ECON 457 - Lec21 - Schumpeterian growth: creative destruction as the core foundation of capitalism

let me get on a head start so this is Schumpeterian growth you can present a mini subtitles to this one subtitle could be the so called logo the market value of the Schumpeterian ideology which is the idea of creative destruction and I'm going to formalize this idea into an official setting game another subtitle could be with a little bit of drama could be the antecedent the priors of the raw Marion Croft with a slight change in notation you will realize and appreciate it Romer had picked up almost all of the ideas from the Schumpeter's framework in exchange trumpeter had borrowed a lot of things from Marx David Ricardo and Adam Smith who in turn borrowed things from physiocrats all the way back to Egyptians and the Adam and Eve that's how science progress there is nothing wrong with this but when we talk about R&D driven knowledge driven endogenous growth it didn't occur all of a sudden from a from outside scratch so put any title you want priors to Romer created destruction or the the main source of the R&D driven growth model let me highlight a couple of the basic messages of this framework one we have the premise that innovation is intentional and costly that is the parameter that we denoted as a in most of our production technologies it does not occur by itself it is an intentional end result of entrepreneurs tried to get benefits profits pecuniary returns being an idealist serving for Humanity and coming with up with ideas is credible there are numerous examples of this great mathematicians philosophers technicians who could not reap the gains of their products and died in poverty including Marx himself but this is an exception the ideas had been put into current productive economic use due to intentional activity and they always had been costly there is no free lunch based on this thing another premise is these costs costs of innovation have to be confronted with monopolistic profits or have to be covered let sit rather than confront that is the price system the market system in a perfectly competitive setting will fail to deliver enough profits to cover these costs and you know the basics of the story it is because knowledge or innovation in general is a public good once you invent something then it is almost free of charge to disseminate it and these first initial costs have to be covered and the only way the market system can provide a coverage is through monopolistic profits now the Schumpeterian addition to these two premises as a slight change in the notion of our equilibrium concept if you will summarize in a romanian setting the equilibrium or one of the equilibrium concepts we are invoking is the fact that these profits are just barely enough to cover the fixed costs that is there is no net gain that had been left to the monopolist monopolists make profits but they use their profits to cover the costs in Schumpeter the idea of equilibrium is slightly different or maybe more than slightly in debt under his conceptualization each new innovation is associated with withdrawal of an existing Enterprise from the system each new a replaces an existing enterprise that one of the existing enterprises who had not been successful enough to compete with the new innovation drops out of the system it is destroyed so each new invention that is each new creation each new creative activity withdraws an existing enterprise simply destroys it so there is a creative destruction and just like we have assumed in Roemer that each new blueprint let's say a +1 was generating a new intermediate firm and a new intermediate input and the set of information was expanding this way you are coming up with ideas each new idea is used set up a new product while the remaining products remained intact in contrast in Schumpeter each new a creates a new X but in the meantime destroys a previous X let's say X minus 1 in in slight dramatization of the events for example the rise in Apple iPhone Samsung is and their innovations is associated with the decline and fall and or caught and called destruction of Nokia for example and there are other examples the the innovations in the airline industry like the Turkish Airlines becoming one of the greatest airlines in the global air fare is associated with the destruction of Pan Am for example Pan Am was the first using the passenger corridor technology but it had been a all marketed by new innovations so so that under Schumpeter monopolies cannot persist under rumor you set up a new firm and they are there indefinitely they are not making net profits their profits are going to cover costs but nevertheless as monopolies as enterprises they remain indefinitely under Schumpeter each new innovation brings up a new product line and it destroys an existing monopolist so monopolies are not permanent that's a super theory task so created destruction creates and destroys so at the outset cotton got the number of enterprises or the number of technologies at present do not expand or do not fall they remain constant this is the idea of equilibrium under Schumpeter in terms of competition both Romer and Schumpeter they do not regard competition in price on market terms Schumpeterian competition is in terms of institutions and new enterprises at the monopolistic enterprise level one up all monopolies try to remain in business new monopolies try to advance their market behavior exactly exactly the quantity of number of enterprises and the number of products in line are stable but the quality improves all the time there is a qualitative expansion reflected in terms of falling costs so that's the main idea now let's put these things in a in a slight algebra and makes a formal description of the equilibrium so what we have is a world where new products X 1 X 2 dot X and that the data are expanding and at each new round of a new innovation and all enterprise fails and is taken out of the system these