The political economy of innovation development breaking the vicious cycle of economic theory

eco-Keywords Schumpeter’s theory of economic development Schumpeterinnovations as fundamental category The gap between neoclassic theoryand innovation activities Political Economy of in

of Innovation Development

National University of Kyiv-Mohyla Academy

Kiev, Ukraine

ISBN 978-3-319-54851-7 ISBN 978-3-319-54852-4 (eBook) DOI 10.1007/978-3-319-54852-4

Library of Congress Control Number: 2017939600

© The Editor(s) (if applicable) and The Author(s) 2017

This work is subject to copyright All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed.

The use of general descriptive names, registered names, trademarks, service marks, etc in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use The publisher, the authors and the editors are safe to assume that the advice and information

in this book are believed to be true and accurate at the date of publication Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made The publisher remains neutral with regard to jurisdictional claims in published maps and institu- tional affiliations.

Cover image: Modern building window © saulgranda/Getty

Printed on acid-free paper

This Palgrave Macmillan imprint is published by Springer Nature

The registered company is Springer International Publishing AG

The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

1 Introduction 1

2.3 Innovations: The Known Unknown Factor of Economic

v

4.2 Key Factors of Economic Development as Sources of Added

4.3 The Necrophilia Syndrome of Political Economy:

Fig 4.1 Key factors of economic development according to different

paradigms, dates of the worldwide economic crises, and

creating main economic conceptions regarding the decline

of the US PTO utility patents granted per million populations

vii

Table 4.1 The dynamics of the GDP per capita of selected countries

in Eastern Europe 1990–2008 compared to the average

to the citizens of the states which demonstrated dynamic

of branches on the basis of the different technological

ix

Abstract The chapter presents the key conceptual contents of the bookthat reveals the category of Schumpeterian innovations as an isolatedfactor of economic development which creates a new added value andmay become like“stem cell” of the new mainstream theory of economicdevelopment The neoclassical approach does not distinguish innovation

in this role and it leads to formation gap between the fundamental nomic theory and the real innovation processes in modern economy Theanalysis of the threats and negative consequences of the existence of thisgap for economic theory and practice as well as positive impacts of itselimination is contained The readers can have a fresh look on some knownproblems and recognize new approaches

eco-Keywords Schumpeter’s theory of economic development
Schumpeterinnovations as fundamental category
The gap between neoclassic theoryand innovation activities
Political Economy of innovation development
Structure of the book

The subject of this book can be attributed to one of the fundamentalphenomena of our existence, true nature of which is not always immedi-ately understandable to science, and it takes a long time to elucidate thismatter A classic example is discussions about structure of our SolarSystem Approximately it took 150 years for scientists to abandon

© The Author(s) 2017

I Bazhal, The Political Economy of Innovation Development,

DOI 10.1007/978-3-319-54852-4_1

1

Claudius Ptolemy’s geocentric planetary system, which was the canonicalposition for more than 1,300 years, in favour of the heliocentric system ofNicolaus Copernicus In our view, today a similar situation exists regard-

Schumpeter, in which Schumpeter propounds the idea that the primarydriver of economic growth is the phenomenon known asinnovations.This phenomenon we all can observe every day Information on thissubject is constantly provided by companies, universities, governmentbodies, the media, books, etc., whereas in fact it remains ignored byfundamental economic science Using the above-mentioned historicalexample, an allegory may be offered: everybody sees and feels the Sun(innovations), but the dominant fundamental economic theory (main-stream) does not present it properly in structure of its scientific categories

It may well be that the reader’s first reaction to this statement is quitecritical:“That’s not true!”, “That’s impossible!” However, the book waswritten precisely to prove the soundness of our conclusion and draw theattention of theoreticians and practitioners to the actual existence of thementioned paradox, and what is more, to demonstrate the risks andnegative consequences of this controversy for economic theory and eco-nomic policy

It has been over 100 years since Joseph Schumpeter put forward a newtheory of economic development However, as noted earlier, themain-stream of economic theory still does not view innovations as the isolateddecisive factor of growth These phenomena are recognized as separateingredients of the traditional aggregate production factors (in productionfunction): capital (K), labour (L), total factor productivity (TFP) ButSchumpeter proved scientifically that innovations are emerging as keydeterminants of economic development that are isolated from the existingfactors ofK, L, and TFP

In this book we would like to draw the reader’s attention to the existingconceptually state of things when the modern mainstream of economictheory in fact does not consider Schumpeter’s theory of economic devel-opment as a systematic science doctrine That is why a separate chapter ofour book is dedicated to laying out the specifics of this doctrine

The present book represents the proofs showing that the main modernUniversity textbooks in Political Economy, Macroeconomics, andEconomics contain virtually no detailed systematic exposition ofSchumpeter’s theory of economic development in which the category ofinnovations is put as a separate key factor of economic growth On the

other hand, we point at the obvious fact that innovation policy today is themain component of economic strategy of all successful business structures,

on the microlevel, and of advanced and dynamic countries, on the level Thousands of scientific and popular books on innovative manage-ment and marketing have been published, in addition to dozens ofthousands of research papers on practical problems of innovative activity,which present a multifaceted empirical analysis of innovation processes indifferent countries But in Universities the students do not see this moderndemand practice on innovations while they are studying the basic funda-mental textbooks in economic theory

macro-Hence, several research questions are emerging Why has this hugeconceptual gap between the fundamental economic theory and actualpractice regarding the Schumpeter innovations phenomenon has beenformed and why does it still exist? What are the threats and negativeconsequences of the existence of this gap for economic theory andpractice? What the positive impact on economic theory and practicecould be from the perception that the category of Schumpeter innova-tions constitutes a key factor of economic development? This book tries

to answer these questions in the conceptual framework of fundamentaltheory ofPolitical Economy This is its specificity and originality

As far as we know (partly this is demonstrated in the text), the approachpresented on theoretical analysis in the book has a high degree of noveltyand therefore is natural that it is open to criticism and further develop-ment Moreover, the format of “Palgrave pivot” series presumes a briefpresentation of major new ideas that will be further disclosed in thefollowing publications

The mainfindings of this book are related to the consideration of theparadigmatic assumptions of Schumpeter’s theory of economic develop-ment, which give to this theory the status of a separate economic doctrinethat is conceptually different from the neoclassics mainstream Theseassumptions of Schumpeter’s theory can claim to be the fundamental con-ceptual blocks of the newPolitical Economy of Innovation Development.Given the format of the book, we focus mainly on those conceptualblocks of Schumpeter’s theory that are little or not fully disclosed in theliterature Due to this we paid less attention to certain achievements ofSchumpeter’s theory, which are thoroughly developed and presented inscientific publications First of all, we mean advanced heterodox theories,especially Evolutionary Political Economy concerning the analysis of therole of innovations for unbalanced economic development as well as

Complexity Economics and Information Economy concerning the policyunder uncertainty and taking into account the current economic features

of the innovation high-tech achievements

So what are these lesser known, but vitally important for economictheory and practice, conceptual blocks of Schumpeter’s theory that weexplore in this book to justify the appropriateness of talking about a newdoctrine ofPolitical Economy of Innovation Development?

