May 2, 2010

Economic Models Ill Prepared for Foreign Innovation

Economic models have long been based on the assumption that there is an optimal level of efficiency in the production processes of goods and services. Businesses make inventory as well as research and development decisions based on these models. As is often discussed in class, these models do not take entrepreneurship (i.e., innovation) into account. As a result, we are seeing the companies who have built their businesses on these models being left behind and some of the deficiencies of the models are brought to light.
A recent article in the economist points out that emerging, developing companies that were once simply a source of cheap labor, are now becoming a leading source of innovation. Much of this innovation is due to the fact that these countries are not allowing themselves to be bound by the parameters of the model and are testing new methods of production, delivery and inventory. One example cited in the article is about how Japan surpassed American auto makers in the early 1980s. This was accomplished by a new system of making things that the Japanese invented called "lean manufacturing." The importance of this process is a conceptual one. The Japanese did not continue to try and find ways to increase efficiency within the model, as that would only allow for a certain (optimal) level of efficiency to be attained. According to the model, once that level or equilibrium is reached, there is no reason to search for a better way to do things because you have reached the point that marginal output will begin to decrease. Therefore, the Japanese disregarded the model in a sense and the results of willingness to try something new was increased market share and greater profits.
In emerging markets worldwide, they are experminenting with new business models. This trial and error approach is allowing these countries to not limit themselves to predetermined outputs and in some cases, they are now producing more than the classic model predicted they could produce. This level of innovation is also challenging in terms of who can enter into different markets and produce a quality product. Innovation not only spurs competition in the sense that better, cheaper products appear in the marketplace, but also in the sense that barriers of entry can be lowered or in some cases, sidestepped altogether. This can happen when there are barriers of entry in the production of one product but innovation leads to the invention of a comparable good that may have different or lower barriers of entry that make entry more accessible to more people. As this happens, the numbers of companies in these emerging companies grows. More companies generally means more capital. A line chart in the Economist article shows that GDP growth in emerging markets has outpaced that of GDP growth in the U.S. since the year 2000. What this demonstrates, I believe, is that many of the classic models inhibit creativity and in many ways, growth. The models therefore become somewhat self-fulfilling in the sense that since there is no account of entrepreneurship, it can inhibit this type of activity. One who believes in and works within the model will not see the options of innovation or trial and error. Those who look beyond the models are the ones utilizing their creativity and are rewarded these days with higher growth rates.

1 comment:

Larry Eubanks said...

Given the topic you've chosen here, you might be interested in listening to the interview you will find at this link: