ENDOGENOUS INNOVATION

MARCO SCOTTINI

Dipartimento di Economia e Statistica “Cognetti de Martiis”, Università di Torino & Collegio Carlo Alberto

ABSTRACT. This paper aims to summarize a large theoretical framework upon which innovation emerges as result of an

endogenous process, analyzing the systemic conditions that make the creative reaction and hence the introduction of

innovations possible. Both New Growth theory and Evolutionary Approach will be criticized and integrated into the

Schumpeterian legacy implemented through: a) the reactive decision making; b) the characteristics of knowledge

externalities; c) the Neo Schumpeterian approach and the classical legacy; d) the new economics knowledge and the

organized complexity; e) the non ergodic path dependent dynamics.

In conclusion, this paper will try to examine the organized complexity of the economic system, into which interactions among

heterogeneous agents are embedded. This endogenous process shapes and explains the generation of innovation, which

appears as an emergent property (Anderson, Arrow, Pines, 1988; Arthur, Durlauf, Lane, 1997; Lane et al., 2009; Antonelli,

2009; Arthur, 2009; 2010; 2015a; Fransman, 2010).

JEL classification: O31 L20

Keywords: Innovation, Evolutionary Complexity, Path dependence.

INTRODUCTION

The 1947 essay by Joseph Schumpeter, The creative response in Economic History, probably generated one of the most

fruitful humus in which economics of innovation has grown. Looking specifically backward, Schumpeter had the brilliant

intuition of firm’s endogenous creative response in out of equilibrium conditions through history. “Acting outside of the range

of existing practice” as Schumpeter asserted, it means a creative reaction instead of an adaptive one. It seems similar to the

physic properties of matter among which there are plasticity and elasticity. Firm’s adaptive response decreases equilibrium

level in the course of time and thus leading to failure, as well as plasticity deforms the matter until a break. Besides, a

creative response that introduces innovation may ignite a virtuous cycle that could bring back the firm to equilibrium or even

better, as well as elasticity assimilates shocks and then coming back to the original form. According to Schumpeter, the

creative reaction - which shapes the whole course of events - can always be understood ex-post but never ex ante. Its

outcome in terms of frequency, intensity, success or failure depends on by endogenous availability of knowledge externalities

(Schumpeter, 1947).

The evolutionary economics and the new growth theory attempted to go beyond the limits of standard economics, where

technological change falls like manna from heaven, but they did not provide convincing results. Although we are well aware

of how and where innovation takes place, we still have a lack of knowledge about why is innovation is introduced and when.

Thus, the understanding of innovation as endogenous process crosses deeply with the notion of creative response. Into the

latter has been integrated a new analytical platform that integrates many different analytical traditions including the tools of

the economics of complexity (Antonelli 2008, 2009; 2011 and 2015).

NEW GROWTH THEORY

According to the new growth theory, knowledge plays a central role as the engine of growth. The theoretical system is based

on Zvi Griliches genial intuition about the affection of knowledge externalities on total factor productivity (Griliches, 1979),

which is the very first crucial basis to understand innovation dynamics. Particularly, accounting for total factor productivity (A),

the role of external knowledge (EX) compares next to the standard inputs of capital (C) and labour (L):

(1) Y = A [C(a)

L(b)

IK(c)

] , where A = (EK)

Romer, rediscovered this formulation, firstly applied by Griliches to R&D expenditure, assuming a key point about the output

elasticity of knowledge. He considered the output elasticity of knowledge as a combination of appropriable (c1) and non-

appropriable components (c2).

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(2) a+b+c > 1, where c = (c1 + c2)

- Then, a+b+c1+c2 > 1 - Splitting in two components, a+b+c1 = 1 and A = f(c2)

(3) Y = f(c2) [C(a)

L(b)

IK(c1)

]

R&D expenditure is now funded by the marginal productivity of appropriable component of knowledge and increasing returns

take place at the system level but not at the firm level. The limited appropriability of technological knowledge has a double

effect: it reduces the potential inventor’s revenue and it spills through the system reducing the costs of its generation for

anybody else.

In conclusion, the non-appropriable component (c2) of new technological knowledge (c1) contributes directly to increase total

factor productivity at the system level (Romer, 1990). Nevertheless, empirical evidence has gradually shown a huge variance

of total factor productivity levels and rates of increase across historic times, agents, industries, regions (Craft, 2010). The

new growth theory seems to be vulnerable to two main critics.

