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30 Years of economics for development

A Commentary on Entrepreneurship and Economic Development (ed. Wim Naudé)

Robert J. Strom

Interest in the study of entrepreneurship has flourished among scholars in recent years. This research has brought to light, among other things, the important role of entrepreneurship and innovation in economic growth. We know that innovative entrepreneurs—those who bring new products and processes to the market—are disproportionately responsible for the breakthrough or ‘disruptive’ innovations that change our daily lives and allow for the rapid improvement in standards of living that developed countries have experienced over the past century, and also disproportionately responsible for job growth in industrialized economies. While we have learned much about the effects of entrepreneurship, many of the mechanisms of change remain open for research.

The role of entrepreneurship in the economic growth of developing countries is certainly even more complex. Studies of this topic often look to history for answers, following the development path of industrialized or growing nations to find the ‘secret sauce’ for their success. Just as innovative entrepreneurial activity is vital to the ongoing growth of developed countries, innovation and entrepreneurship are essential components to a developing economy’s long-term growth. This is the topic of the recent UNU-WIDER book Entrepreneurship and Economic Development, edited by Wim Naudé. In the remainder of this article, I provide some perspective on this contribution.

(Photo: Guy Oliver / IRIN)
(Photo: Guy Oliver / IRIN)
 

Firm and industry dynamics

In his chapter to the UNU-WIDER book Entrepreneurship and Economic Development (see further reading 3), William Lazonick compares development in industrial Great Britain, post-war Japan, and the technology boom in Silicon Valley. In each of these cases, he argues, the creation and growth of indigenous enterprises was the necessary ingredient for lasting development. While investment in education and foreign direct investment may make important contributions to growth, he suggests that they were insufficient without entrepreneurial activity.

While the macroeconomic perspective on entrepreneurship and its relationship to economic growth and development convinces us of the vital importance of this phenomenon, it is equally important to consider microeconomic research that analyses entrepreneurial activity from the perspective of individual firms and industries in the context of developing countries. Discovering the reasons why firms start and grow, how they develop, and why they may eventually die, is critical to economies that rely on innovative new businesses for sustained growth.

Identifying data to analyse the processes of firm and industry dynamics is difficult even in highly industrialized nations with more extensive reporting requirements. By its nature, the entrepreneurial economy can only be described as turbulent, making it difficult to fully measure. As developing countries face this same entrepreneurial turbulence amidst an already more tumultuous legal and social environment, it is even more difficult to observehow successful firms come into being.

Innovative entrepreneurs

Studies linking entrepreneurship to economic development largely focus on innovative entrepreneurs—those who introduce radically new products and processes to the market. These innovative individuals are very different from the population William Baumol has called replicative entrepreneurs—those who start new businesses similar to those they see around them (see further reading 1). While replicative entrepreneurship may lift individuals and families out of poverty, it is the innovative entrepreneurs who are the key to long-term economic growth.

In fact, this differentiation between innovative and replicative entrepreneurs is one of several important distinctions to make when studying the vast population of business owners. In her chapter on ‘Measuring Entrepreneurship in Developing Countries’,  Sameeksha Desai mentions that a consistent definition of entrepreneurship and an understanding of the great variation among the population of business owners are necessary for good scholarship. In the introduction to Entrepreneurship and Economic Development, Wim Naudé offers a definition of entrepreneurs who contribute the most to growth and development, calling them ‘opportunity-driven agents who drive economic change through innovative new firms’.

In addition to highlighting the difference between innovative and replicative entrepreneurs, Naudé’s definition speaks to the distinction between opportunity entrepreneurship and necessity entrepreneurship. Opportunity entrepreneurs choose to start a business because of a promising void they see in the market, engage in some calculation of the potential gain presented by this opportunity, and assume the risks associated with a new business venture. While many opportunity entrepreneurs may start replicative businesses, innovative entrepreneurs exclusively fall in this category. In contrast, necessity entrepreneurs are driven by the need to avoid unemployment. Without other options for income and without any particularly compelling business idea, these individuals start businesses—almost exclusively replicative—solely intended to produce income for themselves and their families. As Desai suggests, necessity entrepreneurs may be especially prevalent in developing countries, making this distinction particularly important for these studies.

The population of entrepreneurs may also be broken down by the extent to which they are productive or unproductive. As William Baumol explains, productive entrepreneurs create social benefits in addition to their private benefits. Unproductive entrepreneurs, by contrast, engage in rent-seeking behaviour that looks to take others’ share of the pie rather than increasing the size of the pie itself (see further reading 2). This contrast may, in fact, be even more striking in the context of developing countries where political corruption and weaker legal protections allow for more unproductive opportunities.