First of all, this is a heuristic invention by Schumpeter thatinnovationsare the new isolated production factor that by itself can create new addedvalue It is becauseinnovations create“a new purchasing power,” which isthen transformed into the innovator’s earnings by crediting This profit isnot the result of the redistribution of the total income of the country ofthe previous period, but that arises as the new added value That is whySchumpeter innovations can ensure by itself the actual economic growththat is the increase in the country’s GDP Therefore, in the “Pareto

efficiency” state the Schumpeter innovations can extensively increase thecountry’s GDP without increasing the given resources by creation of newinnovation resources

We consider this to be a paradigmatic discovery in economic science,because it helps explain many modern phenomena of economic realitywhich are mysterious for the traditional neoclassical mainstream andprovide theoretical justification for the innovative model of economicgrowth

These mysterious phenomena include the following: the existence of a

“life cycle” of mainstream economic theories, when they have declinedinevitably after temporary dominance (present neoclassical mainstream isalso in crisis); the unexplained nature of such specific income as growth ofshares value (equity), which now rapidly generates earnings of billions ofdollars and creates thousands of new millionaires; the generation of newadded value by knowledge capital; non-inflationary growth of wages with-out an increase in productivity of the existing (before the emergence ofinnovation) capital and labour resources, but in the conditions of innova-tion implementation; economic nature of production with high addedvalue (without the specifics of Schumpeter innovations is difficult to explain

it just because of the high degree of processing of goods); the dominance

of service industries in the GDP of developed countries; and other Thesecond important conceptual block of Schumpeter’s theory, which isoverlooked by the neoclassical mainstream, is the explanation of theeconomic nature of periodic economic crises and mechanisms to

overcome them through the understanding of the flow of innovationprocesses in a historical context The distinction of Schumpeter’s theore-tical approach from neoclassical logic lies in its recognition of the innerforces of the market system, which conditions the economic crises ofcapitalism, whilst also determining recovery and economic growth.These forces are technological innovations.

When previous innovations become as conventional productionresources, the national economies will inexorably come to a crisis point;progressive innovation of technological change can help overcome suchcrisis and stimulate economic growth Thus, innovations become as“end-less transition,” as “endless technological change.”

In the general sense, we consider two contradictory approaches to

Neoclassical and Schumpeterian The first believes in the efficiency ofgeneral equilibrium supporting the constants of main ratios between out-put, investments, consumption, and employment: this methodologicalpath does not pay special attention to the proportions of the nationaleconomy’s technological structure Conversely, the Schumpeterianapproach does pay attention to the emergence of technological innova-tions and the economic structure by sectors with a different level ofinnovation technology Josef Schumpeter referred to these two attitudes

as the“Statics” and “Dynamics” stages of cyclical economic development.According to Schumpeter, the real economic growth can only be foundupon the“Dynamics” stage This conceptual segment has been develop-ing in Neo-Schumpeterian approaches and we use them to elaborateappropriate analytical tools and proposals in order to enhance economicpolicy

The uncompromising separation of the existing state of the economyand the future one, which is formed by the emergence of Schumpeterinnovations, is another important conceptual block of Schumpeter’s the-ory His theory of economic development is a theory that denotes funda-mental changes to the current state of affairs: a leap into a new quality (newcombination), which is mostly impossible to foresee Hence, it is important

to focus particularly on the fact that in order to ensure long-term nomic growth of a country, it is necessary to form new productionstructures on the basis of innovation technology, rather than transformingtraditional production structures These structures are important for thepreservation of existing scopes of national product and the support ofoperations in the mode of economic “Statics,” but the “Dynamics”

eco-mode of economic systems is directly related to innovation developmentand the corresponding growth of that country In this book, we show thatthisfinding is particularly significant for transition economies.

The title of this book has two parts:“Political Economy of InnovationDevelopment:Breaking Vicious Cycle of Economic Theory.” We believe thatcategory ofSchumpeter innovations as isolated factor of creating new addedvalue has direct connection to differentmainstream economic theories inhistorical dimension But this relationship has been remaining invisible.Schumpeter innovations have been changing the economic world, and as

we consider they also have been transforming the mainstream theories Inthis book we show that there was and exist today the problem to include thecategory ofinnovations into categorical systems of mainstream theories Wetry to give arguments for our hypothesis that mainstream theories have falleninto decay because we did not take into consideration the meaning ofSchumpeter innovations This state can explain the existence of surprisingVicious Cycle of Economic Theory when any mainstream theories could notkeep themselves in such quality for the long time It seems that the neoclas-sicalmainstream is no exception

Our retrospective look at the history ofPolitical Economy provides anargument for concluding that there is also a certain “vicious cycle” insolving some of the fundamental theoretical issues We believe that thereare two interconnected key issues (or main research questions):“How arethe states getting rich?” (The Wealth of Nations) and “What is the nature

of added value?” Every new theory of Political Economy that acquired

“mainstream” status has put forward a new theory concerning the mainfactor (driving force) of economic development, and rejected a previoustheory This descended from the invention of a new concept of addedvalue If a country in economic policy will be operating in old concept ofadded value, such economy will remain under threat of crisis

In this book, we give evidence that indicates the existence of a“lifecycle” for each of the core theories At the beginning of their practicalapplication, each of these “life cycles” promoted the progress of humancivilization; however, later the crisis aroused revolutions, after which neweconomic development was conditioned by the implementation of new

recognition of the new main factor of development, etc The presentperiod is not excluded Today, traditional Political Economy is in crisisand again, as in history, many experts talk about the decline of economics

as a discipline In this book we aim to substantiate the view thatPolitical

Economy in order to revival must include the category of Schumpeterianinnovations as a mandatory key part of conceptual framework.

The same we could have observed regarding influence of new logical paradigms in forming different mainstream economic theories It iswell known about influence of innovation technological change on themany economic and social processes in historical dimension But wedemonstrate that among key categories of mainstream theories the iso-lated category of technological innovations is absent As we shown, thecategory of resources’ productivity cannot present the Schumpeter innova-tions in a full measure Innovations were precisely this phenomenon whichpushed the emergence of new economic relations and concepts However,this factor has always remained in the shadows when the core construction

techno-of main successive theories has been established and discussed Whyinnovations did not become as the main special category of PoliticalEconomy? I think it is enigma the history of economic thought Here wealso make attempt to give some explanation In this book we position thecategory ofSchumpeterian innovations like a stem cell of Political Economy

of Development

The reader will certainly wonder about the practical significance of ouranalysis and conclusions presented in this book Do they have todaypractical application? We are trying to answer this question in the text.Further in the introduction we will briefly present the main findings that,

in our opinion, make the book both theoretically and practically relevant.The analysis showed that the absence of the category of Schumpeterinnovations in mainstream economic theories did not allow them toadequately explain economic processes that occurred due to change inthe technological paradigm of the economic system First of all, this wasdue to improper identification of the causes of global economic crises thatperiodically arose in the recession phase of the technological paradigm(Kondratiev’s long wave) As a result, such theories not only lost theirexplanatory function and consequently fell into decay, but also became areactionary obstacle to economic development, predicting the collapse ofthe economic system

Today, we can clearly observe such processes The economic policy,which is based on the rules of the dominant neoclassical theory, demon-strates its effectiveness only for theStatics mode of economic system Butthe recipes of this theory in response to crises are linked not to activation ofinnovative processes, but to the implementation of austerity policies withreduced funding for science, education, and innovation infrastructure This,

invariably all the same, leads to the formation offinancial bubbles becausedebts generate new debts, to the threatening increase in social inequalityand poverty, increase in unemployment, uncertainty in the future, especiallyamong young people, etc.