Firstly, there is ambiguity about the characteristics that set up appropriable and non-appropriable components of knowledge

and hence the relative ratio. The Arrovian market failure and undersupply of knowledge take place because a lack of

microeconomic incentives: firms will not invest more that the levels of the marginal productivity of the knowledge that they

can appropriate (c1 Y/K) and they will not generate the equilibrium amount of knowledge defined by the total marginal

productivity (c Y/K) if they cannot maximize expenditure’s outcome.Moreover, the new growth theory does not explain how

an increase in total factor productivity should be bigger than inventor’s losses. Consequently, it is not clear if new growth

theory can be considered a positive or negative sum game. Even if it is positive, there is no explanation about why

opportunistic behavior should not prevail.

Secondly, recent advances in the new economics of knowledge suggest that technological knowledge, that is as at the same

time an input and an output, is characterized by high levels of tacitness and hence is difficult to obtain. The hypothesis

behind, in which spillover effect of external knowledge takes place instantaneously seems difficulty sustainable.

BEYOND PURE AND SYNCHRONIC KNOWLEDGE EXTERNALITIES

As a consequence, we consider the distinction of knowledge externalities between appropriable and non-appropriable

components in a dynamic perspective. The dichotomy does not take place instantaneously and synchronically, but

diachronically through time. Besides, relevant efforts in terms of screening, identification, and recombination are required to

adopt external knowledge thus knowledge externalities are pecuniary. Processing external knowledge as an input into the

generation of new knowledge does cost and takes time. Agents can appropriate the benefits from a generation of new

technological knowledge only for a limited period of time: as a result, the flows of new technological knowledge are added to

the stock of public knowledge.

(4) Y = A [C(a)

L(b)

K(c)

]

a+b+c = 1 constant return of scale

- K is the stock of knowledge produced by each firm and accumulated in a limited stretch of time - A = (τ) is the stock of public knowledge composed by the flows of knowledge produced by each firm and

appropriated for a short period of time.

The introduction of diachronic knowledge externalities is essential to implement the original generation function and

technology production function advanced by Romer. Now, the output of knowledge (K) is produced by the combination of the

stock of public knowledge τ and the stock of proprietary knowledge (IK) that firms can command for a limited period of time.

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(5) K = (τ a

IKb)

(6) τ = Σ Κ t (N-n)

The stock of public knowledge is the summation, after a short time window (n), in the time interval (n-N) of the flow of

knowledge generated at each point in time (K). The stock of proprietary knowledge (IK) is the summation just for a short time

window of appropriation (n) of the knowledge generated by each firm.

(7) IK = Σ 𝐾𝑡(𝑛)

(8) CK = z τ + u IK

We assume that the larger is the stock of public knowledge (τ) and the lower are both the costs of its absorption (z) and the

cost of knowledge as an output (u). The knowledge produced (K) enters the technology production function, next to capital

(C) and labor (L), as an input.

(9) CY = wL + rC + u K

This process is localized not only through time but through space as well. Therefore, knowledge externalities are stochastic

rather than synchronic and automatic. As a consequence, knowledge externalities can be highly localized. Thus, specific

circumstances can make available external/public knowledge that can be used at cost that are below equilibrium levels. In

order to introduce innovation, knowledge externalities are necessary but not sufficient (Antonelli and David, 2015).

EVOLUTIONARY APPROACH

Evolutionary approach builds upon a biological approach, considering innovation as a phenomena similar to Darwinistic

behavior in which the constant adaptation, as a consequence of always persistent changes, is essential to survive.

Therefore, the economic system is defined by a large literature (Nelson and Winter, 1973, 1982) as an organism in perennial

change, both in technology and structure. The best way escape a situation is to learn and eventually change the routine to

avoid it. That is the behavior of the firms: keep changing.

The environment (or even better, the market) is the judge of those changes. Some survive and are adopted, many fails. The

process, as evolution, is random and exogenous. Sometimes firms have the chance to introduce innovation, but

deterministically, innovation is considered as such, as an ex-post result of the selection process only and hence it should

take place evenly across agents through time and space.

But empirically, it is a matter of fact that huge variance both in time and space is present inside innovation process and it

cannot be past dependent. The innovation process is heterogeneous: some agents and some areas innovate more than

others. No evidence support the idea that firms have a spontaneous propensity to innovate as well as homo oeconomicus

has. Effectively, agents are reluctant to innovate for three main reasons:

1) Uncertainty. The outcome and timing of innovation process cannot be predicted. Limited appropriability and

tradability make innovation process radically uncertain by definition.

