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7 - Creative Destruction
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 05 July 2014
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- 16 June 2014, pp 210-245
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Summary
An inventor's tacit knowledge is a fundamental aspect of both the process of discovery and subsequent diffusion of the innovation. In a classic example, Collins (1974) examined the transfer of knowledge about the Transversely Excited Atmospheric Pressure CO2 (TEA) Laser. Collins (1974, p. 183) found that “the unit of knowledge cannot be abstracted from the ‘carrier.’ The scientist, his culture and skill are an integral part of what is known” (see also Ravetz, 1971). Collins (1974, p. 167) observed that “[a]ll types of knowledge, however pure, consist, in part, of tacit rules which may be impossible to formulate in principle.” Researchers in various laboratories experienced difficulties in developing their own working versions of the TEA laser from technical specifications and research articles. Their success in developing prototypes depended on the extent of their interaction with scientists who had tacit knowledge of the invention.
Inventors’ tacit knowledge can make it difficult to separate discoveries from the individuals who make them. Although both inventors and adopters may know that a discovery has particular features, some inventors may know how to apply their discoveries better than do potential adopters. Inventors can benefit from their tacit knowledge by becoming innovative entrepreneurs who establish firms to implement their discoveries. However, entrepreneurship entails costs of setting up new firms and rent dissipation from competing with existing firms. Alternatively, inventors can transfer their discoveries to existing firms, but this entails costs of codifying, transferring, and absorbing tacit knowledge and imperfect implementation of discoveries.
9 - The Wealth of Nations
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 05 July 2014
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- 16 June 2014, pp 270-295
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How do innovative entrepreneurs affect international trade and economic prosperity? Realizing gains from trade requires countries to adjust their consumption and production profiles. Some of these adjustments may be achieved through restructuring the activities of existing firms. However, the adjustments needed to realize gains from trade generally will require new firms and often entirely new industries. Innovative entrepreneurs are thus essential to developing the wealth of nations.
The growth of international trade has indeed sparked entrepreneurship in many countries. To better understand this phenomenon, I extend the general equilibrium model of entrepreneurship (Kihlstrom and Laffont, 1979; Lucas, 1978) to examine international trade with heterogeneous technologies (Melitz, 2003; Chaney, 2008). I find that opening economies to international trade does not change extensive margins in comparison with closed economies and does not equalize factor prices, so that efficiency differences and wage differences persist in equilibrium. I then show that entrepreneurs engage in FDI to transfer technology from the country with the lower labor-technology ratio to the country with the higher labor-technology ratio. The main result is that the combination of FDI and international trade equalizes both wages and extensive margins and generates benefits from trade.
The model predicts the direction and volume of international trade and FDI; countries with relatively greater endowments of labor as compared to technology attract FDI and have international trade surpluses and deficits in FDI earnings. Based on differences in relative endowments of labor and technology, the model helps explain why the United States or the European Union (EU) have trade deficits while obtaining net earnings surpluses on foreign investment (Bureau of Economic Analysis, 2010). In contrast, countries such as China, with relatively larger labor-technology ratios, tend to have trade surpluses with these trading partners.
3 - Innovative Advantage
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 05 July 2014
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- 16 June 2014, pp 78-122
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When do entrepreneurs innovate more efficiently than do incumbent firms? Entrepreneurs encounter entrepreneurial inertia as a result of the costs of establishing new firms, the costs of obtaining complementary assets, and the opportunity costs of innovation. Entrepreneurs, however, can benefit from individual initiative and creativity that may not be feasible for managers of established organizations. Existing firms suffer from incumbent inertia as a result of adjustment costs, diversification costs, the replacement effect, and imperfect adjustment of expectations. This chapter examines the innovative advantage of entrepreneurs in comparison to existing firms.
Incumbents often appear to have insurmountable advantages over entrepreneurial entrants. Most significantly, existing firms have complementary assets that enhance the returns to new technologies, including human capital, business reputations, market knowledge, customer and supplier relationships, and sources of finance. Existing firms have the necessary expertise to develop new technologies when they already engage in extensive internal R&D and participate in R&D joint ventures and consortia. Existing firms have the ability to obtain new technologies because of their experience in licensing and purchasing inventions, commissioning research by specialized contractors, and working with technical consultants and university researchers. Additionally, existing firms have trained scientific and technical personnel with experience in applying existing technologies that can be used to obtain, develop, and apply new technologies. Entrepreneurial entrants in contrast face various barriers to innovation including the transaction costs of obtaining assets that are complementary to innovation.