are created and the old ones are replaced now at each round than the profits of in you know no seeum innovators spellcheck okay will they be Auto Jack PRD come on profits of innovators will depend on mainly three things one a markup that is the profitability parameter if you recall under Romer there was a markup ROM or a markup for the oligopolist was a share parameter inverse of their share in total GDP times the marginal cost and marginal cost was the interest rate or the rental rate or whatever price was that equal to marginal cost there was a markup at the rate of 1 over alpha we are going to make a generalization we are going to simply denote this by some mu secondly the level of activity output did say capex that's what our what do you produce in much quantity and thirdly since new rivals are always coming in 2019 2020 2021 we set up the firm but we are subject to pressure from upcoming new innovations so the number of days we remain in business is from our point of view subject to what is the rate of growth of innovations that's in line so we are going to use a third notion number of days or years let's say years the innovator in Norway is expected to stay in business and that we are going to denote by the time index top a higher rate of innovation will reduce Towe it will destroy the existing firms so that the existing innovators profitability will disappear over time and each new firm then let's call this equation 1 profits is simply markup over activity times how much time do you expect to remain in business a very simple algebraic relationship the higher the mark-up the higher usual profits the more you expect to remain in business the more you are going to make profits and the more you produce definitely the more you gain very simple relationship secondly the number of new innovations that we are going to denote by n in computer is using resources at rate little N and R is total resources available in our economy it includes labor labor devoted to research it may include other goods and services each new innovation utilizes resources at the rate and therefore production is simply whatever is remained elsewhere this is like in Romer remember under the Romanian setting we have had labour and some of it went to produce goods in business somehow it went to produce research in the research lab so just like Romer Romanus specification in Schumpeter we have a similar we have total resources portion and goes to research the remaining goes to produce output out of this we are going to rewrite the costs of production the total cost of product or the cost of production of innovation is simply costs typically wage costs times a beta and beta is unit of resources needed to produce one unit of X under Romer if you'll recall we have assumed it's simply equal to 1 1 output requires one unit of input therefore the input output coefficient was 1 to 1 because you wanted to get rid of it which cost times the input requirement to produce innovation that's the cost of it and if beta is the input requirement inverse of it 1 over beta is simply roamers productivity that is the inverse of the input requirement function or input requirement is the inverse of the productivity the more productive you are the less will be the input required to produce that good the less productive do more inputs you will use so it is simply a logical so under that setting let me use this part under that setting the average total cost of innovation will be some function of number of number of innovations the more you innovate innovation is costly the more innovation the higher air costs likewise the higher the input requirement or the lower is the productivity if you want use productivity underneath they are worse the lower the productivity the higher will be the costs or the higher the input required the higher will be the costs of the average cost of production thirdly it will depend on your resources your total expansion of resources the more resources you have the lower will be the costs so it will be a function of these three things how much you innovate what is their productivity and how much resources do you have in your country to innovate based on this you can simply draw a simple diagram here you put the number of innovations and this is our average total cost and this is expanding in general in an given beta and our plus negative so ceteris paribus for each level of productivity and total supply of resources there is an upward sloping relationship between the more you innovate the higher is the average total cost this is the cost side that's what how innovation is going on at the background you can cook up no arbitrage conditions wages you can expand this model you know how to do it but the main idea is very similar to roamers until now anything unclear on the simple ideas letting you want to add food why is average total cost is negative related to resources land capital labor the more you have the more resources you have the lower will be your costs that's the idea the more you are endowed with blessed with resources the lower will be the cost of producing innovation that's a very supply and demand thing all right well that's our problem the problem is what a new innovator would like to do in economics since the very early days you took step into this institution is the notion that each new entrepreneur will try to produce up to the point where marginal costs of production derived from the cost curve is equated with the expected returns in present value of profits that you expect in the future we expect profits but we also discount them in today's prices that's that we take a present value of the stream of profits that is expected costs on this side now we want to have a notion of the present value of innovation Bella one two three five so you expect to innovate expected new blueprints new ideas this is like an agent over a in Roma expected number of new line of research that is hope to be forthcoming is simply