2) Motivation. The agents need a specific motivation to try and innovate. Innovation does not take place like manna

from heaven.

3) Past dependency. According to Nelson and Winter changes spread along standard Markov chains: history matters

only at the beginning of the process, thus speed and direction of the innovation process cannot change.

Even though there are available clear empirical evidences about innovation as a process diachronically shaped across

agents, industries, regions, countries and historic time (Craft, 2010), it is a primary target understand the reasons why firms

try and innovate, especially in a different way through space and historic times.

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THE SCHUMPETERIAN PLATFORM

The 1947 Schumpeter contribution provides a cohesive single framework into which the following analytical blocks are

embedded:

a) Reactive decision making.

b) The Neo-Schumpeterian approach and classical legacies.

c) The new economics knowledge and the selective diffusion of innovations.

It has been progressively clearer that the Schumpeterian platform is able to build up bridges among different approaches,

leading back innovation process as an endogenous product of economic activity (Antonelli, 2008a, 2011 and 2015). Three

essential key point are needed to understand the 1947 essay by Schumpeter

1) Firm’s reluctance to innovate: mismatches in expectation and more in general in products and market factors

condition are the ignition of change and hence the beginning of innovation process. In equilibrium condition of

expectations firms have no reason to innovate.

2) Creative and adaptive response: knowledge externalities influence the firms reaction (creative or adaptive) The only

mismatches without knowledge externalities and vice versa are not sufficient to induce a creative reaction, which

leads to introduction of innovation.

3) New mismatches and new knowledge externalities due to creative response: causing out-of-equilibrium conditions

for other firms may provoke respectively another creative reaction. Thus, the process are fully endogenous: the

structural characteristic of the system generate flows of knowledge externalities that enable new creative reactions

(Antonelli, 2008, 2011; Antonelli, Scellato, 2013).

Reactive decision making

The behavioral analysis of decision making in terms of bounded and procedural rationality plays a central role to implement

Schumpeterian platform, based on reaction and interaction among the agents in the economic system. Mismatches in market

conditions force agents to react. Thus, procedural rationality generated by bounded rationality and burden of sunk costs and

the relative creative response, are contingent on their specific condition and past decisions (Simon, 1947). Yet, changes

are not automatic. Firms are reluctant to change their habits (Kahneman and Tversky, 1979) if they cannot foresee an

attractive payoff. So, the decision to change the business matrix and innovate is possible only in two general circumstances

occur: when firms expected higher profits or losses based on mismatches between expected and current product and market

conditions. In equilibrium conditions, firms do not need to act or react. Only when they are exposed to failure they are pushed

to react. But, firms are able to act as well when their performance are well above equilibrium, making possible to fund

innovative activities. Recent empirical evidence shows a U-shaped relationship between profitability and innovation that has

its minimum in the proximity of average levels of profitability (Antonelli and Scellato, 2011)

Two main issues may deeply influence the generation process of innovation: external condition and social interactions.

Bounded rationality implies that agents cannot process all the information and thus each decision at time t affects the

possible choices at time t+1. Then, agents will have to face future constraints. External context is strongly involved in the

process (Simon, 1969, 1979, 1982). Affecting behavior, strategies and preferences of agents, social interaction modulate the

access to external knowledge and hence the capability to generate new technological knowledge (Antonelli, Scellato, 2013).

But, when advantageous circumstances come upon, entrepreneurial proactivity can be carried on both by incumbents and

outsiders (Audretsch, 2007).

Neoschumpeterian Approach and Classical Legacies

According to 1947 Schumpeter contribution, unexpected changes in the systemic conditions whom creative response can be

derived, does occur both in factor and product markets. Neo-schumpeterian literature focuses on changes in product markets

instead of factors. It is stressed the role of corporations in oligopolistic product markets as the main factor of mismatches.

