off depends on
the technological characteristics of an industry.
 Peneder and Woerter（2014）tested the predictions from the Kamien and Schwartz mod-
el within a comprehensively structured model for a pooled sample of Swiss firms. To take
account of the endogeneity between innovation and competition, they estimated a simulta-
neous system of three equations. First, the innovation opportunity function addresses the
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inverted-U relationship between the number of competitors firms report, and their innova-
tion activity. Second, the innovation production function controls for the relationship be-
tween innovation effort and outcome. The latter is measured by different categories of cre-
ative and adaptive entrepreneurship （see Table 1）
. The final innovation impact function
provides the estimates of how the entrepreneurial status affects the number of competitors.
 They applied three-stage least-square estimations （3SLS） with sectoral taxonomies of
technological regimes as the main exclusion restrictions to identify the system. The taxono-
mies account for the repeated concern about the relationship between innovation and com-
petition being dominated by the specific technological and market environment （Gilbert
2006）.
 In short, the findings confirm a robust inverted-U relationship. This means that at low
levels of initial competition, an increase in the number of competitors incites firms to do
more research, but at a diminishing rate. The largest incentives for own research activities
are found at intermediate levels of competition and then begin to decrease, when the inten-
sity of competition further grows. Technology potential, demand growth, firm size, and ex-
ports also have a positive impact on innovation. Splitting the sample by firm types, the in-
verted-U shape is steeper for creative than adaptive entrepreneurs. This implies that for
the former group innovation effort is more sensitive to changes in competition than for the
latter.
 The analysis reveals three potential stable equilibria. In the first equilibrium, monopoly is
legally protected and hence not contestable. Innovation will be low or non existant. In con-
trast, the second equilibrium is characterized by low competition and high innovation. Mov-
ing from monopoly to rivalry with a few competitors increases innovation. This is consis-
tent with Arrow s （1962） case of a positive impact of competition on innovation. If
competition further increases beyond a saddle point of unstable equilibrium, the industry
moves towards the third equilibrium of no innovation and very high competition（ no inno-
vation trap ）. Comparing the second with the third equilibrium, the estimates are consistent
with Schumpeter s negative impact of competition on innovation, and in particular the im-
possibility of innovation within a market of perfect competition.
 To give a final example, Friesenbichler and Peneder（2016）extend the above model by
integrating an additional productivity equation and test its validity for a large sample of
firms from Central Eastern Europe （CEE） and Central Asia and Caucasus （CAC）. The
data originate from the （BEEPS）
,
conducted by the European Bank for Reconstruction and Development and the World
Bank.
 The results confirm the inverted-U shaped effect of competition on research effort also
for these sample of firms in transition and developing countries. Furthermore, they show
that both competition and innovation have a simultaneous yet independent positive impact
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on productivity for sales and value added per employee. These separate effects are only
identified, when controlling for the endogeneity of competition and innovation in the simul-
taneous system. In the single regressions with no account of their mutual causality, the
16）
competition variable is not significant.
 To conclude, Schumpeter s understanding of the endogenous and complex relationship
between competition and innovation is as relevant as ever. The theoretical literature on
the problem has been prolific, applying ever more sophisticated tools and models and con-
tributing a myriad of theoretical explanations for increasingly specific cases defined by dif-
ferent technological conditions and strategic environments. However, for large cross sections
of firms at least, the inverted-U relationship has proven a powerful hypothesis that recon-
ciles the Schumpeterian rationale with some of the major other mechanisms that shape the
observed empirical variety of effects.

６ Summary and policy conclusions

 What is an appropriate agenda of Schumpeterian economic policies in the 21st century ?

If we consider development as the combination of real income growth and qualitative
transformations of the socio-economic system, there can apparently be no one-size-fits-all
solution to economic policy. The system perspective on mutual interdependencies calls for
caution with regard to mechanistic expectations about the impact of public interventions.
The nonlinear nature of the inverted-U hypothesis is a case in point. The idea of competi-
tion being detrimental to innovation and development is often used as a stalking-horse to
oppose the application of strict antitrust and merger rules or the opening of markets to
trade and entry, and other regulatory reforms. While in practice one must look at each
case in detail, some general conclusions emerge, if we deliberately condition our consider-
17）
ations on the initial intensity of competition in the market.
 For example, cases in antitrust and merger control typically are subject to closer investi-
gation only when there already is reason to suspect a low level of initial competition. As a
general rule, we should hence find most cases in the upward sloping part of the inverted-
U, and expect that innovation also benefits from a strict application to maintain a high
number of competitors. From this follows also a positive impact on productivity. Similar
reasoning applies to regulatory reforms that open markets with territorial protection to the
entry of new competitors. Starting from low initial rivalry, more competition will generally
raise innovation and productivity. Finally, the implications of the inverted-U relationship are
potentially ambiguous for the case of trade liberalisation. Disregarding other factors, it is
however consistent with the principle of asymmetric liberalization, where less developed
economies enjoy some temporary protection. The reason is that an overwhelming foreign
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 Industrial development and policy : revisiting Schumpeter in the 21st century（Peneder） 17

