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A vibrant economy is characterized by its ability to create a continuous flow of new enterprises. Visionary entrepreneurs create new organizations, utilize new methods, bring in new products to satisfy unfilled demands, and correct market deficiency. Entrepreneurial entry also heightens competitions and forces incumbents to be more innovative and productive. Schumpeter (1942) famously envisioned entrepreneurs as the radical innovators who disrupt existing equilibrium and mastermind the “creative destruction,” a process “of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one” (p. 83).
Long-run economic growth and job creation will not happen without a continuous supply of new, innovative enterprises. In the United States, small businesses, those employing fewer than 500 employees, generated 60% to 80% of net new jobs, and created over 50% of nonfarm private gross domestic product (GDP) over the last decade (U.S. Small Business Administration, Office of Advocacy, 2005).
International comparison shows that small firms employing fewer than 250 employees are strikingly more important in some countries than others (Ayyagari, Beck, & Demirgup-Kunt, 2007). For example, small businesses account for 68.7% of formal employment in Denmark but only 5.38% in Ukraine. On average, high-income countries rely on small businesses to contribute about 60% of the total employment and over 50% of GDP, whereas low-income countries see less than 20% coming from businesses of similar sizes.
While it might be plausible that some cultures value and encourage entrepreneurial pursuit more than others, it is hardly convincing that people in high-income country groups possess more entrepreneurial spirits than their counterparts in low-income country groups. The cultures of Japan and Denmark could not be more different compared to those of Denmark and Ukraine, and yet Japan and Denmark, but not Ukraine, enjoy high entrepreneurial entry. Also, entrepreneurial skills are economically scarce human capital that cannot be inherited or be “born with.” Therefore, richer countries do not have a greater advantage of entrepreneurial heritage over poorer countries. The difference in the size and importance of entrepreneurial activities across country groups therefore begs the question of why some countries produce more entrepreneurs than others. The next section focuses on government qualities and behaviors and explores the effects of various government policies on promoting (or hampering) entrepreneurial formation.
Entrepreneurial Creation And The Quality Of Government
This section discusses how measures related to government quality and government behaviors might facilitate or impede entrepreneurial formation. Government could promote entrepreneurship by securing property rights; simplifying entry procedures and reducing the cost of entry; facilitating the exchange of information; and providing start-up financing. On the other hand, certain government policies impede new venture creation. Examples include corruption, the prevalence of government-controlled businesses (the “crowd-out” effect; Kornai, 1986), and public policy that favors established firms.
Private Property Rights Protection
Entrepreneurship is fundamentally determined by the level of private property right protection the home country offers. No business owner is eager to invest if the owner foresees that the business he or she will build over many years of hard work might be taken away at the first sign of success. Johnson, McMillan, and Woodruff (2002) compare the level of property right protection by surveying entrepreneurs in post-Communist Poland, Romania, Russia, the Slovak Republic, and Ukraine. Johnson et al. consider the property rights system weak where extralegal payments are required for obtaining government services, licenses and general protection of commercial activities; unofficial payments are expected by fire, health, and tax inspectors; and private channels, rather than courts, are used to resolve business disputes. They find that weak property rights protection reduce reinvestment of earnings by start-up firms in these countries. Moreover, weak property rights place greater constraints on private sector investments than the lack of external financing. In Poland, Romania, and Slovakia, entrepreneurs on average reinvest 56% of retained earnings, as they perceive their property rights to be secure, and the reinvestment happens whether or not bank credits are available. On the other hand, in the case of Russia and Ukraine, entrepreneurs would simply not want to reinvest because they perceive an insufficient level of property right security.