Two major hypothesis support this approach (Scherer, 1982):

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1) Large firms vs Small Firms, (Fisher and Temin, 1973). Larger firms more likely introduce innovation because

economies of scales in R&D expenditure and the larger opportunity to appropriate the benefits of innovation. Yet, a

strong empirical evidence was provided by Audretsch (1995 and 2006) about the central role of small firms in the

introduction of radical innovation. 2) Oligopolistic markets vs Monopolistic/Perfect competition, (Dasgupta and Stiglitz, 1980). Oligopoly is more profitable

market where introduce innovation in order to obtain a competitive advantage. In perfect completion and in

monopoly there are mild or even no incentives to innovate, for obvious opposite reasons. This hypothesis were

confirmed by Aghion, Bloom, Blundell, Howitt (2005) where it was shown the inverted-U relationship between

market form, number of firms and innovative efforts.

Furthermore, two main crucial elements are useful to integrate creative response framework. They emerge from classical

legacies by Marx and Smith, according to which technological change is respectively an endogenous response to change in

factor costs and aggregate demand.

a. Notion of technological congruence: induced technological change by John Hicks (1932) and Vernon Ruttan

(1997) based on Karl Marx intuition help to implement evolutionary complexity. Technological congruence is an

emergent system property in which cost and abundance of input in local factor markets matches the relative

size of output elasticity. Both rate and direction of technological change are induced by change in factor

markets that push firms to introduce technological change. This approach is perfectly coherent with the

creative response of Schumpeterian platform (Antonelli, 2008 and 2015).

b. Demand pull approach: based on Adam Smith intuition, and later analyzed by Allyn Young (1928) and Nicholas

Kaldor (1981), the centrality of relationship between extent of the market and the degree of division of labor and

specialization, are the main sources of mismatches. The active role of demand in shaping both structural and

technological change suits Schumpeterian synthesis (Saviotti, Pyka, 2013).

The new economics of knowledge and the selective diffusion of Innovation

New economics of knowledge devotes its research to analyze the generation process of knowledge, viewed as an

intentional and dedicated activity characterized by the recombination of existing knowledge items (Arthur, 2009). In this

approach the stock of public knowledge enters directly as an input into a generation of new public knowledge flow,

generating a non-ergodic dynamics. New Knowledge as output is a collective and systemic result of the recombinant

integration of different kinds of public knowledge as input. Following implication are absolutely relevant.

The size and composition of the stock the existing knowledge shape the direction and the rate of the generation of new

knowledge. Thus, larger is the stock of knowledge, better are the process coherence and complementarity, lower are the

costs both as input and output. As a consequence, the likelihood of creative reaction and hence introducing innovation is

higher. New knowledge depends on by access and use of existing stock of knowledge, generated by groups of agents.

Hence, its accumulation - as well as its composition (Nesta and Saviotti, 2005 and 2006) - is quite sensitive to system

condition, circumstances and interactions among agents. The generation of knowledge as a dynamics of stock and flows is

the result of both effort and actions of individual agents and of the intrinsic characteristics of the system, in terms of

organized complexity and knowledge connectivity, into which agents are embedded (Antonelli and Link, 2015; Antonelli and

David, 2016)

For this reasons, diachronic and pecuniary knowledge externalities fully develop through their cumulability, connectivity,

complementarity, and non-exhaustibility. Firms are able to appropriate knowledge only for a limited stretch of time. In fact,

proprietary knowledge gradually, but inevitably, spills and becomes a public good (Griliches, 1986 and 1992). In particular,

knowledge connectivity directly affects not only the size and the quality of stock of knowledge but also its cost of access and

use. Accessing external knowledge does cost, and knowledge interaction is necessary due to the high levels of tacitness of

its continent. Therefore, the acquisition of external knowledge it is not free and its outcome depends on by specific

circumstances. (Antonelli, 2008b; Aghion and Jaravel, 2015). According to the Schumpeterian platform, creative reactions

explain the endogenous amount of knowledge available in the system and the structure of interactions among agents.

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The knowledge governance system is crucial in order to shape rate and direction knowledge and hence of innovation

process. Knowledge externalities are not homogenous and ubiquitous, but highly localized and distributed across time and

space, affected by specific context, interactions and factors. As a consequence, they are stochastic, an emergent property of

the system (Antonelli and David, 2016). The result, is a systems of innovation that keep changing both size and quality of its

composition, especially in terms of connectivity levels (Nelson, 1993; Malerba, 2005; Martin and Boschma, 2010).

The governance mechanism influence directly the quality of knowledge:

a) Poor quality of knowledge governance mechanism leads to an high likelihood of adaptive response to mismatches

instead of a creative response. Accumulation of stock of knowledge is weak and hence innovation process will not

take place.

b) Temporary support to creative reaction even with a mild quality knowledge governance mechanism may lead to

innovation process, if accumulation of stock of knowledge in enough. Probably will follow only a round if the quality

of governance is not improved.

c) High quality of knowledge governance mechanism leads to a persistent creative response which keeps to enrich

stock of knowledge in term of size and quality and hence in flows of pecuniary knowledge externalities that keep to

support innovation process.

