(This essay was published in South China Morning Post on 27 January 2016.)
Most of the time innovation entails a minor tweaking of old ways, but occasionally it generates revolutionary change. The iPod was a modest improvement over many MP3 devices but it transformed the Apple business and impacted most people’s lives.
There are two economic views of how innovation comes about.
Harvard Professor Joseph Schumpeter (1883-1950) emphasized the role of the entrepreneur as an innovator in capitalist economies. His theory is that competition drives invention and discovery. Creative individuals seek out new ways of doing things and finding new things to do in order to increase profit margins and improve their living standards.
Schumpeter described the act of innovation to replace old technologies as “creative destruction.” Silicon Valley best exemplifies his model of capitalist growth, with its abundance of entrepreneurial and technological talent and have access to a vast unfettered market economy.
Chicago Professor Frank Knight (1885-1972) held a different view. He distinguished between risk and uncertainty. Situations with risk have unknown outcomes but are governed by probability distributions known at the outset. In situations of uncertainty, both the outcomes and the probability models that govern them are unknown.
Knight’s distinctive idea is that risk is insurable, but uncertainty is not. Profits earned by the entrepreneur are his reward for embracing an uncertain environment. His success is not merely a product of his personal attributes, but also his positioning in the economic network and relationship to others in that network.
This is an empirically convincing idea. Entrepreneurs seek market niches to maximize profit and minimize competition, but have very diffuse knowledge and hardly any control over the market. In fact, Knightian entrepreneurs act less in response to actual demand than by anticipating it.
Malcolm Gladwell’s popular book The Tipping Point: How Little Things Can Make a Big Difference (2000) describes how innovative businesses can catch on like an epidemic emanating from a small niche but sweeps through the network impacting most relationships and reconfiguring them forever. The central figures in Gladwell’s book are the mavens, connectors and salesmen who trigger and propagate these network avalanches. They are the Knightian entrepreneurs behind the tipping points.
There are many examples of huge companies that have filled small niches in the global market network. Uber is the largest taxi company in the world yet it owns not a single vehicle. Hong Kong’s DHL became a highly successful international airfreight forwarding and express service company without first owning a single airplane.
So what attributes do economies need for innovation and entrepreneurship to thrive? Government policies to encourage entrepreneurship do not really differ whether one believes in Schumpeter or Knight. What matters, however, are the following:
First, a free and open economy and society.
Second, investment in human capital and in attracting human capital talent from the rest of the world.
Third, upholding the rule of law and protecting intellectual property rights.
Fourth, maintaining a business regulatory regime that lowers barriers to entry for startups and new companies.
Fifth, supporting the development of telecommunications infrastructure to make information access cheap and convenient in the digital age.
Sixth, facilitating financial and managerial support for startups.
Seventh, developing infrastructure for basic and applied research.
According to this list of attributes, I would place Hong Kong one notch behind the U.S. primarily because of its lack of scale in human capital and research infrastructure; in these areas it is also falls behind Mainland China. These shortcomings are tied to the size of our population and economy.
Mainland China has an enormous advantage in scale, which compensate for its weaknesses in other areas of entrepreneurial fitness. Still it will continue to punch below its weight if the other critical attributes cannot catch up.
The Silicon Valley model has been the dominant model of innovation-led growth. It is largely the Schumpeterian model. Many countries have sought to repeat its success through government policy and fallen short because no economy in the world is close to the US in terms of both scale and entrepreneurial fitness. This means no economy can repeat its success, not even Mainland China with only a scale advantage.
Hong Kong’s current ecosystem for supporting innovation is quite good except it does not have scale. So it should take a page from the Knightian model and position its business innovations in niches in the global economic network to maximize profit and minimize competition. It should mobilize all the knowledge of its networked people and their partners to act as mavens, connectors and salesmen to find these niches, and play host and hub in forging connections. Connecting China to the world and the world to China will be one of the outcomes.