In our opinion, the lack of attention to the innovation policy ments in the proposed neoclassical recipes is caused by the lack of theconceptual vision that Schumpeter innovations independently create newadded value, which can help the budget grow and not be the sum fromreallocation of existing added value in favour of new articles and expendi-ture volumes Therefore, such policy does not provide the desired eco-nomic development for a country, especially while the policy of theinclusion growth is realized

instru-At the same time, we see the success of the economic policies which defacto implement Joseph Schumpeter’s innovative model of economicdevelopment These include the dynamic countries of Southeast Asia,the USA, Canada, Scandinavia, Germany, Great Britain, Switzerland,Denmark, the Netherlands, Estonia, Israel, and others They spend con-siderablefinancial resources primarily on the development of the country’shuman capital, and the development of national innovation systems Theseright actions were probably the result of empirical observations of theeffective activity of successful businesses and countries rather than theprovisions of the basic University textbooks or the recommendation ofscientific centres that are followers of the theoretical positions of neoclas-sicalmainstream

Thus, we believe that the reason for the fact that many countries cally do not provide the intensive innovation development is mainly the lack

practi-of adequate theoretical understanding practi-of the role practi-ofSchumpeter innovations

as the key driving force of economic growth By focusing on the tion of traditional factors of economic growth, they supply the austeritypolicy concerning the education, science, institutions supporting innovationprocesses, and the social security But priority is policy to supporting offoreign investment andfinancial lending for the development of traditionaleconomic sectors without giving due attention to the need for creation ofadvanced innovative industrial structures As a result, not only such coun-tries fail to achieve the desirable grows, but also politicians often cannotexplain the reasons for failure, because they seemingly were applying recom-mendations of recognized expert organisations, in particular theInternational Monetary Fund But explanation to this situation is becauserecommendations were as neoclassical not from Schumpeterian approaches

revitaliza-This collision is most prominent in transition economies In our sis of the features of this group of countries, in many cases, we examinethem based on the facts and materials relating to Ukraine On the onehand, this is due to the fact that, living in Ukraine, the author operateswith the experience and data that he knows well not only through statisticsand literature, but also through active participation in discussions accom-panying drawing up economic policy-making and the evaluation of itsresults This allows for deeper perception and understanding of the con-ceptual nature of opinions of politicians and experts, including foreignconsultants who had influenced decision-making But by using Ukrainiandata, the author’s aim was not to highlight the specificity of Ukraine’seconomy as a separate topic The main reason for operating with theUkrainian experience in this study is that Ukraine among the Europeantransition countries has become the distinguishing economic victim ofimplementation the recipes of neoclassical theory.

analy-Today, after 25 years of building of market economy, Ukraine hasdescended to the last place in Europe in terms of GDP per capita, level

of salaries, pensions, and social security We believe that this is the result ofunderestimation of the innovation factor of economic development Suchconclusion regards many countries not only Ukraine The evidences of thisassertion are main content of this book The Ukrainian sample give ussuitable case to use in analysis the method proof by contradiction, whenthe innovation development factor is insufficiently implemented in acountry It gives us opportunity to discover and analyse the deep metho-dological roots of current mistakes of economic policy

But these processes also are manifested in other transition countries,where building an efficient market system had been from virtually “zerocycle.” So these countries have become an unique experimental polygon

to testing economic theories This book considers these samples throughthe innovation model of economic development This approach letexplain the “trap” in which the some developing transition countrieshave found themselves, that were focusing on a policy of increasingoutput of traditional industries, but were not supporting the creation apowerful innovation resources for dynamic long-run development.Many of these countries, including Ukraine, failed to achieve prosperity

in terms of a welfare economy Why did that happen? Why the classicalrecipes of building market institutions turned out not effective? Whatmistakes were made? The common, typical answers from a current eco-nomic literature arise from the same neoclassical approaches: the failures

were due to bad market institutions which did not give an appropriateenvironment to manifest market forces But there are many examples inhistory when the countries implementing these neoclassical recommenda-tions did not reach levels of success Our analyses of these subjects alsonecessarily lead us to elaborate a new theoretical framework to answer thequestions.

In this book we would like to show that model of building alism according to the canonic neoclassical recommendations in rea-lity did not improve the lives of the majority of transitive countriesbecause it was the model which Schumpeter classified as the “Statics.”Moreover, those countries that complied with only the “canonical”neoclassical prescriptions from the “Washington consensus” sufferedmajor setbacks

capit-Another Ukrainian context is presented in detail in the book notbecause the author wants to highlight his region but because of impor-tance for presenting the main subject of the book, which applies to anycountry This also relates to necessity to use the theory of economic crisis

of the famous Ukrainian economist M.I Tugan-Baranovsky in moderntheoretical discourse This theory was formulated in 1894, and it is rightlyconsidered to be thefirst scientific theory of economic crises And what isimportant for our analysis is the fact that this theory became a fruitfulconceptual basis for Schumpeter’s theory of economic development(through the influence by Arthur Spiethoff) This relates to proving thehypothesis of the existence of internal objective factors of economic crises.The important point here is that these factors are directly related to theinnovation process This theory of M.I Tugan-Baranovsky is less known

to the public, but it is very important to know for a better understanding

Neo-Schumpeterian approaches

The reconsideration of the Schumpeterian approach gives the author anew methodological space to upgrade understanding of some key funda-mental concepts that are nearly forgotten in modern publications and textbooks: the significant meaning of the original key subject of PoliticalEconomy, namely, The Wealth of Nations, but not only the Pareto equili-brium; the theory of value, theory of long-run economic cycles, thestructural technological policy, and the influence innovations on increas-ing the real wages The rethinking of core theoretical categories will bemanaged by comparing the principles of neoclassical “Statics” economywith special features of the innovative“Dynamics” economy

The timeliness of this book is highlighted in that today, the model ofinnovation economic development de facto engages in competition withthe conception of“Industrial Modernization” that has become popular inmany countries, especially amongst those that demonstrate weakness intheir potential for innovation development In such countries, manyexperts suggest building a strategy of economic development basedupon supporting traditional industrial enterprises by their modernization,including through innovation This point of view is limited because todaythe traditional industrial markets reach maturing very quickly, and theirprofitability subsequently decreasing The current economic crisis hasfurther confirmed this finding.