1 - Introduction
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 05 July 2014
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- 16 June 2014, pp 1-38
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Much like the popular myth that a bumblebee's flight is aerodynamically impossible, experts often suggest that innovative entrepreneurship is economically impossible. Entrepreneurs must be irrationally optimistic because there are few economic returns to innovative entry. Entrepreneurs cannot innovate effectively because incumbent firms have better complementary assets. Entrepreneurs cannot possibly innovate because only incumbent firms have the necessary size and market power to support innovation. And yet, they fly!
Innovative entrepreneurs add value to the economy through individual initiative, creativity, and flexibility. Innovative entrepreneurs help overcome two types of institutional frictions. First, existing firms may not innovate efficiently because of incumbent inertia resulting from various organizational rigidities. The innovative entrepreneur compensates for incumbent inertia by embodying innovations in new firms.
Second, markets for inventions may not operate efficiently because of transaction costs (search, bargaining, contracting, monitoring), imperfect IP protections, costs of transferring tacit knowledge, and imperfect information about discoveries. The innovative entrepreneur addresses frictions in markets for inventions through own-use of discoveries and adoption of innovative ideas.
This chapter presents a dynamic economic framework that will be applied to study the innovative entrepreneur. The entrepreneurial process has three stages: invention, entrepreneurship, and competitive entry. The dynamic framework emphasizes the interaction between the personal consumption-saving decisions and the business decisions of the individual inventor and entrepreneur. As economic functions change, the individual’s role shifts from inventor to entrepreneur to owner, although there may be different individuals at each stage. The time line of the three-stage entrepreneurial process appears in Figure 1.1.
Preface
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 05 July 2014
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- 16 June 2014, pp ix-xvi
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Managers of existing firms already innovate – why is there any need for entrepreneurs to start new firms? The answer comes from the individuality of entrepreneurs, whether acting alone or as members of a team of founders. The economic contributions of the innovative entrepreneur result from individual initiative and creativity. Entrepreneurs can be innovative in ways that may be difficult or impossible for managers of existing institutions. This basic insight helps address the major questions in the economics of innovation and entrepreneurship.
The innovative entrepreneur is defined as someone who introduces commercial, scientific, and technological discoveries to the marketplace by embodying them in new firms. Innovative entrepreneurs not only provide new products and production processes but also create new transaction methods, business institutions, and industries that fundamentally change how the economy operates. Their impact on economic growth and development is extensive and evident.
The innovative entrepreneur differs from the replicative entrepreneur who establishes a firm by imitating or acquiring existing business models. Understanding the contributions of the innovative entrepreneur does not imply any criticism of the replicative entrepreneur. Both types of entrepreneurs establish firms that implement and diffuse inventions. Both types of entrepreneurs take risks, exercise judgment, and contribute time, effort, and personal funds. Both types of entrepreneurs provide useful products and services, invest in productive capacity, increase employment, and stimulate economic activity.
This book presents an economic theory of the innovative entrepreneur. The theory helps answer the major questions that continue to challenge researchers in economics, law, and management. The theory considers the motivation of individuals to become innovative entrepreneurs. The theory shows how individual initiative can give entrepreneurs an innovative advantage over incumbent firms. The theory examines how competitive pressures impact entrepreneurial incentives to innovate. The theory shows how market frictions affect the choice between entrepreneurship and technology transfer to existing firms.
6 - Creative Destruction
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 05 July 2014
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- 16 June 2014, pp 188-209
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Jeff Bezos's establishment of Amazon.com involved launching a new brand, introducing new business methods, and developing novel e-commerce technologies. Amazon.com provided a product that was differentiated from those of other book retailers. Amazon's business methods as an online retailer differed from traditional bricks-and-mortar retailers such as Borders or Barnes & Noble. Amazon.com also introduced new transaction techniques, such as its patented invention of the “1-click” checkout system (“Method and system for placing a purchase order via a communications network”). Amazon.com subsequently licensed its ordering system to Apple for use in its iTunes online store. Innovation is typically multifaceted. Inventors rarely confine their activities to new products, new production techniques, or new business methods, because they often change many things at once.
This chapter shows how multidimensional innovation helps explain innovative entrepreneurship. Imperfect transferability of product and process innovations affects the mix of entrepreneurship and contracting. Inventors affect the rate and direction of inventive activity by either transferring technology to existing firms or by becoming entrepreneurs who embody new technology in new firms. The resulting market outcomes determine what types of firms innovate and how product and process inventions are commercialized.
