WEEK 3

Innovation, Enterprise and Society

 From week 1 - Four features of innovation
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1. Product innovation: A good or service that is new or significantly

improved. This includes significant improvement in technical
specifications, components, materials or user friendliness.
2. Process innovation: A new or significantly improved production or
delivery method - including significant changes in technique, equipment
or software 
3. Organizational or administrative innovation: A new organizational
method (business, workplace, institution or in external relations)
4. Innovations in marketing: A new marketing method, significant changes
in product design, packaging, placement, promotion.
 Last week (week 2)
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 Different schools of thought - on economies and societies

 Demand and Supply
 Equilibrium
 Scarcity
 Exchange value
 RECAP OF LAST WEEK:
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 A What is “socially necessary” or “socially average” labour time? (Basis of

exchange value/equilibrium values).
 What is “surplus-value?”: The value that remains after labour and capital
inputs have been purchased at their values.

 Surplus value is created by labour in the process of production.

 THIS IS BASED ON THE FACT THAT ONLY LABOUR (BEING

HUMAN) IS CAPABLE OF CREATING MORE VALUE THAN IT
NEEDS TO REPLACE ITSELF.
 Week 3 Creative destruction: a term
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by Joseph Schumpter –
 WEEK 3: Innovation as a systemic describes the process of
process – industrial mutation that
 part 2: incessantly revolutionises
 “Creative Destruction” - Cost the economic structure
competition, Technical Rents, small
from within - incessantly
firm lager firm relations
destroying the old one,
incessantly creating a new
 Debate: each group has 20 minutes to
make your case (for or against the
one."
debate topic)
 Then 15 minutes right of reply
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 At the microeconomic level, restructuring is characterized by countless decisions to create and

destroy production arrangements.
 These decisions are often complex, involving multiple parties as well as strategic and technological
considerations.
 The efficiency of those decisions not only depends on managerial talent but also hinges on the
existence of sound institutions that provide a proper transactional framework.
 Failure along this dimension can have severe macroeconomic consequences once it interacts with the
process of creative destruction (see Caballero and Hammour, 1994; 1996a; 1996b; 1996c; 1998a;
1998b; 2005).
 Some of these limitations are natural, as they derive from the sheer complexity of these transactions.
 Others are man-made, with their origins ranging from ill-conceived economic ideas to the
achievement of higher human goals, such as the inalienability of human capital. In moderate amounts,
 These institutional limitations give rise to business cycle patterns such as those observed in the most
developed and flexible economies.
 Economic rent
"Economic rent" is a term
Content that defines an amount of
money earned that exceeds
7 that which is economically
 Cost competition (rather than just price competition) is at the heart of or socially necessary
capitalist development?  Any payment to an owner
or factor of production in
 RENT: What is the difference between "Economic Rent" and "Profit"? excess of the costs needed
 What kinds of evidence, if any,  do we have indicating that value created in to bring that factor into
labour intensive small firms (the  price competitive sectors of the economy) production.
is systemically  transferred to mechanized oligopolistic corporations?
Profit
Profit is a financial
 Thinkers who are interested in long wave analysis have been engaged in an benefit that is realized
ongoing debate about why the latest landmark innovations - the INTERNET when the amount of
and IT generally - have not resulted in a long booming period of economic revenue gained from a
growth. Certainly , this technology has dramatically altered work and business activity exceeds
 business in most sectors of the economy - however it appears to be the first the expenses, costs and
taxes needed to sustain
time that such a wide scale diffusion of a landmark technology has NOT
the activity.
resulted in a long period of economic growth? Why do you think that is.
Class to read and debate – reading in vuws
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• There are two different ways to look at the economy:

1- Microeconomics: the bottom-up view of the economy, focusing on
individual, households and
firms
 2- Macroeconomics: the top-down view of the economy, focusing on

aggregate characteristics e.g. Inflation, economic growth….