The book is structured as follows

mainstream of economic theory takes no notice of Schumpeter’s theory

of economic development as the systematic doctrine This raises serioustheoretical and practical problems because the innovation developmenthas become a key priority of successful economic policy The chapterreveals the conceptual nature phenomenon ofinnovations as central cate-gory of Schumpeter’s theory, which is positioned as independent factorcreating new added value Category ofinnovation may become like a stemcell of the new Political Economy of innovation development It is shownthat methodological underestimation ofinnovation as fundamental cate-gory of economic theory led to the inadmissible gap between the neoclas-sical mainstream theories and the real innovation processes of moderneconomic life

eco-nomic development The chapter analyses its core methodologicalfindingsand gives theoretical grounds for proposition that only innovation devel-opment can be able to increase national added value; it highlights theconclusion that an economy based on reproduction and development oftraditional production structure is unable to obtain substantial increase innational wealth The chapter also analyses a less known conceptual back-ground of the Schumpeter’s innovation theory related to M.I Tugan-Baranovsky ideas on the business cycle theory, as well as the Neo-Schumpeterian theory of technological paradigm, which has created aconceptual basis for a new methodological vision of the cyclical nature ofeconomic development and the anti-crisis state policy

categorial system of the economic theory, and it is substantiated of its

importance in order to recognize the subject ofPolitical Economy as thedoctrine onthe Wealth of Nations It is shown that over time the country’sabsolute economic wealth was lost as the main subject in Economics Thechapter shows that phenomenon ofinnovation did not acquire the status

of a key scientific category in the formation of new theories and remained

as the visible invisible factor of development The technological tions not only changed the course of economic history; they also havebeen changing mainstream economic theories

attempts to establish the names for current and future type of our economic system It is shown that unexpectedly many experts came back

socio-to the old used terminology and have offered socio-to define new phenomena touse category of “Industrialisation” in different combinations, but notusing category of “Innovation” The chapter analyses such controversyand considers as avoidance of the recognition of Schumpeterian concep-tion as new mainstream of economic theory The traditional economicprogrammes pay attention to the competitive advantages of availableresource base with proposals of their further modernization ModernSchumpeterian programmes must be created to elaborate the innovationmodel focusing on the creation of new knowledge resources for gainingnew competitive advantages

Schumpeterian hypothesis about innovative nature of economic ment The rating method of“Global competitiveness report” was used toevaluate innovations’ impact on welfare of different countries The resultsare that all rich countries had an active innovation processes, and thedynamic catch-up countries demonstrate strong interest in implementa-tion of innovation technologies The chapter also analyses the structuraltechnological development of Ukrainian industry The structure of indus-trial sectors was classified according to technology levels and as belonging

develop-totechnological paradigms It could be an effective analytical method toevaluate production facilities of the economic activity in the context oftechnological determinism of the innovation theory of economicdevelopment

give an understanding of the contemporary“paradox” of the productivityslowdown that has emerged simultaneously with a fundamental change ofinnovation technologies and increasing accumulation of human capital.The chapter analyses this problem for transitive countries regarding the

big differentiation of its labour cost It is difficult to explain this enon by the cardinal changes in the physical labour productivity for theexisting comparable productions, but it can be done taking into accountthe difference in the wages policy and the innovational changing oftechnological structure of production The analysis shows the transitivecountries that had undertaken considerable gradual increase in labour costand simultaneously stimulation of the innovation activities have ensured ahigh dynamics of real GDP.

phenom-The proposed new Political Economy of Innovation Development tainsfindings that the R&D and the technological innovation sphere of acountry is not so much the result as the key factor of sustained economicgrowth In many ways, the innovation technological determinism shapesthe economic preconditions for the cyclical surge formation with its phases

con-of recovery and expansion after crisis Readiness to innovations becomesthe main competitive advantage of national economies, determines itsposition in the world competitiveness ranking, and becomes the maincapability in order to reaching the well-being of these countries

The presented new concept ofPolitical economy for innovation opment, the new analytical angle to analyses of urgent economic problemsand challenges of the economic development policy will be interesting foracademics, professional analytics, and politicians in many countries, espe-cially in transitive and emerging economies Also, it could be attractive forthe mass audience interested in modern economic problematics and dis-cussions It gives to readers the materials to have a fresh look on someknown problems, to recognize new ones and, that is very important, toattract more attention to recognition a practical function of moderneconomic theory

devel-Innovations: A known Unknown

Phenomenon of Economy

Abstract This chapter considers the existence of conceptual collisionwhen the mainstream of economic theory takes no notice ofSchumpeter’s theory of economic development as the systematic doctrine.This raises serious theoretical and practical problems because the innova-tion development has become a key priority of successful economic policy.This chapter reveals the conceptual nature phenomenon of innovations ascentral category of Schumpeter’s theory, which is positioned as indepen-dent factor creating new added value Category of innovation may becomelike a stem cell of the new Political Economy of innovation development

It is shown that methodological underestimation of innovation as mental category of economic theory led to the inadmissible gap betweenthe neoclassical mainstream theories and the real innovation processes ofmodern economic life

Schumpeter innovations
Neoclassics theories
Schumpeterian cal models
Total factor productivity
Creative destruction

Comparing the scale of presence of the“innovation development” topic inthe modern real economic policy and practice, especially in the developedcountries, and level of attention to this subject in fundamental economic

© The Author(s) 2017

I Bazhal, The Political Economy of Innovation Development,

DOI 10.1007/978-3-319-54852-4_2

15

theories, we can easily recognize a big difference in favour of real policiesand practices This gap needs explanation in itself and raises the question:

“Does the modern economic theory fulfil its practical function?”

In this book, we will try to pinpoint the cause of this paradox, whichshould enable us to eliminate it going forward Fundamental economictheory and the theory of innovation activities must exist in organic com-bination to help solve the current problems of economic theory andpractice alike and create the methodological basis with a view towardsthe formation of an effective economic development policy

As it is well known, the recognized analytical and statistical publications

of the leading international organizations specifically designed for itoring the R&D and innovation practices demonstrate impressive volume

mon-of innovation activities in the economies mon-of developed countries Here arethe links to the latest issues as an illustration: The Organisation for

respected analytical publications of the National Science Foundation(NSF) in the United States of America (USA) (National Science Board,

2016) and resonant innovation ranking of countries by the WorldIntellectual Property Organization (WIPO), Cornell University, and theEuropean Institute of Business Administration (INSEAD) (CornellUniversity et al 2015), etc These are the general worldwide reports.The global pool of publications on the topical issues of the innovationpolicies of individual countries, industries and enterprises includes thou-sands of books, articles, reviews, etc

The phenomena of“innovations” and “innovation activities” are sented here as an independent core object of analysis and policy It shouldalso be pointed out that the authors of the mentioned publications clearlyrecognize this object (innovations) as a key factor of economic develop-ment in different countries, regions, and business Therefore, in order togain an adequate understanding and perception of statistical, analytical,and scientific investigations on the innovation thematic, it is important to

pre-define the specific content of the used terminology and to point out anadditional categorial specific of innovations that we analyse in this book.Interpretations of“innovations” as a term and a category are given a lot

of attention in many publications nowadays Often, the term“innovation”just designates something new, being used as a synonym to“new things”

or“novelties” As a result, a wide array of definitions and interpretations

has been accumulated Those have stimulated special generalized cal studies in this informationfield For example, it is worthy of attentionthe fundamental interdisciplinary monograph by Benoit Godin titledInnovation Contested The Idea of Innovation over the Centuries (Godine

analyti-2015) There, meticulously collected examples pertain to the use andinterpretation of the term“innovation” in philosophy, religion, and pol-itics, and its use in different social relations, economics, etc over themillennia

However, in economic theory and management practice, the term

“innovation” is used not just as a synonym for “new things”, “novelties”,etc, but rather strictly as a generalizing scientific category, which waselaborated by famous economist Josef Schumpeter in his new theory ofeconomic development Theinnovation category presents the economicnature of specific isolated production factor that strictly determines andpromotes the economic development This category was developed bySchumpeter and introduced into Political Economy in his classic bookTheory of Economic Development: An Inquiry into Profits, Capital,Credit, Interest, and the Business Cycle, which was first published inGerman in 1911 and translated in English in 1934 (Schumpeter 2010