De Soto (2000) argues that poverty and instability in the developing world is not caused by the lack of capital, but by “the inability to produce capital” (p. 5). Even in the poorest countries, people save and accumulate wealth and assets. However, these assets are not productive because the legal, economic, and political systems impose insurmountable barriers to formalize the ownership rights. For example, to obtain formal rights to own a house on urban land, a person in the Philippines would need to form an association with his or her neighbors to qualify for a state housing finance program. The process involves 53 public and private agencies through 168 bureaucratic steps. If the state program has sufficient funds, the process would eventually be completed in 13 to 25 years! Without the ability to adequately document ownership, De Soto argues, the asset in the house is “dead capital” and cannot be deployed in productive use such as collateral for a loan. The absence of a property right system and the inability to convert assets into capital cripples entrepreneurs and thwarts economic growth in many developing countries.
In certain countries where general property rights are left unprotected, some governments opt to offer property rights protection to a small number of elites and the firms they control. Once promised respect for the property rights, the small set of favored economic actors would invest so that some tax revenues can be generated and the government supported. The uneven distribution of property rights protection benefits the favored elites, generally consisting of owners of the large, dominant businesses. Already wealthy, the elites can use their economic fortune to lobby for special protection. Future entrepreneurs, not yet established with wealth and connection, would most likely be denied this special protection. Investments from upstarts will unlikely happen where the confidence of the security of property is lacking. The practice of the limited commitment to property rights protection greatly reduces entrepreneurial activities in these countries.
Shareholder Rights Protection
A thriving financial market provides capital, liquidity, risk sharing, and information discovery for aspiring entrepreneurs. Entrepreneurs, geared up with brilliant ideas, tend to start out poor, lacking significant personal wealth to support their business pursuit. Financial markets work as intermediaries to connect them to those with money. The success of microfinance in developing countries underscores the constraints many entrepreneurs face in obtaining start-up capital and highlights how much a small amount of financing could help to pull them out of poverty. A well-functioning financial market also provides a channel for successful exit strategies and thus provides liquidity and diversification benefits. A successful entrepreneur could sell all or part of his or her company to public investors through an initial public offering (IPO). An IPO allows entrepreneurs to cash in their success, diversify their personal risk, and raise capital for the next round of investment and growth. Once successfully exited, many of these seasoned entrepreneurs return and start a next round of experimentations (Stam, Audretsch, & Meijaard, 2006).
The availability of external finance is critically related to the level of property rights protection for investors. When a firm raises funds from the external financial market, investors face both the moral hazard and the adverse selection problem. The moral hazard problem describes a situation where insiders obtain private benefits from the control of the firm at the expense of outside investors, those benefits ranging from shirking to excessive on-the-job consumptions to outright stealing from the company. The adverse selection problem arises from information asymmetries between outside investors and corporate insiders. Share-holders would withhold their investment or demand higher returns when they face a great deal of opacity and uncertainty about the outlook and the true value of the company. These problems curtail the supply of external capital and raise the cost to obtain financing for firms in many markets. However, markets in the developed world such as those in the United States continue to prosper with trillions of dollars afloat. Why would investors in these countries want to give up control of their money to someone whom they never know personally and hope that in the distant future they will be repaid with more?
Investor confidence derives from their rights and protection by the government. The U.S. capital market represents one of the best available practices in shareholder protection. Federal agencies like the Securities and Exchange Commission (SEC) oversee the functioning of the capital markets, regulate major market participants, and prosecute insider trading, price manipulation, and accounting fraud. Investors’ property rights also extend to the rights to obtain timely and comprehensive disclosure about the business and any other pertinent information of the investments. The Securities Act of 1933 requires that publicly traded companies disclose financial and other significant information through the registration of the securities. The Securities Exchange Act of 1934 requires companies with publicly traded securities to report information periodically, in addition to creating and empowering the SEC with disciplinary authority over all aspects of the securities industry. The Sarbanes-Oxley Act of 2002 requires that the CEOs and CFOs of publicly traded firms personally certify their firms financial statements filed with the SEC and assume personal liability for any misrepresentation. With these measures, investors are more confident to invest, and the markets grow with valuation and liquidity. Consequently, U.S. firms tend to become widely held after going public. Helwege, Pirinsky, and Stulz (2007) find that after 10 years from the IPO, outside shareholders end up holding more than 80% of ownership in about 50% of the firms, and more than 90% of ownership in about a third of the firms.
