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Business Creation and Economic Development

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Relationship between entrepreneurship, innovation and economic development

Entrepreneurship and innovation are prerequisite for economic development. This is because; innovation leads to creation of new ideas while entrepreneurship leads to production of goods and services hence the duo are necessary conditions for economic development.

Several advances have been made in the understanding of the relationship between, entrepreneurship, innovation and the economic development. Despite the fact that a comprehensive understanding of this relationship is still lacking, it is true that the variables: innovation, entrepreneurship and economic growth are closely related. This paper aims at coherently and comprehensively shedding light on the relationship between the above mentioned variables drawing relevant examples from the.

 It is important to acknowledge the fact that accumulation of the factors of production for instance, human and the physical capital cannot alone comprehensively explain economic development, and instead addition of other factors such as innovation and entrepreneurship are vital for the transformation of the mentioned inputs in the most profitable ways. This paper will comprehensively discuss how entrepreneurship, innovation and economic development are interrelated in the Schumpeter’s book of economic development.

According to innovation and entrepreneurship are interrelated in one way or the other. However, the role of the entrepreneur in Schumpeter can only be understood if it is placed against his background of his theory of innovation. The theory of innovation put forward by Schumpeter not only have relevance for the understanding of the modern developments but  also contain a concrete contribution because it is one of the few early attempt to understand in combination with entrepreneurship some of what nowadays is known as the ‘black box’ of technology. This paper therefore will try to comprehensively look at the relationship between innovation, entrepreneurship and economic development. The paragraph that follows will coherently look at innovation and economic development.


There is no single definition of the term entrepreneurship; there are many definitions that have been put forward by different scholars. However, according to (Aardt and Mumba, 2011 pg 6) it refers to the act of initiating, creating, building and expanding an enterprise or the organization. Building an entrepreneurial team and gathering other resources for purposes of exploiting the opportunities that are existing in the market for long term gains. According to (Schumpeter, 1934), the high levels of formal-sector entrepreneurship are the economic heart of any given country. Therefore, without such levels of entrepreneurship, there may not be sufficient producers and the sellers of goods, providers of services, generators of income or the income generating opportunities for both job seekers and the prospective entrepreneurs.

Schumpeter's economic views

It is important to note that Schumpeter is one of the outstanding figures in the history of economic development. Schumpeter was born in Australia where his popularity grew  as a theorist because of his outstanding work bestowed in one of his great works” Theory of Economic Development” in the year (1912).  This great scholar also worked in U.S.A as a professor in the University of Harvard where he published most of his renowned works such as the “Business Cycle”. However, his contribution to economic theory investigates mainly those factors that "blow up" balance of market system from within. New industrial combinations which define dynamic changes in economy become these internal factors. Schumpeter allocates some kinds of essentially new combinations of factors of manufacture: Creation of a new product, Use of the new "know-how", Use of the new organization of manufacture, Opening of new commodity markets and raw materials sources. In the next chapter, the paper will describe the relationship between entrepreneurs and innovation basing the argument from (Schumpeter 1934)

Entrepreneurs and innovation

According to (Schumpeter 1934). Concern for the role of the entrepreneur can be seen in a long scanding academic tradition which paid attention to entrepreneurial functions in economic development. In Schumpeter’s own theoretical development, there is much more gradual change in the role played by the entrepreneurs in economic development. Going by Schumpeter’s entrepreneurial activities are seen as the third factor of production next to labor and land. In the explanation of the circular flow of income, Schumpeter’s differentiate labor into creative labor which is seen to be of a higher order and directed labor. Other forms of labor are classified as intellectual and manual labor or the skilled and unskilled labor is neglected as being irrelevant. Schumpeter therefore recognize entrepreneurs as the only agent of economic change in the circular flow of income, he further goes and says that in a sense, the entrepreneur is the personification of innovation or in other words the individual who carries combinations. It is therefore important to note that according to (Schumpeter 1934) entrepreneurs are considered to be neither inventors, capitalists nor a social class. This is because, during the time when Schumpeter came up with this theory, invention itself was considered as being an exogenous factor and therefore the only thing which could count as endogenous factors of economic development was the concrete innovation and the innovative capacity of the entrepreneur. According to (Schumpeter 1934), innovations are introduced by the entrepreneurs and then financed through bank and not credit savings. Credit is very important in the economic development. This is because it enables a potential an entrepreneur to become one and, as the typical debtor of capitalist society to reorganize the existing factors of production in the most effective manner for efficient production.

