Schumpeterian economics: Are Entrepreneurs always a disruptive force?

Joseph SchumpeterJoseph Schumpeter (1883 -1950) came from the Austrian School of economics and was thus a strong proponent of the free-market. In his book, ‘Capitalism, Socialism and Democracy’, he sought to defend capitalism based primarily on the grounds that capitalism sparks entrepreneurship. He is widely considered to be one of the forefathers of entrepreneurship within academia.


Schumpeterian economics placed great emphasis on entrepreneurs being agents of change and drivers of innovation. Introducing new products/services into the economy brings about this change and innovation. Moreover, Schumpeter believed that entrepreneurs were a disruptive force (forming part of his ‘Creative Destruction’ theory) because their new products/services that entered the market resulted in the demise and obsolescence of other products/services.


If we look back to the most of the 20th century, there is much evidence of this – cars, electricity, television, airplanes, mobile phones, digital cameras, CD’s etc. Now, in the 21st century we find ourselves in a different era, where products of the 20th century have proven their viability.  Today, entrepreneurs are either opening up completely new markets or carving out niches within existing markets, and therefore creating complementary products/services to something that already exists. Either way, we are not witnessing nearly as much of Schumpeter’s  ‘creative destruction’ as perhaps we may have 50 years ago. The trend we are now becoming accustomed to falls within exactly what economist Israel Kirzner called the ‘process of discovery’ in entrepreneurship. Unlike Schumpeter’s disruptive force, Kirzner’s theory is one of equilibrium. Instead of pushing another product/service out of the market, the ‘process of discovery’ advocates finding profit opportunities that previously went unnoticed. Equilibrium is restored via new entrants to the ‘niche’ market, who eventually eliminate the profit opportunity.


Kirzner’s ‘process of discovery’ theory very much embodies the tech start-up scene at present. We just have to look at a list of London start-ups to validate this: ubiCabs, Adzuna, Bandeka, apsmart, brightlemon, datasift, everlution, housetrip, ideo, etc. None of these start-ups are shaking up established markets with their ideas. Rather, they are seeking to complement existing markets, or creating niches or micro-niches that offer something new to the consumer. Overall the premise of these start-ups is to make our lives easier. If you speak to the founders of these companies, many of them will tell you, that their idea creation spurned from an existing issue/problem/void that they found in day-to-day life. Its not so much about ‘raffling feathers’ and ‘throwing punches’ anymore, but more about simple augmentation in positive sum terms. Schumpeter’s ‘creative destruction’ theory is waning in this modern era. Yes, Facebook and Google are modern examples of tech behemoths, but their success hasn’t resulted in the complete obsolescence of services that stood before them.  Granted, the same cannot be said about Amazon. Amazon is ostensibly responsible for the demise of the bricks-and-mortar bookstore. But, this is just one example, and in actual fact, over the last decade there are not many examples that come to mind. Is this because the opportunities that lie within niche markets are greater and contain less risk? Or, is it that ingenuity within an established market only comes round once a decade? Regardless of the answer, the Kirznerian economic approach to entrepreneurship certainly wins more plaudits in 2012 than the Schumpeterian one.


The digital age and its collaborative culture

We now are living in very interesting times. Technology is moving so fast that most of us are struggling to keep up, and what we were being warned about (our ever increasing reliance on technology) 15 years ago is now becoming a reality. The internet has evolved into more than just a place where we can search for information and passively listen, read or watch. It is now a platform for us to actively socialize and collaborate. More importantly we are able to do this on such a large scale that our reach becomes exponential. This is all thanks to the new web, and by that I mean web 2.o. Yes, web 2.0 has spawned the ‘N-generation’ (net generation) who collaborate and share through wiki’s, blogs, social networking sites, video sharing sites, folksonomies, and mashups. The new wave of web entrepreneurs are embracing this openness, and instead of being cagey about proprietary software/programs etc, they instead are creating open source software to encourage contributions ipso facto increase innovation.

