Entrepreneurship and Economic Development

Many commentators, beginning with Schumpeter, have argued that entrepreneurship is crucial for understanding economic development.[1]  Acs and Virgill noted that “[t]he empirical evidence is . . . strong in support of a link between entrepreneurship and economic growth” and that [s]tudies have found that regional differences in economic growth are correlated to levels of entrepreneurship”.[2]  They explained that entrepreneurs in developing countries play a key role in “fill[ing] in important gaps left by incomplete and underdeveloped markets” and referred also to Leff’s explanation that “a key function of entrepreneurship in developing countries is . . . to mobilize factors such as capital and specialized labor which, being imperfectly marketed, might otherwise not be supplied or allocated to the activities where there productivity is the greatest”.[3]  According to Acs and Virgill, recognition of the unique value of entrepreneurship in developing countries has led policymakers in those countries to “begin to work on perfecting their markets by eliminating barriers to entrepreneurship and other market failures”[4], a trend which can be seen in the increased interest of policymakers and researchers in the role that institutions play in promoting entrepreneurship that can lead to economic development.

While focusing on and describing the “economics of innovation”, Porter suggested that countries go through three stages of economic development: a factor-driven stage; an efficiency-driven stage; and, finally, an innovation-driven stage.[5]  Acs and Szerb provided the following brief description of each of these stages[6]:

  • The factor-driven stage is marked by high rates of agricultural self-employment and countries in this stage generally compete based on low-cost efficiencies in the production of commodities or low value-added products. Countries in this stage do not create knowledge that can be used for innovation nor do they use knowledge to engage in exporting activities.
  • The efficiency-driven stage requires that countries engage in efficient productive practices in large markets so that firms are achieve and exploit economies of scale. Industries in this stage are generally manufacturing-based and focused on the production and distribution of basic goods and services.  Self-employment declines during this stage and capital, labor and technology become the key drivers of productivity.
  • In the innovation-driven stage, the key input is “knowledge” and decisions about embarking on new projects are based on primarily on expected net returns and the likelihood that economic activities can generate high value added products and services.

Acs and Szerb discussed the relative importance of institutions and innovation as countries moved through the various stages and noted that while “[i]nstitutions dominate the first two stages of development”, innovation spurred by entrepreneurship plays an increasingly important role in economic activity “in the innovation-driven stage when opportunities have been exhausted in factors and efficiency”.[7]  The institutional emphasis as the beginning of the continuum is illustrated by the need to increase production efficiency and the education level of the workforce in order to transition from the first stage to the second stage and its increased emphasis on technology.  In contrast, the activity of individual agents in possession of new technology (i.e., “entrepreneurs”) plays a bigger role in traveling the road from the second to third stage.[8]

The notion of “stages” of economic development has also been embraced and explained by other scholars.  For Brinkman, economic development is “a process of structural transformations” that ultimately leads to an overall higher growth trajectory.[9]  Liebenstein explained that “per capita income growth requires shifts from less productive to more productive techniques per worker, the creation or adoption of new commodities, new materials, new markets, new organizational forms, the creation of new skill, and the accumulation of new knowledge”.[10]  As noted elsewhere in this publication, the role of the entrepreneur has often been neglected in economic theory, including various “stages of development” models; however, Liebenstein explicitly and celebrated the entrepreneur as “gap filler and input-completer . . . [and] . . . probably the prime mover of the capacity creation part of [the] elements in the growth process” that occurs during the aforementioned processes of change as economies shift to higher productivity.[11]

All in all, entrepreneurship plays a big role throughout the process of economic development, not just at the innovation-driven stage, and entrepreneurship makes a continuing contribution in various forms such as employment, innovation and welfare.  Acs and Szerb argued that relationship between entrepreneurship and economic development was “S-shaped”: during the first transition—factor-driven stage to efficiency-driven stage—entrepreneurship plays a minimum role in productive entrepreneurship; however, entrepreneurship become increasingly important during the efficiency-driven stage and throughout the transition to the innovation-driven stage.  Acs and Szerb also made the interesting observation that “economic activity” can be characterized as a societal “resource” that is capable of increasing and expanding over time as institutional support strengthens and the society learns how to use entrepreneurship in productive, rather than unproductive and destructive, ways.[12]