In summary, the development of financial markets are highly dependent on the security of private property rights. Investors would withhold capital if they perceived the stock and credit market to be dishonest. Shareholder rights protection is therefore the most critical dimension underlying capital market development. Research by Johnson, McMillan, and Woodruff (2000) and others show that secure private property rights assume first-order importance in promoting entrepreneurship and economic growth. Insecure property rights will stop the private sector from investing and growing even when external finance is not constrained. Arms-length financial transactions will only take place once investors are assured of their property rights.
Intellectual Property Rights Protection
Upon entering the marketplace, an upstart faces immediate and fierce competition from incumbents much stronger in various ways. The incumbents might have long established brand names. They might have amassed a large and loyal customer base. They might also command economy of scale and price-setting power. To succeed and survive against all odds, the new entrant needs to be a rule breaker, marketing new concepts and new product lines, developing innovative business process and routines, and employing its resources more efficiently.
Indeed, statistics show that small firms in the United States, on average, are more innovative. According to the U.S. Small Business Administration (2007), small businesses produce 13 to 14 times more patents per employee than large patenting firms. The patents awarded to small firms also appear to be of higher quality, ranked by the total number of citations these patents subsequently received. Patents granted to small firms are twice as likely to be among the top 1% most cited as those produced by large firms.
Entrepreneurial innovation can come in two forms. The “high-level” innovation, as Schumpeter (1934) had envisioned, creates new industries and precipitates fundamental, structural changes in the entire economy. Examples of innovation in this form include the invention of steam engines that kick-started the railway industry and the invention of the Internet that allows free access to information by everyone everywhere. Some innovative technology, such as the Internet search algorithm employed by Google, started out with simply a better search engine in the short run, but slowly evolved into a behemoth empire encompassing media, e-commerce, marketing, and other venues in the long run and would fundamentally change the economy and the society as a whole. In all, high-level innovations ignite fundamental changes.
The “low-level” innovation, first described by Hayek (1943), envisions an entrepreneur as an arbitrageur, profiting from differentials discovered in prices and availabilities. The arbitrageur may also utilize better business practices and form more efficient organizations in order to capture more values in the process. Innovative firms in the wholesale and retail trade generally fall into this category. eBay stands out as the most prominent; it pioneers an electronic trading platform that allows efficient exchanges and transactions with minimal start-up costs. Note that the term low level does not indicate that these innovations are less important or require less technology, talents, or business acumen.
While both kinds of innovations are necessary to help entrepreneurial firms survive fierce competitive challenges, government policies that support innovations come in different forms. To provide incentive for firms to invest in the high-level innovations, governments can provide tax breaks on research and development (R&D) expenses or set up competitive grants to carry innovative firms through the R&D phase of the business. To promote entrepreneurship in low-level innovations that improve business process or conduct price arbitrage, government investments in infrastructure might be critical.
Now consider a Chinese entrepreneur who wants to build a business based on one of his inventions, developed with a government small business innovation grant. How likely is it that his business is going to be profitable and sustainable? Profitability might be obtained, but sustainability is not likely in the long run. As soon as the product hits the market, copycats will quickly drive the profits down to nil. Even technologically sophisticated innovations are subject to reverse engineering, and cheap copycats can reap all the benefits of the invention without bearing any costs incurred in the development process. This might explain why very few private sector firms in China ever grow into major multinational firms when compared to their international peers.
The above scenario highlights the fundamental roles of intellectual property rights (IPR) protection in promoting innovation-based entrepreneurship. With no protection of IPR, few entrepreneurs will succeed, even with the help of government grant money. On the macroeconomic level, the equilibrium outcome is that few would engage in innovation or innovation-based entrepreneurship.