[1934]) In this book, Schumpeter examines the phenomenon that helater defined “innovation” under the name of a “new combination”.This analysis allowed Schumpeter to scientifically justify and introduceinto research circulation a fundamentally new production factor of eco-nomic development, a new political economic category, which wassecured in the economic theory as “innovation” and was internationallyrecognized and gained wide use Now category“innovation” is not trans-lated to other languages In our book, we will consider this category of theSchumpeter’s theory as cornerstone of Political Economy of innovationdevelopment

Over the course of his analysis, Schumpeter was presenting this nomenon by three hypostases:

phe-1) As a specific category of economic theory, differed from the existingtheories in that it reveals the innovation essence of the processes of

“economic development”, and which, according to Schumpeter,could only be explained by the emergence of innovation changesthat independently create the new added value without reallocation

or increasing productivity of existing resources (production factors):innovations generate the increasing of added value by themselves

2) As a specific display of visible in practice forms of existence tions Schumpeter identifies five main external forms of manifestation

innova-ofinnovations (new combinations): new good or a new quality of agood, a new method of production, the opening of a new market,the conquest of a new raw materials or half-manufactured goods,and the carrying out of the new organization of any industry Thisclassification still remains to this day the basis for innovation statis-tics and corresponding analytics based on these statistics

3) As an existence the phenomenon of innovative entrepreneurship asspecial capitalist institution that createsSchumpeter innovations and

in this quality the entrepreneurship becomes also as the specificfactor in economic development To be precise, Schumpeter identi-fied the entrepreneurship phenomenon only as the innovationentrepreneurship But today the name of Schumpeter mainly isassociated with any entrepreneurship

The second and third hypostasis of Schumpeter innovations is more widelyknown in the research and an analytical literature But these external forms ofinnovations do not reveal the conceptual economic nature of the category ofSchumpeter’s innovations (first hypostasis) In our opinion, the perception ofinnovations mainly through their forms of appearance is one of the importantexplanations whyinnovations apply to an account of specific ingredients oftraditional factors of economic growth but not as an isolated phenomenon.The best way to reveal exactly an essence of thefirst hypostasis of innova-tion, which we will continue to call Schumpeter’s innovations, is to give a directquote of J Schumpeter where this category was named as“kind of change”:

this kind of change is the cause of so many important economic nomena that it seems worth while to build a theory for it, and, in order to do

phe-so, to isolate it from all the other factors of change The author begs to add another more exact definition, which he is in the habit of using: what we are about to consider is that kind of change arising from within the system which

so displaces its equilibrium point that the new one cannot be reached from the old one by in finitesimal steps Add successively as many mail coaches as you please, you never get a railway thereby.

(Schumpeter, J A (2010 [1934]) The Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle New Bruswick (U.S.A.) and London (U.K.): Transaction Publishers – p 64).

Regarding the specific definition of the content of visible in practice forms

of existence innovations and that mostly are the objects of statistics andrelevant research and analytics, this task is not difficult due to the fact thatthere are the recognized and standardized definitions that were officiallydeveloped and adopted by OECD and Statistical Development Office of

Interpreting Innovation Data (Oslo Manual 2005) These approachesand indicators are used in many countries and international organizationsfor analytical and research work, international comparisons, and are used

in forming an economic policy These standardized definitions are given in

Box 2.1 Of ficial Definition of Innovation

From: OECD and Eurostat (2005) Oslo Manual: Guidelines forCollecting and Interpreting Innovation Data.Paris: OECD

146.An innovation is the implementation of a new or significantlyimproved product (good or service), or process, a new marketingmethod, or a new organizational method in business practices, work-place organisation or external relations

148 The minimum requirement for an innovation is that the duct, process, marketing method or organisational method must benew (or significantly improved) to the firm This includes products,processes and methods thatfirms are the first to develop and thosethat have been adopted from otherfirms or organisations

pro-149 Innovation activities are all scientific, technological, tional,financial and commercial steps which actually, or are intended

organisa-to, lead to the implementation of innovations Some innovation ities are themselves innovative, others are not novel activities but arenecessary for the implementation of innovations Innovation activitiesalso include R&D that is not directly related to the development of aspecific innovation

activ-150 A common feature of an innovation is that it must have beenimplemented A new or improved product is implemented when it isintroduced on the market New processes, marketing methods ororganisational methods are implemented when they are broughtinto actual use in thefirm’s operations

The third hypostasis of category ofinnovation is broadly well-knownand elaborated by theory and practice But when analysing the phenom-enon of entrepreneurship is not always, it is closely tied to innovativeentrepreneurship, as did Schumpeter Regarding last subject has been

Nevertheless, such research agenda has not included the analysis ofSchumpeter innovations as fundamental category (first hypostasis) focusingonly on the external forms ofinnovation manifestation This circumstancecertainly limits the effectiveness of processes of diffusion of innovationsbecause without fundamental theory of Schumpeter the entrepreneur canhave a vision that innovation strategy is not imperative, and can be thedevelopment without innovations

In the present book, we try to draw attention namely to the conceptualmeaning of Schumpeter innovations as an isolated factor of economicdevelopment which creates a new added value and which may become akind of a stem cell of the new theory of economic development as it wasput forward by Schumpeter In our opinion, separation of mentionedhypostases of the phenomenon of innovations led to the strange gapbetween the fundamental economic theory, as presented by the main-stream, and the real innovation processes of modern economic life

“main-stream”) of fundamental economic theory as a rule has avoided adequately

Schumpeter’s economic development theory A huge gap has been formedbetween the practices of application on the ideas of this theory and study-ing and research of Schumpeter’s theory in the fundamental economicscience, especially in Universities

The validity of this statement on University education was confirmed bythe special study that we carried out together with I Pisotska (Bazhal andPisotska 2012) We analysed the content of many of current basic text-books onmacroeconomics, economics, economic development, etc., which areused by the leading Universities around the world However, we did notfind any sections devoted to complete coverage of the Schumpeter’stheory At best, it was possible tofind a brief mention of the existence ofthe phenomenon of innovations in economy, and also find of a very

popular Schumpeter’s metaphor about innovations as “creative tion.” To confirm this conclusion, we additionally provide examples fromseveral reputable publications.

destruc-In the first editions (the 1990s) of the macroeconomics textbook forundergraduate programmes by Prof N Gregory Mankiw from HarvardUniversity, widely spread and used in many countries, the category ofinnovations and the name of Joseph Schumpeter are not mentioned in theIndex (Mankiw 1997) In the recent eighth edition of this textbook,which consists of 625 pages, we can see that the category ofinnovation

is still missing, but there is already a two-page-long comment on thefamous metaphor of Joseph Schumpeter about “creative destruction”(Mankiw2013, p 257–258) The Index of the world-famous macroeco-nomics textbook for Master’s and Ph.D programmes of Professor inPolitical Economy David Romer from the University of California,Berkeley, has absolutely no references to theinnovations and Schumpeter(Romer2012)

