ABSTRACT
Economic progress is not a smooth, continuous process, but has occurred in
fits and starts. Some periods and regions have experienced periods of rapid growth, whereas stagnation, if not outright decline, has prevailed at other
times and places. Technological progress is considered the main engine of
economic development, but the merit of new technologies is not always
obvious from the start. Societies, therefore, need mechanisms to find and
select innovations and innovators. New ways of doing things exist as plans
before they enter the economy through investments. Innovations can either
be introduced by established or by newly founded firms. Schumpeter’s
model of economic development was based on innovations that were introduced by new firms, unencumbered by former investments (Schumpeter,
1934). He mentioned the discovery of new trade routes, markets and orga-
nizations as innovation types as well as product and process innovations.
Schumpeter emphasized the relationship between the innovative entrepre-
neur and his banker. Weber had advocated saving plus hard work as essen-
tial for economic development in his Protestant Ethic. However, his earliest
work had centered on the relationship between the financier and the entre-
preneur in the medieval commenda organizations. He cast this relationship in the principal-agent mode, which is still applied by modern organization
theorists. Weber considered uncertainty, which prevents accurate prediction
of future events, to be a negative investment-depressing force. Schumpeter
also argued that investors should only choose people, whose qualities were
obvious. Entrepreneurship was open to people of all walks of life, in
Schumpeter’s view, since bankers would provide the qualified with credits.
However, choosing too many entrepreneurs inflates credit creation and cre-
ates a depression. Knight, by contrast, contended that both uncertainty and profits derive from differences in perception among investors (Knight, [1921]
1964). The investor will select the venture, through which he expects to become
most successful. Investors should hold different views on a project’s prospective
worth. Otherwise all investors would flock to the same ventures and drive up
the price of the ‘coveted’ people, who would be entitled to the whole residual.
This chapter builds on Weber’s principal-agent analysis and proposes a revised
principal-agent model based on Knightian uncertainty.
