Teaching Notes · Economic Development and Growth

Technology, Innovation, and Entrepreneurship in Development

The piece on classical theories of development in this series touched on Solow's growth model, where technological progress is the one ingredient capable of generating growth that does not eventually run into diminishing returns. This piece looks more closely at where that ingredient actually comes from: the economics of innovation, the entrepreneurs who carry it into the market, and the different roles technology can play in a formal growth model.

Invention, innovation, and diffusion

It helps to keep three related but distinct stages separate. Invention is the first occurrence of an idea for a new product or process. Innovation is the first attempt to actually carry that idea into practice, turning an idea into something real. Diffusion is the process by which that innovation then spreads, over time and through particular channels, among the members of a social system, after which it is either adopted or rejected depending on market outcomes, network effects, and prevailing best practice. An invention with no diffusion changes very little; the economic impact of new technology depends heavily on how quickly and how widely it actually spreads once it exists.

Innovation itself is commonly split into four types. Product innovation introduces a good or service that is new or significantly improved. Process innovation introduces a new or significantly improved method of production or delivery. Marketing innovation involves a significant change in product design, packaging, placement, promotion, or pricing. Organizational innovation introduces a new method in a firm's business practices, workplace organization, or external relations. A useful shorthand distinguishes sources of innovation into roughly two groups: those internal to an industry, such as a perceived incongruity between what exists and what is needed, a process bottleneck, or genuinely new knowledge, and those external to it, such as demographic change or an unexpected event that opens up a new need the market had not previously served.

Schumpeter and creative destruction

No economist is more closely associated with the economics of innovation than the Austrian economist Joseph Schumpeter. Schumpeter described economic development as a historical process of structural change driven by exactly the invention, innovation, and diffusion sequence above, and coined one of the field's most durable phrases to describe what that process does to the existing economy: creative destruction, a process of industrial mutation that incessantly revolutionizes the economic structure from within, continuously destroying the old and creating the new. On this view, recessions and the obsolescence of entire industries are not simply a cost of innovation but an integral part of how it delivers its benefits, clearing away less productive firms and techniques to make room for more productive ones.

Schumpeter also gave entrepreneurship its classic modern definition, as the act of carrying out new combinations, new products, new methods, new markets, new sources of supply, or new forms of organization, through what he called a process of creative disruption. In his framework, the entrepreneur is specifically the agent who incorporates innovation into economic activity, distinct from a manager who simply runs an existing business, and it is this entrepreneurial function, more than capital or labor on their own, that Schumpeter credits with moving the economy forward.

Two views of where technology comes from

Growth theory has offered two quite different answers to the question of where technological progress actually comes from, and the distinction matters for what kind of policy follows from each. The neoclassical growth model originating with Robert Solow in 1956 treats technology as exogenous, an external factor that simply explains the portion of growth not accounted for by capital and labor, without the model itself saying much about what determines its pace. A later tradition, tracing back to Schumpeter's own emphasis on innovation and entrepreneurship, treats technology as endogenous, an outcome actively generated from within the economy through firms' own investment in research, innovation, and entrepreneurial activity, which puts deliberate innovation policy, not just general capital accumulation, at the center of a growth strategy.

Entrepreneurship as a development lever

International research on entrepreneurship, most notably the long running Global Entrepreneurship Monitor, draws a useful distinction between necessity entrepreneurs, people who enter self employment because they have lost a wage job and have no better alternative, common in countries with weak social safety nets, and opportunity entrepreneurs, people who pursue a specific idea they believe will deliver real benefits because they have identified a genuine opportunity, not because they lack other options. The balance between the two types in a given country says a great deal about its stage of development: in countries with a particularly strong orientation toward innovation, the research finds that opportunity driven entrepreneurs consistently outnumber necessity driven ones.

The same research groups economies into three broad types based on how entrepreneurial activity is structured. Factor driven economies rely heavily on agriculture and subsistence farming across a largely rural population. Efficiency driven economies have moved toward a higher level of industrialization, relying on manufacturing within scale intensive industries. Innovation driven economies have a post industrial structure centered on services and knowledge intensive activity, with high levels of research and development investment. Both the OECD and the broader development literature treat entrepreneurship and innovation together as essential tools for economic competitiveness and job creation, a view reflected in how heavily many governments now invest in research and development to supplement private sector spending.

Why innovation fails, and how technology actually moves between countries

Not every innovation effort succeeds, and the research on innovation failure identifies a recurring set of causes: failing to anticipate and respond quickly enough to a changing market or industry; failing to build appropriate product roadmaps and project management discipline; failing to develop a coherent business model around the innovation; and failing to secure technological leadership, product leadership, or ultimately access to the market itself. These failure modes matter for development policy because they are just as relevant to a government backed technology initiative as to a private startup.

How technology actually moves from one country to another also depends heavily on context. Factors that tend to make technology transfer succeed include a shared language, common ancestry or history between the transferring countries, physical proximity, the technical competence of the receiving workforce, how complex the technology being transferred is, and whether similar transfers have succeeded before. Economists further distinguish three types of technology transfer by what is actually being moved: product embodied technology, transferred along with the physical product itself; process embodied technology, transferring the underlying scientific or engineering process; and person embodied technology, transferred directly from one person to another through training, migration, or collaboration. A developing country's realistic options for acquiring new technology, and the policy choices that follow, differ substantially depending on which of these channels is actually available to it.

Sources: Notes on technology and growth, and the companion lecture on growth theory, following M. P. Todaro and S. C. Smith, Economic Development (Pearson); J. A. Schumpeter, The Theory of Economic Development (1934) and Capitalism, Socialism and Democracy (1942); R. M. Solow, “A Contribution to the Theory of Economic Growth” (1956); OECD, Oslo Manual (2005) on innovation types; Global Entrepreneurship Monitor reports; and J.-P. Deschamps on causes of innovation failure.