The same is true for the modern fundamental works on PoliticalEconomy In the Subject Index of the fundamental work on 775 pages

by Allan Drazen Political Economy in Macroeconomics (2000), the term

“Schumpeter” only with one attribution for two rows of text with tioning about the political cycle In the recent volumetric resonant book in

men-685 pages of Thomas PikettyCapital in the Twenty-First Century (Piketty

2014), we can recognize the same: in Index the term of innovations isabsent, and the name ofSchumpeter is mentioned only once for two rows

of text about the fact that Schumpeter allegedly wrote that socialismwould inevitably triumph over capitalism In fact this is not true, but inour context, it is a wonder that Pikkety did not notice the Schumpeteriantheory of economic development, in which the category ofinnovations isthe key factor of economic growth and where there are many other socialand economic findings The similar picture can be observed in otherrecognized fundamental books (Agenor and Montiel 2015; Reinhartand Rogoff2009; Liu and Premus2000)

The theory and practice of transition countries that were formed from command and administrative economy to the market areespecially indicative in the context comparing the results of the imple-

approaches All the developed countries have long been on the track

of the innovation and knowledge economy, and as we have just shown,

there is a problem of explaining why the fundamental economic theorydoes not proceed through the appropriate changes However, transi-tional economies built their market economy almost from scratch, andtherefore, the choice of a conceptual framework was very important to

conditions

Today it becomes most clear to many politicians and researchers thatunder free market and absence of effective public control, the countrygoes to the formation of an oligarchic and corrupt economy that led inmany cases not to increase its general welfare, but rather to its decrease

In these circumstances, it may contend that experience of transitioncountries has given a convincing demonstration of the existence andactuality of a practical function of the economic theory One couldeven argue that in these cases we could observe how the real macro-economics experiments have been occurring It gives a research oppor-tunity to verify certain conceptual positions of the economic theories.The results of these experiments became evident very quickly.Although, we can note that only few of the active politicians andexperts were performing in accordance with concrete recipes of theexplicit economic theory

Nevertheless in my opinion the mentioned collision between a mainstreamtheory and practice of innovation policies continue to give confirmation thecorrectness of the last paragraph of the famous book by John MaynardKeynesThe General Theory of Employment, Interest and Money on the practi-cality of the economic theory (Keynes1964[1936]) In thisfinale of famousclassical book, Keynes stressed very important aspect for our analysis that anypolicy makers unconsciously stick to the defined economic theory That iswhy it is very important to deeply understand Schumpeter’s theory to provide

it a broad recognition We give the Keynes’ finale inBox 2.2

Box 2.2 John Maynard Keynes about practical function of economic theory

the ideas of economists and political philosophers, both whenthey are right and when they are wrong, are more powerful than iscommonly understood Indeed the world is ruled by little else.Practical men, who believe themselves to be quite exempt from anyintellectual influences, are usually the slaves of some defunct

economist Madmen in authority, who hear voices in the air, aredistilling their frenzy from some academic scribbler of a few yearsback I am sure that the power of vested interests is vastly exagger-ated compared with the gradual encroachment of ideas Not, indeed,immediately, but after a certain interval; for in thefield of economicand political philosophy there are not many who are influenced bynew theories after they are twenty-five or thirty years of age, so thatthe ideas which civil servants and politicians and even agitators apply

to current events are not likely to be the newest But, soon or late, it

is ideas, not vested interests, which are dangerous for good or evil

John Maynard KeynesThe General Theory of Employment, Interest and Money

London: Macmillan, 1936

We are not going deeply into this realm now (partly it will be done belowthroughout the book), but only draw the reader’s attention to the fact that abig number of publications on the problems of economic transition and theconceptual proposals that are provided in these publications for the eco-nomic policy were without the measures to activate the innovation processes.Also, we do notfind there references to ideas of the theory of economicdevelopment of Joseph Schumpeter It is possible to make sure of this one bylooking through such main publications concerning problems of economy

in transition as Sachs and Warner (1996), Zecchini (1997), Roland (2000),World Bank (2002), Aslund (2012), Kolodko (2011), and others

Also there is a similar significant disparity in the implementation of theprinciples and tools of innovation policy into national programmes andstrategies in developed countries, from one side, and in developing coun-tries The rich countries are developing of the national innovation systemsand have created a model of knowledge economy Countries which areoutsiders of economic competition are waiting for better times to imple-ment innovations This difference is especially evident in the countries,which follow the guidelines of the“Washington Consensus” in the eco-nomic policy

In recent times the textbooks with small sections for the Schumpeterianmodels have appeared But they are devoted not to clarifying the essence

phenomenon ofinnovation in the traditional neoclassical models of nomic growth We do not provide here a detailed analysis of this fact andliterature references because this subject will be presented in more detail inthe next parts.

As it was shown in the previous paragraph, modern textbooks oneconomics and economics virtually do not demonstrate the Schumpeter’stheory of economic development as a separate independent paradigm ofPolitical Economy Its representation in basic textbooks is limited by rathersuperficial references to the metaphor on innovative “creative destruction”and the importance of innovation entrepreneurship The works, whichattempted to build mathematical models of this theory of economicdevelopment, mostly tried to insert the factor ofinnovations into existingneoclassical models through modification of the traditional factors ofproduction We will continue this topic in the following sections, buthere we need to note that the mere absence of detailed chapters on thetheory of Schumpeter in basic textbooks on economics demonstrates thegeneral lack of broad academic support the efforts to engage the theory ofSchumpeter intomainstream

macro-In our opinion, lack of attention to the Schumpeterian category ofinnovations in the main macroeconomic theories can be explained by thefact that these theories did not identify this category as a separate isolatedspecific production factor in economic development, as it is supposed bythe theory of Schumpeter Various doctrines ofPolitical Economy interpretvisible phenomena ofinnovations as components of traditional factors ofthe aggregate production function: Labour (L), Capital (K), and Totalfactor productivity (TFP) In conceptual economic literature, it is mainlybelieved thatinnovations influence economic development either throughthe increase of productivity of theLabour (L) factor or through an increase

in the amount of productivity of the Capital (K) factor through itsaccumulation

However, even extraction in the neoclassical production function of aseparate variable, which reflects the characteristic of changes in productiv-ity of factors L and K, which was namedTotal Factor Productivity (TFP),essentially left the traditional production factors L and K as the mainendogenous variables of resources for economic development both in

the neoclassical models of economic growth and in the imagination ofmany experts It is also possible to mention that TFP as factor and asexogenous variable of production function cannot exist independentlyfrom factors L and K that present the proportions of the initially derivedaggregate production function, because TFP reflects the changes in pro-ductivity of these factors.

According to Schumpeter theinnovations are a new separate isolatedproduction factor which promotes economic growth and the existingregardless of the initially available factors L0and K0that were before theimplementation of theinnovations Schumpeter innovations create a newproduction function, in which the proportions of production factors arealready qualitatively different (KinandLin), and the nature of their inter-action in the new production function changes In this case,innovationsbecome a separate factor of country’s economic development and as thefactor that creates new value, which increasesthe Wealth of Nations Insuch qualityinnovations becomes a new economic category proposed bySchumpeter in his theory of economic development

In publications belonging to themainstream economic theories, thephenomenon of innovations is considered primarily as novelties, whichhelp to increase the productivity of the existing production resources (L0

andK0) However, analysing in this perspective, they often make a vation that these novelties can fail to increase the wealth of the country, ifthe unemployment caused by those novelties rises and, paradoxically, theycan even cause an economic andfinancial crisis of relative overproduction.Such an influence of innovations drew attention of many researchers,starting with the classics: David Ricardo’s labour theory of value andrespective analysis on influence of machinery on economy (Ricardo2004

reser-[1821], Ch 31); then the K Marx with hisThe General Law of CapitalistAccumulation (Marx 1992[1867], Ch 25), other Classics economists,and then Neoclassics, Keynesians, etc

