Schumpeterian Profits in the American Economy: Theory and Measurement

Research-Technology Management, Jan-Feb, 2005

Schumpeterian Profits in the American Economy: Theory and Measurement (Working Paper No. 10433); William Nordhaus; National Bureau of Economic Research, Oct. 2004.

This paper examines the impact of new technology on profits, emphasizing three implications: 1) understanding the role of innovational profits in total profits; 2) identifying the impact of innovation in stock market returns; and 3) gaining greater understanding of technology's wealth effect on aggregate demand, as defined by Federal Reserve Chairman Alan Greenspan (which Nordhaus labels the "Greenspan effect").

Nordhaus begins by considering the impact of technological change on prices and profits. Do technological improvements primarily result in lower prices for consumers or in higher profits for producers? If producers are able to capture (or appropriate) most of the social returns to innovation, then profits will rise and prices will fall relatively little.

How much of the profits from a new technology are captured by innovators will vary greatly across industries. In industries with well-defined products and strong patents, such as pharmaceuticals, producers may be successful in capturing a large fraction of social gains in "Schumpeterian profits"--profits above those that are associated with the normal return to investment and risk-taking. Nordhaus suggests that Schumpeterian profits were only 0.19 percent per year of the replacement cost of capital over the period 1948-2001. Using these estimates for the New Economy suggests that entrepreneurs could capture only $400 billion, not $6 trillion. Nordhaus speculates that part of the New Economy bubble might have arisen because investors overestimated the appropriability of innovations in that sector.