In practice, innovations often involve simultaneous improvements in product features, production costs, and transaction techniques. Multidimensional innovations are what Schumpeter termed “new combinations.” Alfred Chandler (1990, p. 597) observes:
The first movers – those entrepreneurs that established the first modern industrial enterprises in the new industries of the Second Industrial Revolution – had to innovate in all of these activities. They had to be aware of the potential of new technologies and then get the funds and make investments large enough to exploit fully the economies of scale and scope existing in the new technologies. They had to obtain the facilities and personnel essential to distribute and market new or improved products on a national scale and to obtain extensive sources of supply. Finally, they had to recruit and organize the managerial teams essential to maintain and integrate the investment made in the processes of production and distribution.
Index
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 16 June 2014, pp 357-365
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2 - Entrepreneurial Motivation
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 05 July 2014
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- 16 June 2014, pp 39-77
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Why do individuals choose to become innovative entrepreneurs? The life-cycle theory of entrepreneurship presented here shows that entrepreneurs create start-ups and establish firms as a form of asset accumulation. Entrepreneurship is integral to the individual's life-cycle planning because of the close connection between saving and investment decisions. Entrepreneurs make consumption and savings decisions at the same time that they provide effort, IP, and investment to create and develop the start-up. The entrepreneur's ownership shares in the start-up and the firm are among the assets accumulated over the individual's lifetime. The entrepreneur may divest ownership of the firm after it is established or later during retirement. The entrepreneur may transfer ownership of the firm and other assets to younger generations. This approach draws on Modigliani and Brumberg's life-cycle theory of consumption, which argues that individuals accumulate assets over their lifetime and begin to sell off assets during retirement, resulting in a transfer of assets to younger generations.
The innovative entrepreneur maximizes life-cycle utility subject to budget constraints that include the costs and returns associated with entrepreneurship. The entrepreneur both contributes personal assets and builds personal assets. The entrepreneur often faces financing and liquidity constraints in creating the start-up and establishing the new firm. The entrepreneur's personal contributions to the start-up and the new firm include IP, human capital, and investment capital. As a consequence, the entrepreneur's business decisions and personal consumption and saving decisions tend to be financially interdependent.
5 - Creative Destruction
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 05 July 2014
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- 16 June 2014, pp 164-187
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When do markets choose innovative entrepreneurship over technology transfer to incumbents? To address the Question of Creative Destruction, this chapter and Chapters 6, 7, and 8 consider a strategic innovation game with endogenous entrepreneurship. An inventor and an existing firm choose between cooperation and competition. When the inventor and the existing firm cooperate, the inventor transfers technology to the existing firm. When the inventor and the existing firm choose competition, the inventor becomes an entrepreneur and establishes a firm that competes with the existing firm. The strategic innovation game illustrates the trade-offs between entrepreneurship and technology transfer.
Creative destruction is an efficient form of innovation if there are net benefits from entry and growth of new firms and displacement of existing firms. Creative destruction can be inefficient if there are greater benefits from growing and restructuring existing firms than from establishing new firms. Entrepreneurs innovate by establishing new firms that embody new products, manufacturing processes, transaction patterns, and business methods. Existing firms can innovate by commercializing products and processes developed through their internal R&D laboratories and collaboration with R&D partners. Existing firms also can innovate by acquiring or licensing new technologies from independent inventors and other firms and by acquiring start-ups. This chapter shows that transaction costs and imperfect protections for IP rights generate market frictions that favor creative destruction over cooperation.
Frontmatter
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 16 June 2014, pp i-iv
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The Innovative Entrepreneur
- Daniel F. Spulber
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- 05 July 2014
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- 16 June 2014
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Innovative entrepreneurs are the prime movers of the economy. The innovative entrepreneur helps to overcome two types of institutional friction. First, existing firms may not innovate efficiently due to incumbent inertia resulting from adjustment costs, diversification costs, the replacement effect, and imperfect adjustment of expectations. The innovative entrepreneur compensates for incumbent inertia by embodying innovations in new firms that compete with incumbents. Second, markets for inventions may not operate efficiently due to transaction costs, imperfect intellectual property protections, costs of transferring tacit knowledge, and imperfect information about discoveries. The innovative entrepreneur addresses inefficiencies in markets for inventions through own-use of discoveries and adoption of innovative ideas. The Innovative Entrepreneur presents an economic framework that addresses the motivation of the innovative entrepreneur, the innovative advantage of entrepreneurs versus incumbent firms, the effects of competitive pressures on incentives to innovate, the consequences of creative destruction, and the contributions of the innovative entrepreneur to the wealth of nations.