Changes in the innovation system may be evaluated as the endogenous result of interactions among the creative responses

of agents and characteristics of the system that define the endogenous availability of knowledge externalities. High quality of

knowledge governance system produce flows of pecuniary knowledge externalities that are able to re- generate new strong

knowledge externalities and positive feedbacks. Along an extended period of time, a self-sustained cyclic innovative process

takes place. The constant introduction of innovations increases the generation of new knowledge externalities together with

creative reactions in the system.

The 1947 contribution by Schumpeter is still a unique source of assets upon which Schumpeterian platform explains the

origin and the changes in the system of innovation. The conclusion is that the diversity of agents, technologies and

innovations are generated by the system as the result of an endogenous process. Moreover, although a large literature about

selective diffusion process of innovation is available (Foster and Metcalfe, 2012), the Schumpeterian platform can benefit

from the biological analyses of the selection of the species. According to evolutionary approach, at each point of time, many

innovations compete and only a few are eventually adopted (Nelson and Winter, 1973, 1982). Only a fraction of innovation

produced by firm fit the factor market conditions, so their selection process tends to converge to the eventual identification of

a dominant design (Utterback 1994, Anderson and Tushman 1990). This notion is helpful to integrate and implement the

notion of emergence.

THE COMPLEXITY OF ENDOGENOUS INNOVATION

The complexity economics framework provides basic tools, such as endogenous variety, emergence, organized complexity

and knowledge connectivity, path dependence, which are extremely well suitable to implement the Schumpeterian platform in

order to produce an economic theory of endogenous innovation. Evolutionary complexity is particularly useful to analyze

microeconomic interactions that affect the levels of organized complexity of the system, its non-ergodic dynamics, the

availability of pecuniary knowledge externalities and hence the capability to introduce technological changes (Lane and

Maxfield, 1997; Lane 2009; Bonifati, 2010; Arthur, Durlauf, Lane, 1997; Miller and Page, 2007).

Endogenous variety and Emergence

The notion of variety plays a central role in the Schumpeterian analysis. Endogenous variety of agents implies different

reaction to the mismatches between planned and actual market conditions given a specifically available amount of

knowledge externalities. The agents are heterogeneous and also are the derive from the heterogeneity of the system. The

result is that both are the endogenous product of the reactive dynamics. Alongside this line, the notion of emergence

property is helpful to implement once more the Schumpeterian notion of innovation. Where the creative reaction is contingent

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upon the organized complexity peculiarity and the agents heterogeneity with micro-level interactions, a creation of positive

pecuniary knowledge externalities is boosted (Antonelli, 2008a; 2009; 2011). Thus, the connective structure of the system’s

elements makes innovation an emergent property: the system as a whole produce different outcome than a part can produce

individually. Emergence can be analyzed in term of both product and process, which have both static and dynamic aspects.

Not only the agents but also the system matters. The coexistence between individual decision making (creative/adaptive

response) plus individual entrepreneurial action/initiative, stress the collective role of the innovation process and highlight the

weight of the system.

Therefore, the characteristics of the system are crucial to assessing the rate and direction of the innovation endogenous

process. The introduction of innovation and hence the increment of total factor productivity is the combination between a

peculiar system structure with organized complexity and the individual action. These elements are the endogenous cause of

innovation. For this reason, sharing the hypothesis that describes innovation as the outcome of resultant property (Harper

and Lewis, 2012) of individual action only, regardless the characteristic of the system and agents interactions is impossible.

The introduction of innovations and the consequent creative destruction generate new mismatches between plans and actual

market conditions. From this viewpoint, the notion of innovation as an emergent property of the economic system into which

the agents are embedded, reduces the weight of the individual entrepreneur, stresses the collective role of the innovation

process and highlights the weight of the system.

The first bifurcation (A) takes place when the levels of organized complexity and the consequent levels of knowledge

externalities are sufficient to support the reaction of firms and enable to make it creative instead of adaptive (Antonelli, 2008,

2011, 2013).

Region A shows how the bifurcation takes place.

