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Entrepreneurial Enterprises, Large Established Firms and Other Components of the Free-Market Growth Machine*

William J. Baumol

ABSTRACT. The paper studies the principal influences accounting for the unprecedented growth and innovation performance of the free-market economies. It indicates that vigorous oligopolistic competition, particularly in high-tech industries, forces firms to keepinnovating in order to survive. This leads them to internalize innovative activities rather than leaving them to independent inventors, and turns invention into an assembly-line process. The bulk of private R&D spending is shown to come from a tiny number of very large firms. Yet the revolutionary breakthroughs continue to come predominantly from small entrepreneurial enterprises, with large industryproviding streams of incremental improvements that also add up to major contributions. Moreover, these firms voluntarily disseminate much of their innovative technology widely and rapidly, both as a major revenue source and in exchange for complementary technological property of other firms, including direct competitors. This helps to internalize the externalities of innovation and speedselimination of obsolete technology. Some policy implications for industrialized and developing countries are also discussed.

1. Introduction Entrepreneurship has long been valued as a key contributor to the growth of an economy. This view often refers to the entrepreneurial activity entailed in the original usage of the term – the mere organization or establishment of just any new firm, even one thatmerely duplicates something that has been done many times before. In the
Final version accepted on September 19, 2003 C.V. Starr Center for Applied Economics New York University 269 Mercer Street NY 1003 New York U.S.A. E-mail: william.baumol@nyu.edu

following discussion, it is natural and appropriate to emphasize instead the meaning that was assigned to the term by Joseph Schumpeter(indisputably the 20th century’s prime contributor to the economic analysis of entrepreneurship and innovation), taking the entrepreneur as the partner of the inventor – as the businessperson who recognizes the value of the invention, determines how to adapt it to the preferences of prospective users and whose tasks include bringing the invention to market and promoting its utilization. It is widelybelieved that economies that are abundantly supplied with entrepreneurs will tend to grow far more rapidly than those in which entrepreneurial talent is scarce. Yet Schumpeter himself was led to conclude that the day of the entrepreneur was waning, that the expanding role of routinized innovation by big business was threatening to make the entrepreneur obsolete. I will argue here that part of thepertinent mechanism has been correctly discerned both by those who continue to have faith in the individual entrepreneur’s critical role in economic growth and by any who follow Schumpeter in concluding that routinized innovation by giant enterprises is assuming a primary role. Yet each side here is telling only part of the story and, as a result, overlooks much of its essence. The entrepreneurcontinues to play a critical part in the growth process, and there is no reason to expect that role to disappear. But in the modern economy the entrepreneur, working alone in the marketplace, cannot carry out the task most effectively. Fortunately, the market mechanism has provided the partners that the entrepreneur needs for the purpose.

Small Business Economics 23: 9–21, 2004.  2004 Kluwer AcademicPublishers. Printed in the Netherlands.

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William J. Baumol

In seeking to explain the unprecedented and, indeed, miraculous growth performance of the free-market economies, this paper focuses upon the difference in, but complementary relationship between, the characteristic innovative contributions of large and small entrepreneurial firms, pointing out that these two groups have...