Now again several newest influential approaches interpret innovations

as the potential threat of unemployment For example, this is the wide-recognized conception of “Industry 4.0” (Schwab 2016), and inUkraine there are some analytics who recognize embedded innovations

world-as a source of economic crises (Ryaboshlyk2014)

The main doctrines ofPolitical Economy mainly considered this last type

of impact ofinnovations on economy, when the productivity of existingproduction resources increases Therefore, the mainstream theories didnot associate the growth of country’s wealth with the Schumpeter

innovations as a specific production factor that exists independently anddifferent from the traditional production factors L and K, while theirproportions were derived using retrospective data analysis to constructaggregate production functions The history ofPolitical Economy showsthat in this methodological framework, without theSchumpeter innova-tions, crises of the economic theory always appeared The mainstreamtheories, changing one another, without involving the factor ofSchumpeter innovations quickly had exhausted their explanatory capacityand practical value But exactlySchumpeter innovations led to appearance

of new resources and products, and related new production functions,and new mainstream theories

However, current empirical studies and facts of real economy prove

more evidence of the decisive value of Schumpeter’s category of vations as a generator of new economic reality for dynamic economicgrowth

To illustrate the conclusions made in the previous section, we will considerthe basic proposed approaches to inclusion ofinnovations to the neoclas-sical models of economic growth Such modernization of neoclassicalnotions of economic growth factors is associated with the development

of endogenous models of economic growth and models that are calledSchumpeterian We used the word“called,” because Schumpeter innova-tions, which we mentioned before, are not directly identified and are notincluded in these models

Use of the CobbDouglas aggregate production function, tion of which is performed by the way of inclusion in it of the effectscaused byinnovations, is the classification feature of neoclassical models ofeconomic growth Thus, these phenomena, the existence of which wasimplicitly assumed in the exogenous parameter of this formula, wereexplicitly added to the interpretation of the content of endogenous vari-ables K and L, and then they have acquired the status of endogenousvariables

moderniza-The mentioned base exogenous variable of the CobbDouglas aggregateproduction function is the‘Total factor productivity’ (TFP), which was

named by Natan N Rosenberg also as“the black box”, that is analogy ofthe category in cybernetics (Rosenberg1983):

Y ¼ AKαLð1αÞ;whereY is total output of economy, K is the capital accumulation, L is theaggregate labour recourses,A is total factor productivity which presentsthe index of change of the productivity of factorsK and L (A is also called

as factor of “technology”, “technological progress”, or “technologicalchange”, but in this formula we cannot discern and reveal concrete phe-nomena that influence the productivity), α is capital’s shares of output, and(1 – α) is labour’s shares of output under assumption of unchangingproductivity ofK and L

The growth model of R Solow became an important interpretation ofthe features of economic growth in the long term, presented with thisfunction This model was built on the modification of the Cobb-Douglasproduction function, when all the endogenous variables were presented in

a normalized way per labour resource unitL (Solow1957):

Y

L

αLL

ð 1α Þ

! y ¼ Akα

Considering the dynamics of economic growth by this model, R Solowmade a well-known fundamental conclusion that when the economyreaches a certain levelk*, which he called“the steady-state level of capitalper man (or per man-hour),” economic growth of the country is possibleonly due to TFP This is the level at which a country’s investment becomesequal to depreciation, and increment of capital is discontinued:

Δk ¼ i  δk; k! i  δk ¼ 0ð Þ;

whereΔk is increment of capital per man; i = sf(k) is investment per man, s

is saving rate; andδk is depreciation of capital per man

According to this model, the further growth of the economy thatreaches “the steady-state” does not depend on the impact of extensiveexpansion of traditional resources K and L, which is subject tothe law ofdiminishing returns Growth of productivity of these resources becomes

the main factor of development in these conditions For the productivityfactor, which Solow called also the “technology” factor (the same are

“technological progress,” “technological change”), the law of diminishingreturns does not work That is why a new type of neoclassical modelsemerged, whereK resource began to represent the capital, which condi-tions the productivity growth

David Romer in the well-known textbookAdvanced Macroeconomicscalled the chapter with such models “Beyond the Solow model: newgrowth theory” (Romer1996, Ch 3) This group of models is also calledendogenous models, because different methods of presenting the aforemen-tioned exogenous variable A (TFP, “the black box”) as endogenousvariables of production function are their characteristic feature The so-called AK model is the conceptual representative of this group:

Y ¼ AK;

where Y is output that is produced by capital (K) causes productivityincreasing (without diminishing returns effect), andA is a constant mea-suring the ratioY/K

In such form the change in productivity depends on the specific type ofcapital stock (capital accumulation), which includesHuman capital, R&Dinvestments, and other intensive inputs Detailed reviews of theseapproaches are presented in Barro and Sala-i-Martin (1995) and Aghionand Howitt (2009)

In the context of our analysis, it is important to pay special attention

to the fact that the“intensive inputs” do not present in this model thespecific Schumpeterian innovations, that is those innovation technolo-gies and innovation products, which together able to radically alter theproduction function, derived from the previous time-series parameters

of the economy, that is without these innovations As part of thisapproach, we can only talk about innovations that modernize onlythe existing technologies or products, increase productivity of thefirst and the quality of the second These innovations are called “incre-mental” However, Schumpeterian innovations, which are also called

“radical”, do not fall into the field of representativeness of suchmodels

Of course,Schumpeter innovations seriously influence the exogenousparameter TFP (“black box”) in the analysis using the Cobb-Douglas

production function However, the fact that these innovations influence

on growth does not mean that it is the increase in productivity of theexisting before production resources Schumpeter innovations rather aug-ment the new added value that is not directly identified as productivity rise

in the models of endogenous growth This is the fundamentally newmethodological feature of this category The essence of this process wasbriefly presented by Schumpeter in a famous metaphor that we alreadycited, but, because it is important, repeat again:

The new one cannot be reached from the old one by in finitesimal steps Add successively as many mail coaches as you please, you will never get a railway thereby.

(Schumpeter 1934 [ 2010 ], p 64)

The mentioned feature of Schumpeter innovations is not directly sented in the proposed endogenous models, which is why, we think, theyfailed to provide compelling arguments for achieving broad recognition inthe basic textbooks in Economics Models that are directly called theSchumpeterian did not adequately represent Schumpeter innovations aswell Let us consider the examples of a conceptual content of such models

repre-in detail

The model proposed by P.Aghion and P.Howitt in the article“A model

of growth through creative destruction” (Aghion and Howitt1992) was

developed These authors have collected descriptions of differentSchumpeterian models in a fundamental book dedicated to the problems

of economic growth (Aghion and Howitt2009, Ch 4) Peter Howitt inhis review article on the endogenous growth theory forThe New PalgraveDictionary of Economics refers also to other pioneer articles on modellingthe Schumpeterian approach (Durlauf and Blume2010; Segerstrom et al

1990; Grossman and Helpman1991; Jones1995; Young1998)