The mismatches that lead to the creative reactions and hence to introduction of innovations occurs only if the system owns

an high quality organized complexity. At the same time innovations which are introduced, are the primary source of the

unexpected changes in product and factor markets that stirs the reaction of firms.

This is crucial to only provide knowledge externalities and generate new technological knowledge, but also make it cheaper

than in equilibrium conditions. Low level of organized complexity lead to adaptive reaction because a lack of knowledge

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externalities. The economic environment shape the reaction of individual agents, stressing the systemic character of the

innovation process.

The dynamic of the systems is the following:

Introducing structural and technological at each point of time re-shape the levels of knowledge connectivity and hence the

stock ok knowledge available which now is larger. In conclusion, endogenous knowledge externalities are essential for the

innovation system as much as endogenous innovation.

OUT-OF-EQUILIBRIUM CONDITIONS

OUT-OF-EQUILIBRIUM CONDITIONS

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Organized complexity

The composition of the system into which reaction can be either adaptive or creative is crucial and endogenous:

mesoeconomic characteristics play a crucial role in assessing the changing size and composition of the stock of knowledge.

Intrinsic heterogeneity of knowledge affects the stock of external knowledge in terms of specialization, diversification,

complementarity, coherence, interrelatedness and rarity, interoperability and interdependence.

The quality and the characteristics of organized complexity as a combination of these factors depends on by the level of

knowledge connectivity, which is crucial to determine the size, relevance and the speed of knowledge externalities

widespread, upon which innovation process is based. This capability is not given once forever but it keeps changing in both

directions: progress and decline (Page, 2011). The system plays a key role spreading knowledge flows that enable the

creative reaction and hence the introduction of innovations. As a consequence, better is the organized complexity and the

consequent knowledge connectivity of the system, larger is the rates of introduction of innovations.

When the quality of organized complexity is high, and the knowledge connectivity is strong enough to favor the accumulation

of the stock of knowledge, the system enters a loop of self-sustained creative reactions. On the contrary, with low levels of

organized complexity and poor knowledge connectivity, the reaction of firms is adaptive and leads to equilibrium conditions.

Innovations are not introduced, no new mismatches and no new knowledge externalities are generated.

Intrinsic heterogeneity of

knowledge

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The levels of organized complexity of a system are endogenous to the system itself as they depend upon the structure and

architecture of knowledge interactions and transactions that take place within the system. They are far from automatic as

they are the result of processes that are dynamic, endogenous, non-ergodic and far from deterministic.

Structural consequences and effects of introducing innovation

Innovation is the consequence of a creative reaction to mismatches, which is made possible thanks to high levels of

knowledge connectivity and knowledge. Firms are able to recognize mismatches and eventually react creatively, if the

conditions permit it, because of creative destruction of previous introduction of innovation, which allows to observe and

analyze:

a. The product and factor markets.

b. The organized complexity of the system and the levels of knowledge connectivity.

c. The size and composition of the stock of knowledge, and the actual levels of knowledge externalities are no longer

the expected ones.

Coping with unexpected mismatches by adaptive response consists of movements within the existing technology and the

existing structure of the economy while creative responses consist of technological and structural changes. Thus, given

jointly characteristics of both system and agents into which are embedded, the generation of innovation process take place,

with the following effects:

1. New mismatches between expectation and the actual conditions of product and factor markets will occur.

2. The levels of knowledge connectivity determined by the structure of knowledge interactions and transactions

reshape the organized complexity of the system.

Accumulation of the stock of knowledge

High quality of organized complexity Strong knowledge connectivity

Loop of self-sustained creative reactions, generating of both new

knowledge externalities and new mismatches that feed further changes.

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3. The size and the composition of the stock of public knowledge upon which the provision of knowledge externalities

depend will change.

4. The generation of additional technological knowledge will be shaped in a path dependent trajectory.

Region B shows the creative reaction self-sustained loop as structural consequence of introducing innovation.

A second bifurcation (B) take place introducing innovation, which affects the organized complex system by its pillars. The

result is that the structural conditions of the system at time t+1 may be different in comparison to time t, fostering a self-

feeding dynamic. This loop is possible only when introduced innovations increase levels of knowledge connectivity, a stock

of knowledge and knowledge externalities and at the same time keeping them on a necessary level to support a new

creative reaction. When these conditions occur, creative reaction induces creative destruction the enable the further

introduction of innovation. Besides, the process will stop if technological and structural changes deteriorate or even are not

able to implement knowledge connectivity, a stock of knowledge and knowledge externalities. As a consequence, a reaction

will be simply adaptive. In conclusion, the introduction of innovations does not only affect product and factor markets but also

the organized complexity of the system, the knowledge connectivity and the accumulation of the stocks of knowledge. The

consequent generation of knowledge externalities may have both positive and negative effects.