Lack of IPR protection is particularly detrimental to innovative small firms. First, relative to established firms, a greater proportion of a small, innovative firm’s value is derived from intangible assets. Entrepreneurs incur larger losses when the protection of their brainchild is lacking. Second, entrepreneurial undertaking is generally considered high risk and is likely financed with a high cost of capital. Thus, the cost of innovation is higher in smaller firms. Third, large firms may have the capacity to protect their intellectual property rights through vertical integration and research networks. Zhao (2006) asks an intriguing question why companies place their research facilities in poor IPR protected countries. She finds that the research conducted and products developed in these facilities are generally not valuable when they stand alone without fitting into a greater technological structure. The value of the research can only be realized when combined into the mainframe technology available in the headquarters, located in countries with good IPR protection. These venues are most likely not available to small firms.
Therefore, entrepreneurial activities are more scant in countries with poorer IPR protection, as upstarts are particularly vulnerable to IPR invasions. Government policies aiming at protecting IPR would unproportionally encourage pursuits of innovative ideas and the formation of new enterprises.
Bureaucrats in Business
Frye and Shleifer (1997) classify governments’ involvement in the economy into three different levels. The first, termed as “the invisible hand,” refers to a government that restricts its activities to providing the basic social infrastructure such as law and order, some regulations and contract enforcement, and not getting involved in private economic activities. The next is “the helping hand,” describing those governments that actively pursue some sort of industrial policy, supporting selected firms and industries and facilitating economic transactions. Corruption is present but organized and often involves those bureaucrats high up with major decision-making power. The third is “the grabbing hand,” which intervenes in every aspect of economic activitity and preys on businesses in every encounter. Corruption is rampant, and paying bribes is a way of life for businesses.
Entrepreneurship is most likely to blossom under an invisible hand government. Under the helping hand and the grabbing hand, potential entrepreneurs face two distinct problems: the resource allocation problem and corruption. The discussion that follows will focus on the resource allocation problem. Issues in government corruption will be discussed in the next section.
The most direct way a government gets involved in resource allocation is by setting up state-owned enterprises (SOEs). Other channels include establishing large grant and subsidy programs and setting price controls. SOEs are generally large in scale and occupy key industry sectors and are therefore the most visible and researched while evidence about the other channels tends to be more scattered.
SOEs make up significant proportions of many nations’ economies. Data collected by the World Bank shows that on average, government investment in state-controlled enterprises account for 14% of the total gross domestic product (GDP) worldwide during the 1990s, an era of massive privatization. Through direct involvement in these enterprises, governments retain control of “strategic” sectors, carry out industrial policies, and achieve social and economic goals.
Bureaucrats tend to make poor business managers. Studies comparing the financial performance of former SOEs before and after privatization find, with very few exceptions, that state-controlled enterprises lack the operating efficiency found in the private sector, and that the results are insensitive as to which country the study took place (see, e.g., La Porta & L6pez-de-Silanes, 1997; Megginson, Nash, & van Radenborgh, 1994). In other words, SOEs are inefficient users of valuable economic resources.
Efficient market wide capital allocation therefore will not be possible when bureaucrats take control of limited resources and invest in a large SOE sector. Similarly, when bureaucrats hand out subsidies to the preferred individuals to establish selected industries, fix prices for goods and services, or through any other means effectively remove the price discovery and communication process by the free market, resource misallocation occurs.
Resource misallocation carries a large negative externality on the formation of entrepreneurial pursuits. First, excess government investments crowd out private investments by bidding up factor prices. With deep pockets supported by tax revenues, governments face “soft” budget constraints, and tend to overinvest. That leaves less capital for the private sector and raises the cost of capital for the private sector. Second, inefficient SOEs raise the costs of doing business for private market participants. Many governments designate SOEs to be the sole suppliers of raw materials, utilities, and telecommunications, and their monopolistic positions give SOEs the market power to set prices at levels much higher than those achieved through free-market competition.
Third, when the government invests in public enterprises to carry out social engineering goals, it inevitably becomes business partner of the large private sector. It is simply more transaction-cost-efficient to deal with a handful of large businesses and their principals than to coordinate with thousands of small businesses. Direct dealing between the government and large businesses could then lead to government policies favoring the established and obstructing the creation and growth of new ventures.