Naude et al. acknowledged the utility of the model created by Acs and Szerb but also argued that it tends to “understate the importance of innovation by entrepreneurial innovation in the early stage of [economic] development”.[13]  Naude et al. believed that it was important to distinguish between “incremental” and “radical” innovations and focus on the impact that a particularly type of innovation has on the local economy.  Using this criterion, innovations that might not be that important in developed countries can, in fact, be quite significant in developing countries that are embarking on “catch-up change”.  For example, entrepreneurs in developing countries engage in innovation when they imitate products or processes originally developed in other parts of the world and adapt them for use in their local economies.  This type of “innovation” serves an essential function with respect to technology upgrading and increasing production efficiency.  Developing countries can also benefit from another type of “innovation”: development of the capacity to “absorb and creatively adapt international technological knowledge . . . [to] . . . achieve accelerated growth”[14], skills that served countries such as Chile, China, Korea and Taiwan well.  Finally, the “mere” exploitation of new markets and development of new ways to organize businesses, each somewhat commonplace in developed countries, is a key method of innovation in developing countries.  Naude et al. concisely described the important role of “innovation” at the earlier stages of development as follows:

“Entrepreneurs in low-income developing countries provide innovations that are important for firm and country growth, even if they are incremental in nature.  Innovation in developing countries involves the process by which firms master and implement the design and production of goods and services that are new to them.  Many small improvements in product design and quality, changes in the way production is organized, creativity in marketing and modifications in production processes and techniques reduce costs, increase efficiency and flexibility to respond to changes in competitive conditions and enhance productivity and employment growth.  In emerging economies innovation involves upgrading and shifting to higher levels of technological sophistication. . . Innovation plays an important role in catch-up and growth in a globalized economy.”[15]

While on the face of it one might assume that entrepreneurship would have a positive impact on economic and social development, there are those that have questioned this proposition.  Baumol, for example, has observed that “entrepreneurship can take various forms, and not everything labeled as ‘entrepreneurial’ might be desirable from a macroeconomic and societal perspective”.[16]  If this is true, policymakers developing tools to encourage and support “entrepreneurism” need to have a better understanding of just what types of entrepreneurial activities are likely to have the most positive impact on economic development.  Baumol distinguished between “productive” and “unproductive” entrepreneurship while commenting that “. . . there are a variety of roles among which the entrepreneur’s efforts can be allocated, and some of those roles do not following the constructive and innovative script that is conventionally attributed to that person.  Indeed, at times the entrepreneur may even lead a parasitical existence that is actually damaging to the economy.  How the entrepreneur acts at a given time and place depends heavily on the rules of the game—the reward structure in the economy—that happen to prevail.”[17]  Welter explained that “[p]roductive entrepreneurship includes any activity that indirectly or directly contribute to economic output or the capacity of the economy to produce additional output”, while unproductive, or “destructive” entrepreneurship “includes, but is not limited to, rent seeking, illegal activities and shadow activities or different forms of corruption”.[18]  This distinction is sometimes simplified by assuming that the activities of legal, registered businesses are productive and that the activities of illegal, informal businesses are unproductive and, in fact, destructive in those instances where they attracts followers that engage in wholesale circumvention and defiance of the legal and normative framework of the society.[19]  Assuming all of this is true, policymakers developing tools to encourage and support “entrepreneurship” need to have a good understanding of just what types of entrepreneurial activities are likely to have the most positive impact on economic development.

While much of the research regarding entrepreneurship and economic development assumes that there is a direct correlation between the success of the entrepreneurial activities at the “micro”, or venture, level and the contribution of those activities to society at the “macro” level, it is useful to analyze a particular set of activities using the model developed by Davidsson and Wiklund which allows for the fact that entrepreneurial activities may have either positive or negative outcomes at both the venture (i.e., micro) and societal (i.e., macro) levels.[20]  The result is a typology of four different enterprises that can be described as follows:

  • “Hero” or “success” enterprises, which have positive societal and venture level outcomes, generally as a result of introducing new products or services and creating personal income and wealth.
  • “Robber” or “re-distributive” enterprises, which are successful at the venture level, yet contribute nothing at the societal level since their success is tied to the use of strategies that Baumol would classify as “unproductive”.
  • “Catalyst” enterprises, which may not be successful at the venture level, yet do make a positive contribution at the societal level. An example would be a venture that develops ideas and methods that do not generate profit for that venture but which eventually are successfully imitated and productively exploited by others in the future.
  • “Failed” enterprises, which are unsuccessful at both the venture and societal levels.