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 COST COMPETITION, CREATIVE DESTRUCTION, OLIGOPOLY, TECHNICAL
RENT
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 Cost Competition,
 Price Competition
 The Process Of “Creative Destruction”
 (Josef Schumpeter) The Logic of Mechanization and Innovation In A
Market Society:

 GROUP WORK – Upload your group responses onto Discussion

for the rest of the class to consider.
MECHANIZATION, ECONOMIES OF SCALE AND OLIGOPOLY (CONCENTRATION OF CAPITAL).
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 Mechanization means that MORE chairs can be  NATURAL MONOPOLY (NATURAL

made in the same amount of time, using the OLIGOPOLY) This is related to, but has
same amount of labour. to be distinguished from, market
monopoly or market oligopoly.
 This means that the potential SCALE of
production tends to increase with
mechanization and the value of each product  Natural monopoly refers to an industry
falls when that highly mechanized technique where mechanization and economies
becomes the social average or industry of scale are so substantial (where fixed
standard. costs are so high) that the industry is
most efficiently operated with one or
 What does that imply about the number of firms less than a handful of firms.
which can efficiently meet consumer (or
downstream firm demand) for that industry?
 NATURAL MONOPOLY/NATURAL OLIGOPOLY AND THE CONCENTRATION OF INDUSTRY:
THE RISE OF THE CORPORATION.
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 Economies of scale mean that there is very little room for hundreds of small firms (higher cost) in mechanized
industries.
 In the nineteenth century, as process innovation developed, the many small firms in industries were
systemically wiped out (generally during recessions) as the era of mass production took hold.
 As the extent of mechanization intensified, as the scale of production increased, it become more and more
difficult for small firms to adopt the up to date technology and compete – THE FIXED COSTS ALONE FORMED
A NATURAL “BARRIER TO ENTRY” – leaving the giant corporate incumbents with little PRICE competition from
outsiders.
 By the first decade of the nineteenth century, our statistically verified picture of the industrial landscape is
output in the capital goods sector and in MOST manufacturing/distribution industries were dominated by four
firms or less (Alfred Chandler’s The Visible Hand –account of the rise of the modern corporation.) Small high
cost firms sprang up and fell on the margins, soaking up demand in boom times and frequently bankrupting in
recessions.
 Political economists refer to this as the concentration of industry.
 THE INTERESTING THING IS THAT ONCE AN INDUSTRY IS DOMINATED BY A FEW FIRMS, THE NATURE OF THE
GAME CHANGES.
 SUNKEN COSTS, RISK AVERSION, PRICE COLLUSION AND INTENSIFIED PRODUCT AND
COST COMPETITION (PROCESS INNOVATION):
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 In a oligopolized industry, the fixed costs, as we’ve noted, are very high (otherwise
many other firms could enter.)
 However; these very high fixed costs put the incumbent firms in a very vulnerable
position – it means that they have to pay millions, before they have even
produced one unit of output.
 This means they have to proceed cautiously.
 PRICE WARS are no longer a frequent occurrence, a matter of routine or normal
business practice.
 IF they occur at all – they would have to be saved for special occasions only!
Remember that now, the corporation’s main competitors are equally powerful
corporations!
 PRICE COLLUSION
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 or Price Leadership model - is the risk averting option.

 Topic for discussion - price leadership

 However collusion on price by no means implies that competition has ceased

– in fact, the imperative to cut costs, develop new and more efficient process
technologies, and create new and “edgier” products actually more intense
than ever in the era of corporate oligopoly – as Schumpeter points out.
WHY?

 Discuss using 2 products (eg Coke versus Pepsi – on board)

 Key issues
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 The corporation’s bottom line is its cost structure – the rival corps can potentially wipe out the
firm in an unannounced, unexpected price war IF their bottom cost line is lower.
 In a technically dynamic industry – one corporation cannot know for sure if its rivals have
developed a cheaper technique or more efficient machines – they would keep that a secret.
 So the firm is itself forced to continually innovate – just in case – EVEN when it is enjoying
massive super-profits and colluding on price with its rivals.
 Modern developments – one corporate conglomerate can successfully engage in price war by
subsidizing the war with surplus profits from another branch of production in which it operates
(Classic example, Virgin aggressively entering the airline industry operating at a loss, using
revenue from its super profits from Virgin Records).
 However; this only intensifies the necessity of cost competition (and super profits) in the industry
providing the subsidies.
 Same with marketing – the million dollar marketing blitzes have to be FUNDED from super-
profits – from a large price-cost margin!
 IMPLICATIONS FOR INNOVATION AND THE COST OF INNOVATIONS TO
CONSUMERS AND DOWNSTREAM FIRMS:
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 There is a very strong pressure to develop new techniques/products BEFORE your