Fogel (2006) shows that oligarchic family control of the largest businesses is prevalent in countries where governments’ involvement in business activities is direct and extensive. Bureaucrats, captured to be long-term business partners to the principals of the established businesses, might promote policies that preserve the status quo of the established and curtail competition and innovation from upstarts.
Studying governments’ roles on entrepreneurial entry in Europe, Fogel, Hawk, Morck, and Yeung (2006) find a higher entry rate in countries where price controls are less common, more government subsidies go according to merit but not connections, and the award of public contracts is less opaque.
Hayek (1944) and others argue that central planning and government intervention are inherently inefficient and will inevitably lead to uncontrollable discretionary power for politicians. Entrepreneurial activities would likely be suppressed as bureaucrats use (or abuse) their power to control monopolistic sectors, bid up factor prices, and partner with oligarchs.
Entrepreneurial spirit unleashes when government relinquishes control of the productive assets through privatization programs. Post-Communist Poland, for example, witnessed the transition of about 80% of its business from public to private hands in 1990 and 1991 alone. More important was the “immediate and dynamic growth in new privately owned businesses,” according to Curtis (1992), who recounted that “[i]n 1990 about 516,000 new businesses were established, while 154,000 were liquidated, a net increase of 362,000____By September 1991, an additional 1.4 million one-person businesses and 41,450 new companies had been registered since the beginning of the year.”
Many governments allow new firms to start only when they meet certain requirements. Entry regulations help protect consumers and investors by screening out bogus businesses. However, excessive entry regulation, motivated by unscrupulous politicians collaborating with incumbents attempting to impede competition, might serve as the most effective deterrence to entrepreneurial formation.
Hernando de Soto, a native Peruvian, is the first to study the costs of entry using a field-study approach. Trying to understand why many businesses in Peru operate outside of legal institutions and give up all the protection and facilities afforded by the formal sector, De Soto and his research team simulated the experience of an ordinary person going through all bureaucratic requirements to legally register a small garment factory. Their findings were astounding. Without connections in the government, this person of average means would need to spend 289 days to fulfill the 11 bureaucratic procedures required to set up a small factory. The total pecuniary costs incurred in the process amounted to 32 months of minimum living wages. De Soto argues it the high cost of red tape forces as much as 61% of productive hours worked in Peru into the informal sector and it limits growth of the small entrepreneurial establishments as they were hiding from authority and deprived of access to external financing, marketing, and official arbitration of contract disputes.
The path breaking work by De Soto (1989) was carried out by the World Bank Doing Business project (http://www. doingbusiness.org) in almost every country in the world. Djankov, La Porta, and Lopez-de-Silanes (2002) document the effort and show that entry regulations vary drastically across countries. The total number of days it takes to legally register a business ranges from 2 days in Australia to 694 days in Suriname, with a median of 35 days across the globe. The total number of bureaucratic procedures ranges from 2 procedures in Canada, New Zealand, and Australia to 20 in Equatorial Guinea. The minimum investment capital required for a start-up is about 5% of per capita Gross National Income (GNI) in the Organization for Economic Co-operation and Development (OECD) countries, and about 163% of per capita gross national income (GNI) in Sub-Saharan countries.
De Soto’s concern is vindicated in a large cross-section of countries. Entrepreneurs face more cumbersome screening and licensing procedures to register a business in relatively poorer countries. Contrary to the popular belief that these regulations are necessary to screen out deceitful entrants or correct market failure like a monopoly or negative externality like pollution, more regulations do not bring the citizens of those countries higher quality public goods, safer products, or less pollution. However, more start-up requirements are associated with more widespread corruption. Lengthier screening procedures provide ample opportunities for bureaucrats to collect side payments. Consequently, more businesses in those countries choose to operate in the informal sector. In a word, Djankov et al. (2002) argue that entry regulation is created not to protect the public, but to extract rent from entrepreneurs and enrich politicians and bureaucrats.