competition can otherwise inhibit the build-up of own innovation and production capabili-
ties.
 But there is also a more general point to make. Examining the prevalent logic of public
interventions in the economic system, the common textbooks, which tend to reflect the ma-
jority view of our discipline, rationalize economic policy in terms of the well known market
failures to be diagnosed. These have proven to be a powerful and flexible theoretical tool,
which one can relatively easily mould to policies anyhow considered useful. There is, how-
ever, considerable disagreement within the profession. Roughly speaking, those to the right
of the mainstream view continuously stress the perils of government failure as an argu-
ment against public interventions. Conversely, those to the left of the mainstream view like
to invoke so called system failures, strategy failures, coordination failures or similar notions
to justify them.
 It is revealing that all the rationales refer to failures as the argument for or against cer-
tain activities. Can we think of any other area in which we accept such a
to motivate human actions ? Probably not. It is a very peculiar attitude of our profession,
which relates to our preoccupation with welfare economics and the way we accept hypo-
thetical perfect states as a normative benchmark. But the Schumpeterian perspective tells
us that in a dynamic and open system, normative benchmarks of hypothetical perfect
states are ill-defined, and therefore the heuristic of failure is a poor foundation for interven-
tion.
 Seeking an alternative route, Peneder（2017）attempts a dynamic concept of competitive-
ness and industrial policy as drivers of Schumpeterian development. Proposing a dynamic
logic of public intervention, he aims to reconcile the theoretic rationales with actual con-
cerns of policy practice. He thereby turns to evolutionary economics, the aim of which is
to explain the growth of productive knowledge understood as the human ability to cre-
ate （material） welfare （Stoehlhorst, 2014, p. 677）. In contrast to explaining the allocation
of given scarce resources, the emphasis is on explaining how cumulative change alters
the resource constraints （ibid., p. 670）.
18）
 At the most general level, and consistent with a wide array of authors, evolutionary
change is characterized by the simultaneous interplay of the three elementary principles of
variation, accumulation, and selection. These are not meant as an analogy from the natural
sciences, but represent a higher level of abstraction（a meta-theory）to characterize differ-
ent systems and forms. Combining these system functions with the ontological distinction
between the micro-, meso-and macro-targets of intervention, he proposes a new taxonomy
of economic policies. These are distinctively motivated by the dynamic rationale of Schum-
peterian development rather than the welfare maximizing logic of market failure.
 As a final remark, let s not forget that Schumpeter s most influential publication is more
than 100 years old. If his agenda is enduring and fertile, one must find progress in re-
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 18 The Ritsumeikan Economic Review（Vol. 65 No. 4）

search on constitutive elements of his theory. These findings should add new perspectives
and detail to our knowledge, or point at ambiguities and raise novel questions. As the vari-
ous examples presented in this paper tried to demonstrate, Schumpeter s theory still pro-
vides a surprisingly strong and enduring thread to guide us towards challenging new re-
search.

Acknowledgements

 This article is dedicated to my dear friend Kazuo Inaba. Throughout our extended con-
versations about economics, politics, Japanese and European cultures, shōchū, parenthood,
and other challenges of life, I have been continuously stunned by his extraordinary kind-
ness, wisdom and openness of mind. !

Notes :
1） At the times of Schumpeter the ecological limits to growth were not yet on the agenda. But
by his reasoning, environmental concerns clearly raise the social value of sustainable products
and methods of production. Activities to improve our environment thus create value, and this
value added should be counted as a rise in real income（that is, the quality of life we can af-
ford）
. Consequently, the needed transformation towards a sustainable economy goes together
with qualitative change and a rising standard of living, i.e. development precisely in his sense.
2） See Knight（1921）.
3） Brynjolffson and McAfee（2016）, Ford（2016）
4） Gordon（2016）.
5） See Kushida（2015）, Kushida and Murray（2015）.
6） See Freeman（2015）.
7） See Peneder（2009）.
8） Please note that for a meaningful transfer of the concept from economics to other areas of
social activities, one must redefine the incentives in terms of individual, often non-pecuniary
payoffs, and draft a proper institutional framework, which can complement or substitute for
market selection.
9） As the Schumpeterian motive of temporary monopoly profits does not directly apply to sala-
ried personnel, other pecuniary motives must be in place to drive their entrepreneurial initia-
tive, such as performance related pay, the external valuation on the job market, or the pros-
pect for promotions.
10） In addition to spending his own wealth, he borrowed heavily from his privileged bank ac-
count, repaying short-term loans as the value of assets increased, and he raised considerable
funds from third parties. See Peneder and Resch（2015）.
11） ibid.
12） This creative banker is no academic fiction, as innovation well existed before the emergence
of institutional venture capital, and many innovations are still financed by credit （apart from
own cash-flow, which is even more important）
. Schumpeter actually subsumed them all in his

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 Industrial development and policy : revisiting Schumpeter in the 21st century（Peneder） 19

functional interpretation of finance, where e. g. the owner-manager of a firm simultaneously ex-

certs the entrepreneurial and the capitalist functions.
13） See Carpenter and Petersen（2002）.
14） See Gilbert and Harris （1984）, Fudenberg and Tirole （1987） or Gilbert （2006）. The discus-
sion goes back to Tullock （1967） and Posner （1975）, who argued that firms competing for a
monopoly raise their rent-seeking investments up to the expected value of the monopoly rent,
which one should therefore add to the welfare loss of monopoly. Obviously, this conclusion con-
trasts sharply with Schumpeter s dynamic perspective of development where innovation is a
productive investment.
15） See also De Bondt（1977）or De Bondt and Vandekerckhove（2012）.
16） Among the exogenous variables education, foreign ownership and own exports are the most
robust drivers of firm-level productivity. Impeding the diffusion of new technologies, better ap-
propriability conditions have a negative impact on total sales and value added
per employee.
17） See Friesenbichler and Peneder（2016）.
18） See, for instance, Nelson and Winter （1982）, Metcalfe （1998）, Peneder （2001） or Hodgson
（2002）.

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