 

The big question then arises – How do the large corporates respond to this ‘new’ age of free information, peer-to-peer sharing, and digital collaboration. The ‘n-geners’ and tech entrepreneurs might feel that it is the norm, as this is a space they are used to. For a company that is perhaps centuries old and has a rather draconian approach to business, this then may not be their ‘cup of tea’. The mere fact that Wikipedia is set to close down for day in protest against the Sopa Act (stop online piracy) which is expected to be passed through congress soon exemplifies the existing divide between big corporates and web 2.o collaborators.

 

With this said there are some companies embracing the free flow of information that web 2.0 has brought us, and as a result are seeking to optimize their business through innovation. Large Corporations such as Dupont, IBM, Boeing, Honeywell and Proctor & Gamble use idea sharing platforms as a way to augment their business. These guys take ‘change management’ seriously, and understand the pivotal role that the web space now plays in all facets of business. One way they do so is to use a platform like innocentive which helps organizations solve pressing problems through crowdsourcing innovation. The organization gains in innovation and someone out there makes them self a nice bit of money. Another, is to use a transfer marketplace like yet2.com where corporations can sell unused patents. The corporations ameliorate their losses stemming from the dormant patents, and another company gains the right to make something it could have never made before. These are all win-win examples arising from the cross-collaborative nature of the modern day internet.

 

One medium-sized Canadian gold mining company has to be given some credit for the existing ‘collaborate-to-innovate’ model that presently exists. In particular, credit must go to its CEO at the time, Rob McEwen. Read the story here

 

And so a new year begins…..

 

Well, here we are. Into 2012 with almost the first week behind us. I’m still just finding my feet in this new year. I have to say that 2011 absolutely flew by! The good news is that things are looking up for you and I in 2012. The U.S created 200,000 jobs in December alone and the unemployment rate has been reduced to 8.5.% , the lowest in nearly 3 years! The US usually takes the lead on these sorts of things, and then the rest of the developed worlds tends to follow. The road to recovery is in sight, albeit with a few hiccups in Europe. Although the market is still depressed, I have attempted to exploit and tap into any potential openings within the free market. Through hard hard and perseverance I have managed to make some good connections and as a result have built some great relationships.

 

This is the beauty of the free market. You as an individual have a choice to put yourself ‘out there’ and carve a particular niche. There is very little holding you back, except for fear and apprehension. So go on, and get out there, and show your market why you are the such a valuable asset. If the formal channels of promotion, seek out new unconventional channels. Over the last year, when looking for a job, the formal approach I took lead to very few prospects, yet when I sought out potential employers via a ‘back door’, personal connection, social media conduit etc, my success rate increased dramatically.

 

Good luck in your pursuits this year, and hope all your goals can be fulfilled!

 

E-waste dumping in Ghana

Following on from my previous post on planned obsolescence, in this post I will look at e-waste dumping.

 

As a consequence of planned obsolescence, many developing countries are subjected to the dumping of electronic waste – electronic goods that no longer work, and need to be disposed of somewhere get sent to these vulnerable countries. Ghana is particular has fallen victim to this dumping more than other developing countries, largely because of its strategic location and also the fact that it has one of the deepest ports in West Africa which can accommodate large freight vessels. It is the new ‘in’ place to dump e-waste. The US and UK are two of the major e-waste dumping nations in Ghana.

 

I spent 7 months working in Ghana last year, and every day whilst driving in and around Accra I was faced with the eyesore of e-waste. It really got to me after a while, because I could see nothing was getting done about, and I knew the effects of it were long-lasting. The e-waste that is sent to Ghana’s is exported under the guise of second-hand goods, with the ‘intention’ that these goods will ostensibly help bridge the tech divide between rich and poor countries – Ghanaian citizens will now be able to buy second-hand mobile phones or computers for 1/10th of the regular price. Unfortunately this is not the case, as most of the e-waste sent to Ghana is exactly that – it is waste – broken, defunct and irreparable. As result of this these products end up in landfills across Accra, a bit like this one:

 

Agblogbloshie

 

As a result of this, a market for scrap metals and plastics grows and develops. As long as e-waste keeps coming in, the market for scrap will prevail. Poverty-stricken people attempt to extract what little scrap metal and plastic they can get in return for a nominal amount of money. This is due to the greater problem of unemployment, which although is never accurately reported sits well above 40%.  The scrap they extract and sell on is only a fraction of what remains in the landfill.