Schumpeter stresses the role of the entrepreneur as an innovator and debtor by presenting his definition of an innovator. According to him an entrepreneur appears to be the true and the only economically relevant change-agent of the pre-trustified capitalistic society. According to (Schumpeter 1934) an entrepreneur is both rationally and irrationally motivated economic agent who seems to be never satisfied by results based on the existing innovations but instead keep on searching for new opportunities

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According to Schumpeter, successful entrepreneurs might become capitalists and stop being entrepreneurs once they fail to innovate and return to capitalistic routines. From this statement, we can deduce that entrepreneurs have to be innovative if they are to remain entrepreneurs. He further says that an entrepreneur should be characterized by his/her proactive behavior and not necessarily strictly rational economically maximizing subject.

Innovation and economic development

Innovation is simply the ability to come up with new unique ways of doing things while economic development may be defined as the positive progression in an economy, it may refer to the adoption of new technologies, transition from agriculture-based industry based economy and the general improvement in the living standards. The basics of Schumpeter’s theory of innovation are found in his economic model of the circular flow. This circular flow is said to describe a stationary situation of equilibrium and the perfect competition which are similar to the Walrasian rate of equilibrium. In this equilibrium, every firm is in perfect equilibrium where the cost is equal to income, prices equal to average cost and the net profits are zero.

According to Schumpeter’s theory of economic development capitalist’s economy is a system that is constantly in motion and which never reached equilibrium. Schumpeter uses the notion of the general equilibrium to contrast and to explain economic after a change in existing routines of companies takes place through innovation. Unlike other authors, equilibrium is not a direct reflection of the economic development. According to Schumpeter innovation can be defined as the successful introduction of new products and the processes and that the economic system is driven away from the neighborhood of equilibrium then gradually, as the effects of innovation wear off a new neighborhood of equilibrium is restored a gain. According to (Schumpeter 1934).  Innovation is only a necessary potential for transformation but not sufficient. This is because, other system too are required to respond and adapt to the possibility created by innovation and to do so in a competitive process whereby resources that had been formerly used in the production of the old goods and services are switched to the production of the innovations.

To capture and explain the changes brought about by innovation from routine economic growth to dynamic economic development, Schumpeter introduced the notion of new combinations. This refers to the introduction of a new product or a new quality of a product, new method of production, a new market, a new source of supply of raw materials or the half manufactured goods and then finally implementing the new organization of any given industry. This may have a positive effect on the economy of any given country.

Role of sustainability in the relationship between innovation, enterepreneyrship and economic develpment

The important role of sustainability in the relationship is given to the credit; this is because it is considered to be the major condition of use of existing factors for creation of new industrial combinations. Banks "create" money for innovators, and redistribution of a stream of resources that is the public capital begins with it. Thus, banks, according to Schumpeter, are a special phenomenon of development which, speaking on behalf of a national economy name, give out powers on realization of new industrial combinations. They act as necessary intermediaries between desire to carry out an innovation and possibility to make it hence sustaining the relationship. The payment for granting of such possibilities also represents percent which is the price paid for acquisition of new productive forces. According to Schumpeter, development in original basically requires the credit. But we will return to the businessman. Having obtained the loan, he goes marketing manufacture factors where, under our assumption, the global equilibrium of a supply and demand reigns and breaks it. The additional quantity of resources is required to it and he offers for them the risen price. The system of the equilibrium prices is broken, the direction of streams of resources, so, and streams of consumer goods changes. All rhythms of circulation, all system of the prices, costs and incomes breaks. Someone is thus ruined, but the great bulk of businessmen follow the innovator - and such "indignation" of system occurs constantly. It is a usual condition, instead of equilibrium circulation. And for this reason constantly there is an enterprise profit and for these reasons capitalism is not necessary on a place, and continuously develops. It is therefore crucial to state that banks play a major role in the sustainability of the relationship between innovation, entrepreneurs and the economic development.


In conclusion, it is prudent to state that the understanding of the innovation as being a major disequilibrating force has not only remained central to Schumpeter’s theory, but instead could still influence modern analysis of the business development and the economy at large. It is crucial to state that introduction of new products and a process plays a great important role in reshaping competition in the domestic as well as in the international market place. In other words, we can say that it has both the short and long term effects on consumers, companies and nations through the creation and redistribution of economic welfare in a gradually expanding economic space. It is also important to state that according to Schumpeter therefore recognize entrepreneurs as the only agent of economic change in the circular flow of income; he further goes and says that in a sense, the entrepreneur is the personification of innovation or in other words the individual who carries combinations. It is therefore important to note that according to (Schumpeter 1934) entrepreneurs are considered to be neither inventors, capitalists nor a social class. This is because, during the time when Schumpeter came up with this theory, invention itself was considered as being an exogenous factor and therefore the only thing which could count as endogenous factors of economic development was the concrete innovation and the innovative capacity of the entrepreneur. It is therefore in order to note that innovation; entrepreneurship and economic development are interrelated going with Schumpeter’s argument.

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