Entrepreneurship and Economic Growth

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Economies grow through some combination of greater inputs — more educated labor and additional capital — and through advances in technology. Whether it is home grown or imported from abroad, technological advances are useful from an economic point of view only when they are commercialized, applied to make new products, make existing products more efficiently, or deliver new services.

Both established and new firms commercialize these advances, but the historical record makes clear that new firms, without a vested interest in the status quo, are disproportionately responsible for disruptive or radical innovations while established firms tend to focus more on incremental advances. Examples of entrepreneurial advances in the United States include the telegraph, the telephone, the computer, the car, the airplane, much computer software, air conditioning, and Internet search, to name some of the most obvious. This list also, not coincidentally, includes technologies that define modern life and power advances in growth and living standards.

Entrepreneurs are also crucial in developing countries, where they either may be copying and importing advanced country ideas, or developing and commercializing their own “bottom of the pyramid” products and services tailored for the income levels of their countries.

Entrepreneurial Economies Provide Opportunities

Entrepreneurial economies are those driven by individuals who choose entrepreneurship rather than accept a second-class career because they can’t find a job. There is an element of culture that is difficult to pin down, but in entrepreneurial economies, striking out on one’s own is seen as not only an acceptable career path, but a desirable one, not only for the control it gives to those who seek it, but for the rich rewards it gives to the most successful.

Entrepreneurial capitalism is the most effective driver of economic growth because it provides opportunities for new firms to innovate and create new markets. The advantage of new firms is their independence. Because founders of companies do not often have a vested interest in the status quo, they are more likely to commercialize the disruptive innovation that is responsible for the lion’s share of long-run growth.

Other types of capitalism have different effects. Oligarchic capitalism, where resources and power in the economy are concentrated in the hands of a few, tends not to maximize economic growth but to maximize the welfare of the powerful. Stateguided capitalist systems, which channel resources to industries deemed most likely to be successful, can lead to rapid early growth, but are likely to stall as they approach the technological frontier. Bigfirm capitalist systems benefit from economies of scale, resources for research and development, and capital to deploy, yet big firms hesitate to invest in new products or services that can make their current profit centers obsolete. We must be careful to properly align incentives in a capitalist system in a way that encourages entrepreneurial solutions.

Conditions for Encouraging Entrepreneurship and Innovation

The basic ingredients for encouraging entrepreneurship and innovation are easier to state than to ensure: basic education for all and access to higher education, increasingly online, for many; a minimum acceptable legal and physical infrastructure, and a culture that encourages entrepreneurial pursuits. There is a virtuous cycle here: entrepreneurial success breeds more success, attracting individuals and capital to entrepreneurial pursuits.

Entrepreneurial economies also require a minimum of infrastructure, both physical and legal, to be successful. It must be relatively easy to form a business legally, so legitimate businesses are not forced underground. Property and contract rights must be secure, if not formally then at least informally. Likewise, there must be acceptable means of resolving commercial disputes.

Laws protecting property and contracts and their effective enforcement are key, but it is not necessarily the case that they be strictly formal in the Western sense. China has proved that entrepreneurship can flourish with effective informal legal systems, although as economies grow richer, they can benefit from formalizing the legal conditions enabling entrepreneurship. Also, it is key to be able to form a business, legally, easily, quickly, and cheaply.

As for physical infrastructure, roads and transportation are certainly essential, but in our increasingly global, technologically driven economy, communications infrastructure is also proving to be essential. Even entrepreneurs in the most remote, poverty stricken areas of the world can gain knowledge and access to markets, even the capital they need, if they have a connection to the Internet. Increasingly, that access is mobile. Roughly half of the world’s population has a mobile phone and can use it to access the world.

The foregoing conditions for effective entrepreneurship are universal, although there is room for differences across countries, taking account of unique histories, cultural conditions and so forth. But entrepreneurial capitalism is flourishing throughout the globe in very different countries, with different legal regimes: not just in the United States, but in Eastern Europe, parts of Western Europe (the United Kingdom and Ireland), Chile, and Asia (Taiwan, China, Singapore and even Vietnam). Other countries can gain insights from the U.S. experience but they can also increasingly look to other successful role models.

Robert Litan is Director of Research for Bloomberg Government.

 

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