So what are the consequences:

 

1. Air pollution – noxious gases are emitted into the atmosphere as people burn the electronic goods to extract the scrap metals

2. Water pollution – the residue that remains from the charred e-waste permeates the soil and pollutes the nearby rivers and streams and the water table. Lead and mercury are two other very harmful metals associated with e-waste

 

Thus, the environmental and health implications resulting from e-waste are serious!

 

So what needs to be done:

 

1. We as society need to seriously reconsider our consumption patterns, and more importantly corporations need to re-address product lifespans, and make a collective decision to build in more quality and less obsolescence. Read my previous post on this here.

2. The Ghanaian government needs to implement regulation relating to the importation and disposal of ‘second hand’ electronic goods, and at least put some sort of quota in place.

3. The US needs to ratify the Basel Convention which is a UN-backed accord passed in 1989 to regulate the flow of hazardous waste from industrialized nations to developing countries for disposal. They are the only OECD country not to have ratified it. The convention states that an industrialized nation may only ship hazardous waste to a developing nation if it has received written consent from that country.

 

If the above three actions can come into effect, then the current hazardous situation Ghana faces may not be completely solved, but at least ameliorated with opportunity for further improvement.

 

What are your thoughts?

 

How to curtail planned obsolescence

Have you ever heard someone complain about how the quality of consumer goods has deteriorated since he/she was a child? Perhaps you share the same sentiment? The answer to this can be found in the fundamental economic rule below:

 

Economic rule: “Nothing produced can be allowed to maintain a lifespan longer than what can be endured in to continue cyclical consumption.”

 

Planned obsolescence first came about in the 1920’s when the ‘Phoebus Cartel’ conspired to create a light bulb that would only last 1000 hours (very good documentary about it here). This was the first time in history where a product was purposefully built to eventually break. Now days every consumer good has an inbuilt lifespan, and what we only need to ask ourselves when buying a particular product is, ‘In how many days/months/years will I have to buy a new of these?’ Think about the possessions you own (well they actually you) and the likeliness of needing a new one in the near future. For a start the laptop computer I am typing this blog post on the is 4 years old, and will have to be replaced very soon. The fridge on my boat. Both fridges and toasters are two examples of household appliances that are decreasing in quality year by year. When I was a kid you could buy a toaster and it would last 5 or 6 years. Now you’re lucky if a toaster lasts 2 years! Printers are another example. As I’m sure most of you know, printers these days are fitted with a chip which disables the printer after x amount of hours/pages printed. Apple has even recently been labeled the epitome of planned obsolescence because you cannot change the battery on many of their devices. The list goes on…..

 

But is planned obsolescence such a bad concept? Lets look at a world without the practice of ‘death dating’ where a product life cycle spans into perpetuity. Consumption would most certainly not be a fundamental part of our economy. It would constitute the same as what aggregate saving accounts for now – not a very large proportion of our income. It could then be argued that household saving would rise and fill the void that consumption would leave. Part of these savings would be channeled into investment, and therefore this component of the economic growth equation (GDP) would not be compromised. Unfortunately investment is only one of three vital components of the economic growth equation. Investment indirectly provides the enabling environment for economic growth, but consumption is the key component for sustained economic growth. If we do not have consumption then an economy will eventually grind to a halt, and the citizens may encounter the effects of stagflation (high inflation rate, low economic growth rate). Most importantly a lack of consumption will lead to a significant increase in unemployment. To achieve sustained consumption we either need to be living in a society which is constantly innovating and where new viable products are being launched into the market all the time. This is not that easy to achieve as markets easily become saturated. Alternatively, we need to live in a society where planned obsolescence prevails, but is regulated under the watchful eye of the state (Keynesian planned obsolescence), so that in the course of our lives we do not witness a steady decline in the life-cycle of products. Unfortunately the problem with this second proposal is that although it might ensure sustained economic growth, it will have an adverse effect on environmental sustainability. We live on planet with finite resources, and if we carry on manufacturing at the present rate and ipso facto perpetuate the insatiable demand for goods, then we may not have a habitable planet in 100 years time.

