Small Firms: Why Market-Driven Innovation Can’t Get Along Without Them

William Baumol1 has provided striking evidence indicating that private innovative activity has been divided by market forces between small firms and large, with each tending to specialize in a different part of the task.2 Even though the preponderance of private expenditure on research and development (R&D) is provided by the giant business enterprises, a critical share of the innovative breakthroughs of recent centuries has been contributed by firms of very modest size. These radical inventions then have been sold, leased or otherwise put into the hands of the giant companies, which have then proceeded to develop them—adding capacity, reliability, user friendliness and marketability more generally—to turn them into the novel consumer products that have transformed the way Americans live. Baumol has referred to this division of labor as the “David-Goliath partnership,” the value of whose combined products clearly exceed the sum of the parts.