rivals do.
 The uncertainty, the very high cost of research and development, the typically long
period between research and development and the actual sale of products, the very high
risks that a lot of ideas lead to nowhere.
 Connected to this: there is a very strong pressure to grab as much super profit as possible
from a technique or product innovation before the opposition comes out with a rival
technique.
 There is a very powerful incentive for a firm to protect its innovations, R & D for as
long as possible – to prevent other firms from getting access to the
technology/product development.
 This is achieved through highly elaborate and very strict rights over patents and
copyright (our topic for next week – the intellectual property revolution).
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 WHAT IS RENT? WHY ARE THE SUPER PROFITS

ASSOCIATED WITH INNOVATION CALLED TECHNICAL
RENTS OR ‘SCHUMPETERIAN RENTS?”

 What is the difference between ‘Economic Rents’ and ‘profit?” Take a

few minutes to watch the uploaded video on Economic Rents?
 What is technical rent?

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Jot down some responses to these questions – upload on Discussion board and report back to
class)

 Think of a product you consider to be “high tech”. If you can’t think of one, take two smart phones
or laptops (etc).
 WHY is this product “high tech?”
 Why is an older phone, for example, not “high tech?” (Remember here that “useful”, more
“convenient” is NOT the same as having more value - a mass produced synthetic rubber tyre is
VERY useful and has involved a great deal of scientific research.
 Antibiotics are very useful and extremely cheap to produce - again having involved a great deal of
scientific research.
 Look at an older phone – why did it drop in price? Do you expect the latest smart phone (or a copy
of it) to drop in price? When? Why? Would that phone then be selling at a loss? Does that mean that
the phone was selling well above its (mass produced) cost price when it was “high tech?”
 WHAT ACTUALLY HAPPENS WHEN A PREVIOUSLY LABELED “HIGH TECH” PRODUCT
DROPS IN PRICE?
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 The technology underlying the production of the product is protected by a system of

patents /copyright  – this legally “artificially” restricts its supply – it prevents other
companies from making versions of it and distributing them widely. This is WHY the
returns to such product are called “technical rents.”
 Rentiers make a return without actually selling more – in fact they make a return because
the supply of the product is restricted. (Draw a supply and demand curve with fixed
supply to illustrate this.)
 This means that the wealth they accrue has to be coming from some other, more actively
producing part of the economy. HOW? How could that be possible?
 Orthodox economics – monopoly or oligopoly super profits or rents are transfers of value
from consumers. (Illustrated as the loss of consumer’s surplus).
 Political Economy – technical rents are transfers of value from smaller, more labour
intensive businesses. How?
 Class exercise
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Examples of small businesses (eg in the Examples of large corporations in

plaza or on the main street) various sectors of the economy
     

How could firms so different have any kind of

relationship?
What is the point of contact between these different kinds
of firms? Any ideas?
 SECTOR ANALYSIS:
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 Ernst Mandel – Late Capitalism - the rate of profit in the monopoly

(corporate sector) is ultimately bounded by the production of surplus value in
the small business (labour intensive) sector of the economy. Firms with equal
intellectual property power or market power cannot exploit each other.
 James O’Connor – The Fiscal Crisis of the State. The “Monopoly Sector”
(highly mechanized, large corporations charging oligopoly prices and
earning super profits) have a symbiotic relation with small, struggling, labour
intensive business in the “Price Competitive Sector” . We shall explore this
relationship – and its implications for the society in which we currently live,
in more depth in Week 5!
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 LONG WAVES OF CAPITALIST DEVELOPMENT – THIS TOPIC

EXAMINES THE MACROECONOMIC LONG TERM
EFFECTS OF LANDMARK INNOVATIONS.
 A KEY PROBLEM HERE IS WHY THE CLUSTER OF
LANDMAKR INNOVATIONS ASSOCIATED WITH THE
IT/INTERNET REVOLUTION HAS NOT RESULTED IN A LONG
BOOM. If you wish to pursue this question for exams for essays – I
greatly encourage you. I do not wish to overload students – however
you can specialize in this topic. Email me – I will be happy to help
and to provide you with readings.
 Definitions
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 Profit
 Technical Rent
 Economic Rent
 Socially necessary labour time