Economist Nathaniel H. Leff writes, “Revisionist economic history has displaced the entrepreneur from his central role as determinant of a country’s economic performance and placed greater emphasis on structural macroeconomic conditions.” Unfortunately, Sautet might be right. In matters of economic development, there is often a tendency to focus more on dilapidated infrastructures and dysfunctional institutions than on creating a culture of innovation through entrepreneurship. Or as Sautet put it, “the role for the entrepreneur in economic expansion.”
Over the past couple of years, Harvard Business School professor and Christensen Institute co-founder, Clayton Christensen, has served as both a teacher and a mentor to me. He has taught me a lot about innovation, management, and economic development. But perhaps most importantly, he has taught me how to properly frame problems so that we have a better shot at getting at the right solution. Here are three things I have learned from him over the past few years.
1. Not all innovations are created equal
While the word “innovation” has become popular and is now seen as good for society (this was not always the case), the word has also taken on many different meanings. For clarity, let’s define innovation as “a change in the process by which an organization transforms labor, capital, materials, or information into products and services of greater value.” It need not be high-tech nor feature-rich. From an economic development impact standpoint, there are different types of innovations with distinct characteristics—some increase efficiency in a given industry, others create new markets, and some make existing products better.
Each type of innovation is valuable for sustained economic development, but market-creating innovations often serve as the foundation on which many vibrant economies are built. These innovations transform complicated and expensive products into simple and affordable ones, thereby making them available to a larger segment of society who historically were not able to afford the existing products on the market. We call this segment of society which can’t afford existing products, but would benefit from their use, nonconsumers. The new markets that are created by these innovations, in turn, pull in other components an economy needs to thrive. For example, think of all the things the automobile market pulled into America: cars, steel, roads, new laws and regulations, suburbs, and so on.
Although many new markets won’t pull in as much as the automobile market does, the pattern is consistent. Our research into how different types of innovation impact economies shows that the effects of a market-creating innovation on economic development far outweigh other types of innovations.
2. Innovation is a process, not an event
Guess which American city is known as the cradle of the Industrial Revolution. New York? Chicago? Boston? In fact, none of these are correct—it’s Lowell, Massachusetts. Thanks in part to its textile business, Lowell thrived as a great industrial city in the 1850s and, at one point, was home to 40 textile mills, 10,000 looms, 10,000 millworkers, and produced 50,000 miles of clothing annually. It was also home to the largest industrial complex in the United States. But by the early 1900s Lowell began losing jobs to the Southern United States. By 1931, it was described as a “depressed industrial desert.” In 1940, with only three mills left in the city, roughly 40% of Lowell’s citizens were receiving some sort of social support.
Lowell rose to prominence because the city was home to firms that were innovating to meet the needs of customers, both locally and nationally. Textile innovators in the city developed a labor production model known as the Lowell system which drastically drove down the cost of textile manufacturing, made work more humanizing for workers, and ultimately resulted in a boom in textile manufacturing. But over time, Lowell’s textile firms were unable to respond to the changes in their industry, and as a result, suffered massive losses. This negatively impacted the city of Lowell. For it to have remained prosperous, entrepreneurs in the city would have needed to reinvent their business models. They would have needed to keep innovating.
3. Innovation serves as the engine that powers our infrastructures and institutions
Innovation isn’t a thing that happens on the fringes of society after society “fixes” itself, that is, after society builds its infrastructures and develops its courts, legislatures, financial markets, etc. Instead, innovation is the process by which society develops itself. It is precisely through innovations that create, or connect to, new markets that societies can create jobs, pay taxes, and build their infrastructures and institutions. Consider the case of Detroit.
The City of Detroit, once home to 1.8 million people, was one of America’s most prosperous cities. From Motown to the Big Three (General Motors, Ford, and Chrysler), Detroit was a booming city. Today however, Detroit’s population hovers around 700,000 with a violent crime rate that triples the national average. Detroit’s unemployment rate of 23% is the highest among the 50 largest cities in the country. Unable to pay its debts in 2013, the city declared bankruptcy, the largest in America’s history. There are many explanations for Detroit’s demise, but core to the city’s downfall is the loss of jobs in the auto sector.
Detroit’s woes began in the 1950s when major automakers seemed to lose touch with customers, and specifically nonconsumers and those at the low-end of the market. For example, by some estimates, Ford’s 1957 release of a new model, the Edsel Ford, was a $250 million flop (more than $2 billion in today’s dollars). Ford’s Edsel was both too expensive and a gas guzzler.
During the 1970s oil crisis, as Americans were opting for smaller and less expensive vehicles, Detroit automakers were still making larger and costlier vehicles. During the craze for smaller Japanese cars, a Ford engineer noted, “This small-car thing won’t last forever. I can’t see American drivers being satisfied for long with manual gear-shifting and limited performance. The pendulum will swing back.” Unfortunately, the pendulum never did quite swing back and Americans turned to foreign automakers to meet their demand for smaller vehicles. This severely affected Detroit automakers who had to lay off thousands of workers and shutdown many plants, which caused many in the city to find opportunity elsewhere.
As Detroiters left, so did the city’s tax base. Without a gainfully employed and growing population, Detroit found it hard to fund its infrastructure and institutions. The rest, as they say, is history. Today, Detroit is trying to revitalize itself as a city where business and innovation can thrive. City officials should study Detroit’s rise, with an intense focus on the business models that catapulted it to global prominence.
In matters of economic development, institutions and infrastructures are important, but it turns out that innovation is the engine that powers both. Without it, good institutions and functioning infrastructures are incredibly difficult to create, and almost impossible to sustain.