Acknowledgments
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 05 July 2014
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- 16 June 2014, pp xvii-xviii
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Contents
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 05 July 2014
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- 16 June 2014, pp v-viii
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8 - Creative Destruction
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 05 July 2014
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- 16 June 2014, pp 246-269
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Asymmetric information in the market for inventions can make entrepreneurship more likely to occur. Contracting between an inventor and an existing firm to transfer an invention is thus subject to problems arising from information asymmetries. Even if an invention is codified and easily communicated, the inventor is likely to know much more about its features than potential adopters. When features of inventions are not perfectly observable, there may be adverse selection in the market for inventions. The inventor may choose to become an entrepreneur and establish a firm to implement the invention as a means of overcoming adverse selection problems. This chapter considers incentives for technology transfer and entrepreneurship when inventors have private information about their invention.
For Arrow (1962b, p. 150) invention is the production of information, and rents fall when “information becomes a commodity.” He observes that “[a]n entrepreneur will automatically acquire a knowledge of demand and production conditions in his field which is available to others only with special effort.” He further points out that the transmission of knowledge is imperfect because of costly communication and errors in judgment.
Zeckhauser (1996) argues that markets form institutions to address problems in transferring technological information (TI): “Webs of relationships, formal and informal, involving universities, start-up firms, corporate giants, and venture capitalists play a major role in facilitating the production and spread of TI.” To address asymmetric information problems, inventors and adopters form long-term contracts, partnerships, and joint ventures, which further raise the costs of knowledge transfers.
Bibliography
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 16 June 2014, pp 313-356
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4 - Competitive Pressures and Entrepreneurial Incentives to Innovate
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 05 July 2014
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- 16 June 2014, pp 123-163
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How does competition affect incentives to innovate? The significant economic contributions made by innovative entrepreneurs strongly suggest that competition increases incentives to innovate. The discussion in this chapter explains why entrepreneurs generate more innovative projects than an incumbent monopoly with multiple projects. Additionally, competition between entrepreneurs and a monopoly incumbent with multiple projects generates more innovative projects than would the incumbent firm without competition.
At first glance, however, it might seem that competitive pressures would decrease entrepreneurial incentives to innovate. Creative destruction dissipates economic rents thereby reducing incentives to enter the market with new products, manufacturing processes, or transaction methods. Innovative entrepreneurs face many types of vigorous competition: from other entrepreneurs both present and future; from traditional and informal institutions; and from incumbent firms. Entrepreneurial entrants face the risk that the new firms will expand industry capacity above the level that is needed to serve the market. Then, entry will generate vigorous competition, leading to rapid exit or protracted shakeouts of new and existing firms. Entrepreneurial entrants face the risk of unsuccessful entry because other entrants or existing firms will offer better innovations. Entrepreneurial entrants also face the risk that their innovations will fail to perform well: new products may prove unpopular with customers, new manufacturing processes may not function efficiently, and new transaction methods may not be widely adopted. Finally, entrepreneurial entrants face the risk that their innovations will be imitated or expropriated by other entrants and incumbent firms.
10 - Conclusion
- Daniel F. Spulber, Northwestern University, Illinois
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- The Innovative Entrepreneur
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- 05 July 2014
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- 16 June 2014, pp 296-312
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The innovative entrepreneur contributes to the dynamism of capitalist economies. From the industrial revolution to the scientific revolution to the business revolution, innovation is critical for economic growth and development. Innovative entrepreneurs establish firms that introduce many commercial, scientific, and technological inventions to the market place. In this way, the individual initiative of innovative entrepreneurs helps drive economic innovation.
Public policies that affect innovative entrepreneurs can significantly impact economic growth and development. Public policies aimed at stimulating economic growth and development tend to have a macroeconomic focus, using such instruments as fiscal and monetary policy. Microeconomic policies aimed at economic growth and development often target firms and industries through regulations, subsidies, and tax incentives. However, growth-oriented microeconomic policies should take into account the critical role of individuals who are potential innovative entrepreneurs. The most successful policies will be those that remove barriers to individual initiative and creativity.
EntrepreneurialMotivation
Entrepreneurs create start-ups and establish firms to accumulate assets in the context of their life-cycle consumption and saving decisions. Individuals choose to become entrepreneurs in comparison to alternative occupations and investment opportunities. Creative individuals choose innovative entrepreneurship when own-use of inventions generates greater returns than technology transfers to incumbent firms. Innovative entrepreneurs choose to implement discoveries when they provide greater returns than replicative entrepreneurship.
1 - Intellectual Property and the Theory of the Firm
- from Part I - Perspectives on Theories of Intellectual Property
- Edited by F. Scott Kieff, Washington University, St Louis, Troy A. Paredes
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- Perspectives on Commercializing Innovation
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- 05 December 2011
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- 21 November 2011, pp 9-46
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Introduction
Intellectual property (IP) rules are fundamental to economic activity because they affect transaction costs in the market for ideas. Just as transaction costs affect the allocation of goods and services, so transaction costs affect the allocation of ideas. Transaction costs in the market for ideas include the full range of such costs: communication and information processing, search and matching, bargaining, moral hazard, adverse selection, free riding, and contracting. These transaction costs occur in direct exchange among individuals as well as in intermediated exchange through firms. The market for ideas includes the exchange of basic scientific and technological discoveries, new product designs, manufacturing processes, and business methods. Ideas that are subject to market exchange can be embodied in goods and services, including final products, production equipment, software, and consulting services. Alternatively, ideas can be exchanged in disembodied forms, including blueprints, designs, formulas, and other technical descriptions.
This discussion identifies three critical areas in which the system of IP rights affects the economy. First, IP rights influence the establishment of firms because they affect the relative transaction costs of direct and intermediated exchange in the market for ideas. Individuals establish firms when the transaction costs of intermediated exchange are less than the transaction costs of direct exchange. IP rules will affect the relative costs of direct exchange and intermediated exchange in markets for ideas. Therefore, IP rights affect the scope of the firm, that is, the mix between its market-making activities and its organizational activities. However, IP rights also affect the establishment of firms themselves and the economic mix between direct exchange and intermediated exchange. IP rules are inefficient if they induce an inefficient mix of direct exchange and intermediated exchange in the market for ideas. Property rights are important for developing the market for innovations. With well-defined IP rights, firms are able to serve as intermediaries in the market for IP, whether though internal transactions or through external market transactions.
4 - Unlocking Technology
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- By Daniel F. Spulber, Northwestern University
- Edited by Geoffrey A. Manne, Joshua D. Wright
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- Competition Policy and Patent Law under Uncertainty
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- 05 June 2012
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- 13 June 2011, pp 120-165
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Introduction
“Technology lock-in” has joined the pantheon of highly honored justifications for government intervention in innovation that should be laid to rest. The concept of technology lock-in has begun to exert influence in antitrust policy, appearing in Microsoft v. Commission. Advocates argue that technology lock-in occurs when markets adopt an inferior technology and that government action is required to remedy the situation. Yet, the notion that governments can make the best choice among innovations, while markets cannot, is the “fatal conceit” of technology lock-in.
In this chapter I demonstrate that the arguments supporting the idea of technology lock-in are fundamentally flawed, as is much of the evidence for the phenomenon. The desirability of government intervention is suspect as well, particularly as government remediation is built right into the definition of the problem. I show how markets effectively coordinate decisions to adopt innovations. Market participants have economic incentives to make efficient choices among innovations. The concept of technology lock-in thus is likely to misguide public policy. To avoid disrupting incentives for innovation, public policy-makers should exercise more forbearance than usual in markets for technology.
The concept of technology lock-in predicts market failure on a colossal scale. For Brian Arthur, the economy experiences “lock-in by history.” Since technological advances are ubiquitous in the modern economy, such a systematic market failure potentially would entail losses equal to a substantial share of the gross domestic product.
1 - The Structure and Functions of Networks
- Daniel F. Spulber, Northwestern University, Illinois, Christopher S. Yoo, University of Pennsylvania
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- Networks in Telecommunications
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- 05 June 2012
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- 08 June 2009, pp 13-38
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Economic life is critically dependent on a wide variety of privately owned networks: for communications (the Internet and broadband data, telephone, broadcast television and radio, cable television), for transportation (airlines, railroads, buses, trucks, shipping, electric power transmission and distribution, natural gas and petroleum pipelines), and for distribution of products (wholesale trade and postal services). Although different types of networks vary significantly with respect to a wide variety of technical details, they share certain technical and economic features that are critical to understanding network access.
This chapter introduces some basic aspects of network structure and design. The focus of our discussion is on physical networks, involving facilities such as telecommunications switching equipment and transmission lines. The purpose is not only to provide a technical background to our study but also to obtain some important insights into how networks are organized. Evaluating the effects of regulation on the organization or formation of networks is central to our public policy analysis.
This chapter also introduces a classification scheme that is useful for understanding the different types of access to networks. These types of access have generated a variety of public policy actions. Classifying the types of access provides insights into inconsistencies in public policies that can create economic inefficiencies. Our classification scheme provides the basis for the development of a new Coasian theory of communications networks.