Does innovation chase profits, or do profits chase innovation?

Abstract

This paper performs an empirical assessment of a debate held decades ago on whether an entrepreneur’s or a firm’s desire for profits starts with innovation, or whether excess profits or surplus are used as some type of investment fund to perform research, development and innovation.  That is, which typically comes first, innovation and then profits, or do profits come first, and then innovation?  In the former case, it is held that either the small entrepreneur or the large corporation has an idea for a new and innovative product or service and then finds the ways to fund its development.  In the latter case, it is thought that research and development on any new idea or product usually comes about only once a certain level of profitability has been attained by the firm, and development of a new product or service is not undertaken unless it meets a certain target rate of return on investment. The analysis of this paper examines a debate in which Paul M. Sweezy argued that innovation mostly comes about thanks to firms, especially large corporations, investing excess profits into research and development, which was contrary to the traditional view of Joseph Schumpeter who believed that innovative ideas come first, and then firms pursue the innovative ideas. The traditional view is still the predominant view of most people who study innovation, although so far no evidence of a test of the Sweezy contention has been found in the course of doing research on this topic.  This paper uses time series data from different governmental and private sector databases and time series least square regression to test the Schumpeter and Sweezy theories.