 

So what is the solution? Perhaps we should ease off on this whole idea of continued economic growth and accept the fact that economies cannot be expected to grow year on year into perpetuity. This in itself is unsustainable. Lets build companies and industries that are profitable, but that are not striving for unrealistic growth targets, where quality is sacrificed for revenue maximization. If this can be achieved then planned obsolescence can play a less active role in our future society, and we can revert back to time when quality in products reigned supreme. Companies may not make as much money as before, but on the upside there would not be a need to consume as much, and as a result requisite income levels could go down. This would help us as a society move away from the ‘ultra-capitalist’ model we currently operate in. But, how do we change the existing mentality within the free market when the only concern for most is to make hay while the sun is shining and not really care about future generations? Well, here is one company which is taking a revolutionary approach and standing up against planned obsolescence:

                               

 

4 areas in which the current global financial system needs an overhaul: Part 4

What next with derivatives?

 

They go by the names of options, futures, forwards and swaps, and are essentially a bet on the outcome of a future event. Derivatives first came about in the 1970′s with the breakdown of the fixed rate international currency regime. With exchange rates then floating freely and the ceiling being lifted on interest rates, the capital markets were encountering volatility comparable to that of the great depression. Financial institutions reacted to this by introducing the first known derivative in the form of a ‘forward contract’. Its prime function was to mitigate exchange rate risk – one party buys and the other one sells a set amount of currency at an agreed date in the future. This process is more widely known as hedging, and the main reason why the introduction of derivatives should be commended.

 

Since then, financial derivatives have evolved and grown in scope, and with that we have witnessed a transition from hedging risk to outright speculation. Today we have Wall St Rocket Scientists creating complex derivatives in which many professionals do not even understand the workings of. When the recent crisis really began to have a noticeable effect on the citizens of this world, people began to blame financial institutions and their trading of derivatives as one of the root causes of the problem. People started to suggest that derivates be abolished altogether. They wanted to see an end put to this reckless, risky beahviour. This would be unwise, as not all derivatives are bad. Yes, it is true that their sheer complexity created an environment where buyers never understood the structure and underlying risk of the derivative they were buying, and in many cases the sellers didn’t either. It is also true that derivatives have been associated on many occasions with financial failure – stock market crash of 1987, LTCM fiasco and more recently boom-bust cycles in the oil market. With this said, derivatives should not be banned altogether, as there are many ‘plain vanilla’ derivatives which have been trading quite happily for the last 3o years. What needs to be addressed are derivatives that by their very nature create a principle-agent problem. The best example is the Credit-default swap (CDS). This is something that needs a serious overhaul if we are to look forward to a healthy global financial system down the line.

 

The CDS sounds a bit like an insurance contract – it allows the buyer to protect against credit default. Unfortunately in this instance the buyer did not have to be the owner of asset which was subject to the bet. This created a scenario a little bit like those ‘dead peasant’ insurance policies that the big American corporations took out  on their employees who they knew were of poor health. The buyers of the CDS’s were therefore wishing for default which of course only served to create an unethical system within the CDS market. Furthermore, CDS’s were given autonomy when the free market zealot Phil Gramm (Yes, from the Gramm-Leach-Bliley Act which essentially provided the monetary lifeline to banks in the aftermath of the crisis) through the Senate Banking Committee managed to allow CDS’s to be exempt from Commodity Futures Trading Regulation.

 

So what next….

 

CDS’s and other derivatives which are too complex for their own good need to be abolished. Within any insurance contract, it should always be mandatory for the buyer to have an ‘insurable interest’ vis-a-vis a direct stake in the outcome. Unfortunately with CDS’s this is not the case, and therefore the ethics just don’t bode well. Finally, with the remaining derivatives, it would be advisable consolidate their regulation. At present both the SEC and CFTC regulate the derivatives market. In order to achieve standardisation and negate the negative implications on the global financial system from derivatives, it would be a good idea to give either the SEC or the CFTC sole responsibility for regulation of this market.

 

What are your thoughts? Should we abolish CDS’s?