productivity or one over beta times the existing stock of knowledge it's the expected new number of innovations depend on productivity of the innovation and what is new innovation it is some parameter an input-output function which was taken as one under Romer times your resource if you plot this number of research expected new information you get something with gamma or if you want to use the input requirement function or one over beta whichever you want to use our produces an and produces ideas but you are on the right track that will we are going to use it idea that is the effect of an expansion in our or simply a big resource base will reduce the average total cost and will expand and and therefore we are expecting more innovative research more ideas to come out but clearly a Schumpeterian setting is the expected days that you plan to be in operation number of years that you're the innovator expects to stay in business before creatively distracted and this is inverse related with the new ideas this is the conservative character of existing entrepreneurs they were innovators once but once in the in business they want to keep innovation over here and you can imagine all sorts of stories in democracy or the lack of it based on the serve and Schumpeter's classic is capitalism democracy and socialism that's a 1940's book where they describes the concept of democracy the rule of role the governing bodies etc fit in so let's say complex is complete this so this is simply 1 over gamma n therefore since I am interested in present value or expected stream of profits than to be discounted profits were observed mu X tau and expectation is simply mu times x times expected tau which is mu times X divided by gamma and let's call this equation seven and if you want we can add gamma 1 minus R and times R oh this is X is 1 minus n times R this is gamma n let's do it this way I'm replacing X M gamma N and X is 1 minus n times R this is our expected profits and from here on the present value of innovation is simply RIT okay is from one true this guy expect to remain in business or expected Tao of one over one plus R to the power T I am discounting it profits one minus n times R divided by gamma N and if you plot this against an and the present value you observe that this is a downward slopping function where mu R beta and the market interest rate are all ceteris paribus the higher the number of innovations the lower is the present value of the income stream in the future now let's put all these together let's split this way here is our equilibrium and here average total cost which is something of this sort this thing the present value of innovation present value of innovation and over here we are going to put number of number of new innovations or simply a date over a that's the expected innovations and as you remember this is related with and it's something of this sort so the equilibrium is whenever the present value of the discounted stream of expected profits present value of innovation the present value of the discounted value of the stream of expected profits is equated with the costs of innovation that is our critical rate of new innovations and this embeds given the productivity an expected line of new research that's the Schumpeter equilibrium Saturday night guru who took the column a lot of supply yourself series it's two jacks mr. van der Luyden moment darts between my shoulders now starting from here you can play around with things like changes in markup changes in the market rate of return coming from the consumer side you can embed a consumer here with see that over c1 over tatata tatata that we know the rule that our place rose in both here so the consumers behavior towards saving impatience being patient not patient will clearly affect how the Jupiter equilibrium will be resolved changes in productivity definitely with higher change the productivity you will have any inward moving with existing level of resources you will have more research to be produced these are all parametric but this is more or less the Schumpeterian setup now first any comments all right look at this function written in 1940s Schumpeterian expected number of new research new blueprints in Romanian language edit over a is equal to gamma times n and n is input output function of resources by slight change in notation if you want use rather than resource the resource that had been prescribed by Romer number of researchers so if you rewrite this again edit over a is equal to some gamma some and but you can combine the two together write some constants x la take this a to decide what do you have well he is asked in an interview whether he has or how will she place his research with the idea of Schumpeterian destruction and Paul replies I cannot understand it because there isn't enough mathematics in it but that's our science proceeds it polymers think is definitely has more sophisticated mathematics but the main idea that the equilibrium rnd function is very much what we expect from the Schumpeterian framework what with the constraint that even though researchers la subject Jones critique and etc even if there is an increase in L or in Schumpeterian technical terminology and increase in resource happens the notion of equilibrium that the number of monopolies in existence remains stable because the old ones drop out it puts a boundary on the system so it doesn't form an explosion of rate of growth the number of the availability of resources or the availability of human capital had been contracted by the idea of destruction of the existing firms that's how the stability is maintained you

Channel: Bilkent Üniversitesi

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Keywords: ECON 457, Alternative Theories of Growth and Distribution, Prof. Alp Erinç Yeldan, Department of Economics, Bilkent University, Bilkent, #bilkentuniversity, #erincyeldan, #economics

Id: m3nkTrFF2zs

Length: 38min 55sec (2335 seconds)

Published: Fri Jan 11 2019