ANALYSIS AND CRITICAL ASSESSMENT OF THE BAUMOL
INTRODUCTION
Innovation is the implementation of new or significantly improved products and processes with changes in techniques and equipment. According to Joseph Schumpeter lack of innovation brings the circular flow of development to a stationary state (W.J.Schumpeter, 1947). The concept of innovation in relation to growth has evolved over decades, birthing forth various models and mechanisms from different innovation economists such as William Baumol. This paper aims at in-depth analysis of the Baumol’s growth mechanism in relation to other innovation mechanisms as proposed by Rosenberg and Mowery, William and Chandler, Joel Mokyr and Paul David.
BRIEF ANALYSIS OF BAUMOL’S INNOVATION ENGINE
Baumol sees economic growth as the primary product of the free-market growth engine which derives its efficiency from a firm’s fight against “Imminent demise”(Baumol, 2002. Page 10) while innovation is the primary source of the capitalist engine starting off with the “wave of gadgets”(Baumol, 2002. Page 12). Basically, the firm has to avoid outperformance as a matter of survival and must innovate or die. This occurs mainly in the oligopolistic competitive market such as pharmaceutical and computer industries where by innovation is the prime weapon for competition making price the secondary weapon. Other preconditions for the free-market machine include routinasation of innovative activities, productive entrepreneurship, rule of law on contracts and technology selling and trading. Baumol (Baumol, 2002) implies that capitalism owes its uniqueness to innovation and not invention distinguishing between both in a Schumpeterian sense of recognising and practising profitable change ensuring an effective end-use. Early civilisation in Rome and medieval China had a wealth of invention in likes of Leonardo DaVinci whose ideas as outstanding as they were did not materialise and Baumol refers to as “dead-ends in the absence of a systematic innovation mechanism capable of ensuring that they would not languish” (Baumol, 2002. Page 10)
CRITICAL ASSESSMENT OF THE BAUMOL MODEL WITH RESPECT TO OTHER INNOVATION THEORISTS
Baumol relates to the theory of Adam Smith that firms are driven to minimise production cost and create the best mixed product that meets the consumers demand although with an aim of profit maximisation, implying that innovation is demand driven while Rosenberg and Mowery agree to this, but further suggest that innovation is also a supply constrained activity in terms of supply of knowledge (Rosenberg, 1979).
Baumol’s consideration of costs aligns with William and chandler’s theory based on transaction costs and economies of scale. While Joel Mokyr’s theory puts positive feedback mechanism, propositional (?) and prescriptive (?) knowledge as the core elements of economic growth, the Baumol’s model focuses more on prescriptive knowledge suggesting that it has a greater impact on social market (Varian, sept. 2004). Mokyr however emphasised that propositional knowledge has to be invested in, as it sets epistemic basis for prescriptive knowledge, supplies the base knowledge of social capital which is applied to production process and is more generally used in the society.
Rosenberg and Mowery did not base the institutionalisation of innovation on repertoire but agree with Mokyr that institutions and society in general rely on the omega knowledge (Varian, sept. 2004). On the other hand, Paul David in his theory of path dependence suggests market failure and that innovation is a stochastic process based on historical development that lead to further innovation causing first mover advantage through network effects and lock-in of consumers (Ruttan, 1997). Paul David identifies reaching a critical mass as the main aim of the firm rather than the demand driven feature of producing the best product mix in the Baumol’s model, totally opposing it. Paul David also rules out the second mover in his model identifying that all customers are locked-in to the first mover even if another technology develops and this is highly incompatible with the Baumol model. In contrast, Nelson and Winter aligns with Baumol that the most efficient firms in routine changing will survive in the long-run.
Baumol further identifies innovation as the preferred competitive weapon in oligopolistic competition, putting every firm at risk of either not innovating or investing in failures since innovation is mainly an unpredictable process. This brings about a repertoire of actions, which is the routinisation of corporate innovation where firms incorporate innovation in their production process thereby ensuring predictability in place of inconsistency.
Consistent innovation stimulates further innovation resulting in a cumulative process with feedback. However, routinisation may tend the firm towards zero profit from innovation unless sunk costs create a barrier to entry. Mowery and Rosenberg identified innovation to be driven by the supply of knowledge (Rosenberg, 1979). It is also demand driven being affected by routine. They further implied that routinisation will affect innovation because specialisation will lead to a bottle neck rendering the firm incapable of diversification into production of other goods. This action would hinder innovation from being market driven by taking the focus off demand.
The market for technology creates additional profit for first movers through rent seeking and pushes second movers to innovate, further inducing the first mover act (the arms race). According to Baumol this inherent structure of the innovation machine results in equilibrium between protection and diffusion, and also between first and second mover advantages causing continuous growth and productivity (Baumol, 2002). Baumol highlighted the negative effect of spill over which signifies that great benefits are enjoyed by the second movers who contributed nothing to innovation. This development in turn discourages first movers from devoting optimal resources to innovation. If the first mover could keep all the benefits, there would be more incentive for innovation and other firms will be willing to invest more. This spill-over problem can be mitigated through technology trading.
However, an inefficient growth process will occur if first movers deny other firms the use of its innovation due to secrecy or patents. This is because the innovation will have been optimally used by the industry and might even be improved on by other firms, thereby totally eradicating inferior goods produced by obsolete processes. Also patents and rights may distort innovation since the time difference between patents and expiry will alter product development in so doing distort competition. Conversely, a total eradication of patents may worsen the problem of spillover and encourage destructive entrepreneurial activities such as suing for monetary benefits. It may also result in patent races which occur when competing firms rush through and duplicate R&D efforts to get ahead of its rival thereby rendering the effort of the second mover wasted.
Baumol suggests that unroutinised innovation contributes more to economic growth than routinised innovation which simply concentrates on product improvement. He arrived at that conclusion because Unroutinised innovation is rarely put under pressure of routinised activities with examples such as the invention of dial phone and scientific calculators (Baumol, 2002). He agrees that the inventor becomes an entrepreneur and establishes a firm which is large enough to compete in the oligopolistic market with routinised and stable innovative system. This implies that Baumol relates productivity and economic growth in terms of internal growth of firms while Kuznets suggests external economic growth: when the number of new firms in an existing industry is more than the number of firms exiting the industry. This highlights the fact that the Baumol’s innovation model is based only on the micro level of product development which is just growth and maturity in the product life cycle
OVERALL REVIEW OF THE BAUMOL MODEL
The Baumol model can be given the credit of first hand experience from Baumol’s consulting work and insight on how firms operate in a competitive environment from discussions with corporate decision-makers. Considering the dynamics of innovation, the Baumol model can be criticised as it does not consider institutional diversity and a case of open innovation. This implies that the model may not apply in every economy although it will help to identify what feature the economy has that differs from others. It also falls short in identifying reasons why some firms do not innovate and others do why some innovate inefficiently and why the best innovation may not succeed.
In conclusion, Baumol’s ideas on how theory of the firm should be mobilised taking innovation into account are insightful especially with regard to routinisation and technology trading among firms and should be further studied to fine-tune its inadequacies.
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