Why Institutions are Essential to Entrepreneurship
An economy that is performing well at one particular point in time may be outperformed in the long-run by an apparent laggard, if that lagging economy proves better able to take advantage of changing circumstances (Schumpeter, 1942). What determines which economy lags or prospers? The answer, according to Schumpeter, is entrepreneurship: the constant creation of new goods, new markets, new methods of production, and new ways of organizing. And what determines whether entrepreneurship flourishes? The answer, I submit, is institutions, institutions that nourish rather than stifle innovation and change, as we can see in the history of the modern market economy.
Today we take it for granted that in developed countries like the United States we can usually buy a car from a dealer, an apple from the supermarket, goods over the Internet, or investments in the stock market without our money being stolen. But when we make these impersonal exchanges we are relying on a host of institutions of relatively recent vintage to protect our interests. For centuries most exchanges were eyeball to eyeball, or else restricted just to people you knew or someone that your family, church, neighborhood, guild, or commercial network knew. Trading with strangers was risky, because strangers could not be trusted and there were no low-cost ways to enforce bargains. Trading over distances and time was even riskier because of the ever-present threats of theft and violence – consider the medieval etchings of the merchant and his goods surrounded by his private army or flotilla. Costly risks limited markets and stifled entrepreneurship. Although the bazaar still exists and networks are still important, the gradual emergence of institutions that reduce transaction costs and protect property rights encouraged impersonal, long-distance trade to flourish.