However, this model does not fully explain how things work in the “real economy”.  For example, Davidsson pointed out that “. . . we have to live with the fact that in real economies ‘legal, yet re-distributive’ and ‘illegal, yet societal beneficial’ are both possible”.[21]  In addition, even enterprises that eventually are found to fall within the “hero” category may sometimes engaged in activities generally thought to be “unproductive” from a societal level at some point during their development.  Even “failed” enterprises cannot be totally dismissed since it is feasible to imagine that the entrepreneurs involved with these enterprises may have learned from their failures and applied this knowledge to new enterprises that were more successful.[22]

Other researchers have found evidence that entrepreneurs “switch” between “proprietorship” behavior, which focuses primarily on income and survival for the individual entrepreneur and his or her family, and so-called “opportunity-based” or “dynamic” entrepreneurship that is more focused on growth and business development and discussed elsewhere in this chapter.  For example, while entrepreneurs may have the skills and desire to oversee growth-oriented ventures, their initial goals may be largely necessity-based as they struggle to create a basic income for themselves and limit their activities to satisfying local demand.  As time goes by, however, and they are more confident in the sustainability of their venture they may shift toward strategies that are most consistent with opportunity-based entrepreneurship.  In addition, researchers analyzing entrepreneurship in the transitional economies of the former socialist countries in Eastern Europe have concluded that most new and small companies are engaged in both productive and unproductive activities at the same time, a situation that the researchers attribute to the lack of formal laws and regulations in those countries and the corresponding need of entrepreneurs to engage in “defiance and avoidance strategies”, particularly rent seeking, in order to simply survive in a turbulent, ambiguous and uncertain environment.[23]  Welter concluded that analyzing entrepreneurship using just assessments of “activities” (i.e., productive or unproductive) or measures of output provides an incomplete picture and that it is necessary to take into account both activities and output in a non-judgmental fashion and consider the environment in which the entrepreneur is operating and the likelihood that strategies may change over time.[24]  Welter also pointed out that it could reasonably be assumed that once entrepreneurs in these economies have survived the initial stages of formation and organization using any means possible some of them may “develop their activities from simply trading towards more substantial businesses”.

This post is part of the Sustainable Entrepreneurship Project’s extensive materials on Entrepreneurship and Sustainability and Entrepreneurship.

Notes

[1]  Z. Acs and L. Szerb, “The Global Entrepreneurship and Development Index (GEDI)” (Paper presented at Summer Conference 2010 on “Opening Up Innovation: Strategy, Organization and Technology”, Imperial College London Business School, June 2010).  A review of the literature regarding the relationship of entrepreneurship to economic development appeared in Z. Acs and N. Virgill, “Entrepreneurship in developing countries”, Foundations and Trends in Entrepreneurship, 2009.

[2] Z. Acs and N. Virgill, “Entrepreneurship in Developing Countries”, Jena Economic Research Papers, No. 2009-023, March 2009, 26.

[3] Id. (citing N. Leff, “Entrepreneurship and Economic Development: The Problem Revisited”, Journal of Economic Literature, 17(1) (1979), 46-64, 48).

[4] Id.

[5]  M. Porter, Global Competitiveness Report (Geneva: World Economic Forum, 2002).

[6]  Z. Acs and L. Szerb, “The Global Entrepreneurship and Development Index (GEDI)” (Paper presented at Summer Conference 2010 on “Opening Up Innovation: Strategy, Organization and Technology”, Imperial College London Business School, June 2010).

[7]  Id.

[8] Z. Acs and S. Laszlo, “The global entrepreneurship Index (GEINDEX), Foundations and Trends in entrepreneurship”, 5(5) (2009), 341-435.

[9] R. Brinkman, “Economic Growth versus economic development: Towards a conceptual clarification”, Journal of Economic Issues, 29(4) (1995), 1171-1188, 1183.

[10] H. Leibenstein, “Entrepreneurship and Development”, The American Economic Review, 58(2) (1968), 72-83, 77.

[11] Id.