Schumpeterian models, which was summarized by P Aghion and P.Howitt, was directly based on the interpretation of the Schumpeter’stheory of innovations, which is represented as a phenomenon of‘creativedestruction’, that is the process of replacement (displacement) of oldproducts by new ones The latter are also regarded as innovative productsfor the prior period, which are replaced with the latest innovations Thedesire of companies is to get a temporary monopoly of an innovator, and

consequently, the gain monopoly profits is the rational economic motive

in these processes These processes are discussed in the format of thetraditional neoclassical microeconomic theory, when the profits of mono-poly and a competitive equilibrium market are compared

Philippe Aghion represents this model with two functions that are built

in the form of the Cobb-Douglas production function in sectoral andaggregated version (Aghion2010):

Yit¼ A1α

it Kitα; 05α51where Yit is the industry-specific outputs in industry i at time t; Ait is aproductivity parameter attached to the most recent technology used inindustryi at time t; Kitis theflow of an unique intermediate product used

in each sector at time, each unit of which is produced one-for-one bycapital Each intermediate product is produced and sold exclusively by themost recent innovator which replaces (supersedes) the previous innovatorand thus improves the parameter Ait:

Yt¼ A1α

t Ktα; 05α51where Yt is the Cobb-Douglas aggregate per-worker production func-tion (aggregate output is calculated as the sum of the industry-specificoutputs YitÞ; At is the labour-augmenting productivity factor(unweighted sum of the sector-specific Ait’s); Kt is the aggregate capitalstock

As we can see in this model, although it demonstrates as if aninnovations are included endogenously but in fact they are fully pre-sented by At, that is by exogenous variable of the Cobb–Douglasaggregate production function The “black box” remains to be unex-plained The innovations are here only to give another interpretationthe essence of At

Philippe Aghion and Peter Howitt also have classified as the tion-based” growth model of “The Product-Variety Model” where newvarieties of intermediate products play role of innovations that counteractthe originating of the“diminishing returns” feature of existing structure

“innova-of production In this case the source “innova-of the aggregate output growth isthe monopoly rents of innovators This production function has thefollowing view:

Yt¼ N1α

t Ktα; 05α51;

where Ytis aggregate output per capita; Ntis the degree of product varietythat also presents the economy’s aggregate productivity parameter; Kt isthe aggregate capital stock that used to produce continuum of intermedi-ate products ini industries (Nit)

Although in this model the new varieties of intermediate productsexceed the quantity of products existing in previous period and may berecognized as absolutely new products, nevertheless their growth effectsare derived from increasing productivity of the capital stock accumulated

at starting point of analysis ButSchumpeter innovations are new productsfrom new resources, and we cannot consider the amount of these product-innovations as the increasing productivity of old incumbents’ capital Itmay be only as mathematical operation but in such case we also mustsubtract the decreasing value of aggregate output due to exit of theobsolete products out of markets

The similar influential innovation-based model of economic growthwas also proposed by Paul Romer (1990) In this approach, the innova-tions also cause productivity growth because they improve the existingstructure of production through widening new varieties of products Forthis it was used the Dixit-Stiglitz-Ethier production function that united

an utility function with variety in consumption (Dixit and Stiglitz1977)and the production function (Ethier1982) If we consider intermediateproducts as innovations it may be made assumption that they cause theincreasing of aggregate output of the appropriate country because havebetter quality (productivity) in comparison with obsolete products Thementioned production function is shown as the following:

Y ¼ L1α

Z A

0 χ ið Þαdi; 05 α 5 1whereY is aggregatefinal country’s output; L is the aggregate supply oflabour;χ ið Þ is the flow input of intermediate product i; A is the panel ofused different intermediate products

Using the Cobb-Douglas aggregate production function, in whichperformance of the available (pre-existing) resources is measured, it isdifficult to represent products belonging to the Schumpeter innovationsthat are mainly produced usingnew resources

If we consider the inclusion of such new endogenous resources asHuman capital, R&D expenditures in the capital parameter in this func-tion, we cannot claim that they increase the productivity of those resourcesthat existed before the emergence ofinnovations We can talk about theperformance of these new resources, but we cannot talk about the change

of their productivity as a result of theirfirst introduction, because there is

no basis for comparison However, in the represented neoclassicalapproach, all the economic effect of these new resources is growth inperformance of the old resources if we count mathematically

In addition, we can also draw attention to the fact that in the format of theCobbDouglas aggregate production function, the sameexisting markets ofcertain products are still involved for which this function was mainly built.Basic interrelation between parameters of factors L and K, as well as coeffi-cientα reflect the market situation that existed before the emergence ofinnovations These formed markets are competitive, and the temporarymonopoly of an innovator on such market can only give local effect to acompany, but not to the entire market Therefore, such presentation ofinnovative processes does not provide convincing arguments in favour oftheir positive influence on the growth of the country’s economy

It is confirmed by various empirical studies, using the above models.Studies presented in neoclassical literature failed to produce convincingresults of confirming the leading role of innovations in the economicdevelopment of a country Works by Mankiw et al (1992), Barro andSala-i-Martin (1992), Griliches (1994), Evans (1996), Barro (1996) may

be examples of such testing

The presentedfindings “damped” attention to innovations as the mainfactor of economic development, but we must note that relatively inade-quate methodology for modelling innovative processes is used in the neo-classical model The characteristic feature of theSchumpeter innovations isthat they are not opposed to some existent competitive market, but create anew market, which means that the entire income of this market is a macro-economic contribution ofinnovations to country’s economic growth

As it is shown above, interpretation of the Schumpeter innovations inneoclassical models, which are called Schumpeterian, is associated withthe process of increasing the productivity of available aggregate factors of

traditional production function The increase in their productivity iscaused by the replacement of “old” resources with new ones, which inthis sense are those that have different (better) quality These modelsconnect the “new quality” of the resources with their greater R&Dintensity, involvingHuman capital, and greater diversification of manu-factured products (The Product-Variety Model).

To measure the performance increase of this kind, variations of theCobbDouglas aggregate production function are used to estimate theincrease in productivity of the factors and effects of substitution of pro-ducts that existed before the emergence of innovation Also it is important

to note that to measure the performance dynamics at a microlevel, it isnecessary to compare the volume of the same products in the basic andnew time periods (comparable products) Innovative products cannotenter into these calculations, because it has no basis for comparison.The magnitude of such innovation products volume that cannot beincluded in the calculation of productivity changes of existing resources isillustrated by the data of Innobaromentr (2015, p 23) that reflect theproportion of a total turnover (goods or services), which appeared as aninnovation over the past two years, for 28 countries of the EuropeanUnion in 2014 (review covers 7 961 companies, 61% of total base) Theshare of innovation products in the total volume of products exceeded 6%

at 59% of companies The share of innovation products from 11% to 25%was in 20% of companies and higher than 26% in 18% of the companies.Data on companies that did not increase total volume of products duringthis period are indicative in this context: their share of innovation productswas 15% It means that in case of application of the Cobb-Douglasaggregate production function, no increase in productivity at these com-panies will be recorded Moreover, the total productivity factor that iscalculated as the sum of the results of productivity dynamics in individualcompanies is likely to be negative Nevertheless, it is clear that innovativeproducts make a separate positive contribution to the productiondynamics

These figures illustrate the methodological nature of the failures ofpositive analysis considering adequate impact representation of the phe-nomenon ofinnovations on economic growth through the application ofthe Cobb-Douglas aggregate production function This conceptual mis-take is conditioned by the perceptions of innovations as one of manyfactors of the productivity increase in production of existent, comparableproducts This theoretical logic is descended from Adam Smith who