Barriers to entrepreneurship

While these definitional challenges pose particular problems in attempts to compare data across countries, entrepreneurship researchers still find interesting correlations that tell us a great deal about the relationship between entrepreneurial activity and various political, economic, and social factors. Causation, of course, is more complicated. Do entrepreneurs drive growth? Or do growth and transitions to free markets produce entrepreneurial opportunities for individuals? And what are the factors that allow for the creation of entrepreneurial firms?

Many scholars analyse available data for the relationship between entrepreneurship and other country characteristics. In their chapter ‘The Impact of the Business Environment on the Business Creation Process’, Leora Klapper, Anat Lewin, and Juan Manuel Quesada Delgado use World Bank Group Entrepreneurship Survey data to show that industrialization is correlated with higher business entry rates and business density, while the least developed countries show the lowest rates in both categories. They also find that those countries with political stability, good governance, modernized business registries, reduced red tape, less corruption, and simplified business and legal forms have higher business entry rates. Similarly, Desai notes the importance of regulations, business registration, licensing procedures and permit requirements, access to credit, and costs of regulation in this context.

These factors help clarify the barriers that stand between potential entrepreneurs and successful firms, in both industrialized and developing countries. It is clear that characteristics of the political system, such as instability or corruption, may play an important role in impeding successful business starts; and regulatory and administrative barriers, such as burdensome bureaucracy in business registration and complicated licensing and permit requirements, also appear to stand in the way of entrepreneurial activity. Here, however, it is important to note a caution from Wim Naudé—business quality is significantly more important to economic growth and development than the quantity of new businesses. A certain amount of regulation and start-up cost may discourage the creation of low-quality ventures, serving as a vetting mechanism for entrepreneurs. Other institutions, too, can serve as roadblocks to the creation of an entrepreneurial economy. Among others, the lack of a strong legal system with private property rights and intellectual property protections can inhibit innovation and new venture creation.

In addition to these institutional barriers to entrepreneurship, research consistently suggests that there are also demographic challenges. Generally, successful entrepreneurs are well-educated and capable of both the creative thinking involved in starting a new venture, as well as the analytical thinking that enables them to consider the risks and potential rewards. Research suggests that successful entrepreneurial economies are found in countries with well-educated populations, and countries that have transitioned from emerging to developed economies share this characteristic.

Indeed, the lack of a solid educational system serves as an obstacle to entrepreneurial success, both because home-grown talent is not fully developed to the extent possible and because it inspires a ‘brain drain’ when the nation’s most ambitious and gifted individuals seek education away from the home country. Many industrialized nations encourage immigration by talented potential entrepreneurs, and developing countries run the risk that these individuals will continue to live and work abroad, never bringing their education and talent back to the country. In addition to creating stronger educational systems to keep high-potential individuals at home, developing nations could work to lure back the innovative citizens who go abroad for education. As recent events in the Middle East and North Africa have so clearly demonstrated, education must be accompanied by opportunity for young people to contribute to their own and their country’s well-being.

Concluding remarks

It is important to understand the relationship between entrepreneurship and growth and the difficulty in creating an environment for successful entrepreneurial activity. Understanding how this phenomenon can lead to successful growth; the mechanisms by which new firms and industries are born, grow, and die; and the conditions that are most conducive to their success is critical to a developing nation’s ability to start down this complicated road. While there will never be a ‘one size fits all’ public policy solution, continued research examining the relationship between entrepreneurship and growth and policy prescriptions to promote an innovation driven, entrepreneurial economy are a big step in the right direction. 

About the author

Robert Strom
Robert Strom
 Robert J. Strom directs the Ewing Marion Kauffman Foundation's  
 commissioned research. He was the discussant at the New York launch
 of the UNU-WIDER book Entrepreneurship and Economic Development,
 
at the UN on 24 February 2011.

 
 
 
 
 
 
 
Further reading and references
  1. Baumol, William J. (1968). ‘Entrepreneurship inEconomic Theory’, American Economic Review 58: 64-71.

  2. Baumol, William J. (1990). ‘Entrepreneurship: Productive, Unproductive and Destructive’, Journal of Political Economy 98: 893-921.

  3. Naudé, Wim (2011). Entrepreneurship and Economic Development, Basingstoke and New York: Palgrave Macmillan.

WIDER Angle newsletter
April 2011
ISSN 1238-9544

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