Path dependence

The generation of new technological knowledge and knowledge externalities consist in the recombination of existing

knowledge items. The stock of existing knowledge plays a crucial role as input into the generation of knowledge as an output.

Along this process, history matters, but the loop of endogenous accumulation of a stock of knowledge to innovations, is a

possible dynamic process that is far from deterministic. Path dependency and non-ergodic endogenous dynamics explain

this process as a whole, including economic change and at the same tame changes in speed and direction (Blume, Durlauf,

2006). The process, in fact, benefits from the past conditions and may lead to different types of reaction, but also it is heavily

affected by events that occur during the process itself. As a result, system’s characteristics are not the same forever but are

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exposed to contingent events along the process, including the endogenous introduction of innovations (David, 2005).

Intrinsically, path dependency does not affect only the type of reaction but as well the structure of the system its capability to

provide access to knowledge externalities. Contingent reaction is indeed taken on the basis of actual conditions which are

shaped by decisions took in the past. Although it seems tautological, path dependency and non-ergodic dynamics allow to

correct the old choices and reshape the process towards a different direction, while in a past dependent dynamic it would not

be possible. The process dynamic is typically historical. As a matter of fact, knowledge externalities are external to each firm

but endogenous to the system. Thus, the introduction of innovations affects the conditions that make further creative

response possible, but successively, knowledge externalities provision may be reinforced but also deteriorated. In

conclusion, the accumulation of the stock of knowledge and the consequent flows of knowledge externalities are at the same

time the result of individual action and its cause.

CONCLUSIONS

The 1947 essay by Schumpeter is an inexhaustible source of theoretical inspiration. Implementing the currently analytical

platform, and giving a comprehensive and solid framework, innovation can be now described as a system property, which is

a process: endogenous, dynamic, non-ergodic, and stochastic, with intrinsic systemic characteristics. Both evolutionary

economics and new growth theory approaches, in which unlimited and automatic knowledge spillover and a spontaneous

and automatic always drive to introduce innovations, no longer hold. The most recent advances confirm that knowledge

externalities are far from being automatic and exogenous. As previously described, high-quality knowledge externalities are

available only in very specific circumstances which are highly localized in space and time. Hence, the level of organized

complexity enables to make external knowledge not only available but also cheaper with costs that are below the equilibrium

levels of reproduction. The Schumpeterian platform clarifies the determinants of innovation. Its process is endogenous and it

is based on individual reactions linked to the characteristic of the system. The procedural rationality of the agents explains

innovation only as a reaction to unexpected changes. The eventual success of the firms is contingent on the characteristics

of the system that become apparent only ex-post.

In conclusion, five more new radical elements can be derived from Schumpeter:

1) Innovation is the result of an unplanned reaction to unexpected events.

2) Changes in both factor and product markets as much as in the levels of aggregate demand cause mismatches that

push firms to try to innovate.

3) Creative response to the mismatches is contingent on the characteristics of the system.

4) The organized complexity of the system, the levels of knowledge connectivity and the available amount of

knowledge externalities are affected by the introduction of new technologies.

5) Both the generation of technological and structural change are endogenous as they are emergent and path

dependent system properties.

Thanks to the Schumpeterian platform it is possible to elaborate the determinants of innovation process and increase of total

factor productivity into two jointly conditions:

A) The endogenous structure of the system is able to guarantee high levels of organized complexity and knowledge

connectivity that boost the accumulation of knowledge and hence the generation of new technological knowledge at

costs that are below equilibrium levels.

B) Firms coping with out-of-equilibrium conditions are able and ready to take advantage of knowledge externalities and

actually introduce innovations.

A self-sustained dynamic requires a positive effect of innovation on stock of knowledge and knowledge connectivity system in

order to produce new creative reactions and further innovations, leading to a new technological frontier that supports the

continual expansion of the economic system and the rates of economic growth. If the effect negative or event not positive

enough, quality of the system of innovation will decrease and firms will be no more able to produce a creative reaction. An

adaptive reaction will be the only solution and equilibrium just one of the many possible outcomes.

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REFERENCES

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