[12]  Z. Acs and L. Szerb, “The Global Entrepreneurship and Development Index (GEDI)” (Paper presented at Summer Conference 2010 on “Opening Up Innovation: Strategy, Organization and Technology”, Imperial College London Business School, June 2010) (citing W. Baumol, “Entrepreneurship: Productive, unproductive and destructive”, Journal of Political Economy, 98 (1990), 893-921; and D. Acemoglu, S. Johnson and J. Robinson, “The colonial origins of comparative development: An empirical investigation”, American Economic Review, 91(5) (2001), 1369-1401).  For further discussion of the Global Entrepreneurship and Development Index, see “Research on Entrepreneurship” in “Entrepreneurship: A Library of Resources for Sustainable Entrepreneurs” prepared and distributed by the Sustainable Entrepreneurship Project (www.seproject.org).

[13] W. Naude, A. Szirmai and M. Goedhuys, Policy Brief: Innovation and Entrepreneurship in Developing Countries (Helsinki, Finland: United Nations University-World Institute for Development Economics Research, November 1, 2011), 3.

[14] Id.

[15] A. Szirmai, W. Naude and M. Goedhuys (Eds.), Entrepreneurship, Innovation and Economic Development (Oxford: Oxford University Press, 2011), 26-27.

[16] W. Baumol, “Entrepreneurship – Productive, Unproductive, and Destructive” Journal of Political Economy, 98(5) (1990), 893-921 (as cited in F. Welter, “Entrepreneurship and development—Do we really know which entrepreneurship types contribute (most)?”  Strategic Entrepreneurship—The Promise for Future Entrepreneurship, Family Business and SME Research?, Papers presented to the Beitrage zu den Rencontres de St-Gall 2010 (St. Gallen: KMU-Verlag HSG, 2010)).

[17] Id.

[18] Id.

[19] Id.

[20] P. Davidsson and J. Wiklund, “Levels of Analysis in Entrepreneurship Research: Current Research Practice and Suggestions for the Future” Entrepreneurship: Theory & Practice, 25(4) (2001), 81.

[21] P. Davidsson, Researching Entrepreneurship (New York: Springer, 2004).

[22] A. Sauka and F. Welter, “Productive, unproductive and destructive entrepreneurship in an advanced transition setting: The example of Latvian small enterprises” in M. Dowling and J. Schmude (Eds.), Empirical Entrepreneurship in Europe: New Perspectives (Cheltenham, UK, Northampton, MA: Elgar, 2007), 87-105.

[23] F. Welter, “Entrepreneurship and development—Do we really know which entrepreneurship types contribute (most)?”  Strategic Entrepreneurship—The Promise for Future Entrepreneurship, Family Business and SME Research?, Papers presented to the Beitrage zu den Rencontres de St-Gall 2010 (St. Gallen: KMU-Verlag HSG, 2010) (citing T. Manolova and A. Yan, “Institutional Constraints and Entrepreneurial Responses in a Transforming Economy: The Case of Bulgaria”, International Small Business Journal, 20(2) (2002), 163-184; A. Rehn and S. Taalas, ”Znakomstva I Svyazi’ – (Acquaintances and connections)-Blat, the Soviet Union, and mundane entrepreneurship”, Entrepreneurship and Regional Development, 16(3) (2004), 235-250; D. Smallbone and F. Welter, “The distinctiveness of entrepreneurship in transition economies”, Small Business Economics, 16(4) (2001), 249-262; D. Smallbone and F. Welter, Entrepreneurship and small business development in post-socialist economies (London: Routledge, 2009); F. Welter and D. Smallbone, “The emergence of entrepreneurial potential in transition environments : a challenge for entrepreneurship theory or a developmental perspective?”,’ in D. Mallbone, L. Hans and D. Jones-Evans (Eds),  Entrepreneurship and Growth in Local, Regional and National Economies: Frontiers in European Entrepreneurship Research (Cheltenham, UK, Northampton, MA: Edward Elgar, 2009), 339-353; A. Yan and T. Manolova, “New and Small Players on Shaky Ground: a multi-case study of emerging entrepreneurial firms in a transforming economy”, Journal of Applied Management Studies, 7 (1) (1998), 139-143).

[24] F. Welter, “Entrepreneurship and development—Do we really know which entrepreneurship types contribute (most)?”  Strategic Entrepreneurship—The Promise for Future Entrepreneurship, Family Business and SME Research?, Papers presented to the Beitrage zu den Rencontres de St-Gall 2010 (St. Gallen: KMU-Verlag HSG, 2010).

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