It’s Friday and I’m procrastinating, so here you go.

Let’s talk about Joseph Schumpeter. Good old John Joseph Jingleheimer Schumpeter, as he wasn’t called. Schumpeter once wrote in his diary that he aspired to be the greatest economist, horseman, and lover in the world^{Prophet of Innovation, p. 4.”>1}. I can imagine the women and horses edging away nervously. Luckily he had it going on with the economics.

The mainstream of economics, then as now, pretty much tries to describe the economy as if it shouldn’t change. If it is changing, it’s changing towards an equilibrium, where it won’t have to change any more. Schumpeter noticed that this is not how it works². Both the economy as a whole and individual businesses change constantly. His model of the latter, in his Theory of Economic Development^here.”>3, explains how some entrepreneurs make an unusually large amount of money.

I would quote the book itself, but the argument is spread out over the course of the chapter. Schumpeter wasn’t a bad writer and the chapter is worth reading, but he never really summarizes his main points. So this is my recapitulation of it.

There are three main parts.

First, almost all entrepreneurs don’t make an abnormal amount of money, even of the successful ones. They make the same amount as if they were doing the same job for someone else. This is not what our entrepreneurial mythology tells us, so some explanation.

In a market economy, at equilibrium, Schumpeter says profit gets competed away. By profit he means “surplus” profit: the money a company makes if its inputs are priced correctly. Crucially this includes the cost of money adjusted for the risk the investor is taking. That is, you can’t increase risk and say “look, now there’s a profit.” That profit is the cost of the money used in the business.

The reason this is true is that if a company produces something using the same inputs as its competitors, and has the same outputs as its competitors, then the costs of its inputs and the price of its outputs are the same. If there were profit above the cost of capital, “surplus” profit, then existing businesses would lower prices to get more customers, or new businesses would start to take some of the surplus profit, until there was none left to take.

These new businesses would be startups, and their founders entrepreneurs. But these entrepreneurs would earn no more than they would if they did the same job as employees for someone else. This is because even the founder, as manager of the company, is an input, just like the other employees. The founder makes the same amount of money for their job as they would working the same job in any other business..there is no other money to make, there is no surplus for the founder. There is no “entrepreneurial profit”, as Schumpeter called it.

Is this true in the real world? Below is a chart from Scott Shane’s The Illusions of Entrepreneurship.

The vast majority of entrepreneurs are people creating their own job so they can work for themselves.

Shane notes that the median revenue of an owner-managed firm is $90,000 and that 81% of founders have no desire to grow their business. This is because most founders are “just trying to make a living, not trying to be a high-growth business.” And they “start firms in industries where there are a lot of firms already in operation” and “report they have no competitive advantage.”⁵ Why do these people go to the trouble then of starting their own company rather than just taking a job? “The real reason most people start businesses…has nothing to do with wanting to make money, to become famous, to better their own communities, to seek adventure, or even to improve the world. Most people start businesses simply because they don’t like working for someone else.”⁶

Obviously, some entrepreneurs