Klapper, Laeven, and Rajan (2006) empirically study the relationship between entry cost and the rate of new firm creation in a sample of European countries. They indeed find that fewer firms form where bureaucratic requirement of entry is higher. They also find that excessive entry regulation particularly discriminates against small firms, forcing the average size of successful entrants to be larger. With more protection against new entrants, the growth in value added from incumbents is slower, as their survival strategy relies on their incumbency status rather than on innovation and productivity gains.
Political Rent Seeking
As governments actively engage in pursuing industrial policies or excessively regulate every aspect of private economic transactions, they risk developing into “mercantilist” states. First used to describe the economies in Europe between the 15th and 19th centuries, “mercantilism” refers to a politically administered economic system in which the government grants special economic privileges to a selected group of favored agents—the “merchants”—through licensing, regulations, preferential taxes, and subsidies. Entrepreneurial success in a mercantilist state entails the ability to infiltrate the government, win privileges, and use the law and regulations to advance one’s own benefits and interests. Politicking does not produce new wealth; it simply redistributes wealth through government intervention. On the other hand, genuine entrepreneurship that invests in innovation and productivity gains could not launch as bureaucratic obstacles render markets inaccessible to outsiders.
A state rooted in mercantilist institutions need not be equated to a corrupted state. For example, political contributions by private businesses to congressional candidates are not only legal, but also receive preferential tax treatment. Activities of this sort are generally termed as “political rent seeking” in modern times and exist in almost every country in the world.
The payoff to political rent seeking is generally large, often many times greater than that from investment in productive assets. One recent study by Liebman and Reynolds (2006) shows that the amount of congressional contribution is positively correlated with the financial gains the contributors receive after passing an antidumping law that distributes fines to U.S. firms. Murphy, Shleifer, and Vishny (1991) show that handsome returns to political rent seeking divert a nation’s top talents away from productive investments.
Political rent seeking resembles ancient mercantilism and can be detrimental to genuine entrepreneurship and economic development in many ways. First, established businesses invest in lobbying and establishing connections to pass favorable legislations to entrench themselves and impede entry. De Soto (1989) argues that the government itself does not have the knowledge and expertise to develop the long, detailed, redundant, and obscure regulations. The details in the regulations are supplied by the incumbent to stop potential entrants and curtail competition. Second, the favored group would likely turn its economic might into political power and distort the development of key institutions such as private-property rights, law enforcement, and access to external finance. Entrepreneurship withers without these essential institutions. Third, large, established businesses have a natural competitive advantage over small, new entrants in the lobbying game. The established can finance the cost of buying connections using their firms’ retained earnings, whereas the newcomers can only dip into the not-so-abundant start-up capital or offer a promise to pay when a firm becomes profitable. The established could also utilize the economy of scale and is therefore more cost efficient compared to new market entrants.
Studying the history of financial markets in 18 countries, Rajan and Zingales (2003) find that the development of these markets does not increase monotonically over time through the 20th century. They find instead that in most countries, the sizes of the equity markets, relative to the countries’ total GDP, were bigger in 1913 than in 1980. The markets exceeded their 1913 level only by the end of the 1990s. Also in 1913, equity issues served as a more important source of funds for corporate investments than in 1980 and in 1990. Rajan and Zingales develop an interest-group theory, arguing that financial market development might be purposely depressed by the incumbents, through lobbying, connections, and rent seeking. A weak financial system gave these incumbents competitive advantages in securing capital at low cost. It also starves new firms of financing at arm’s length and prevents the rise of new entrepreneurial competition that might lead to the demise of the incumbent firms. Similarly, Morck et al. (2000) and Johnson and Mitton (2003) show that ineffective financial markets preserve the interests of dominant business families by limiting market access from start-ups.
In summary, political rent seeking proves to be an extremely unproductive use of valuable resources. Lobbying itself does not improve productivity, but diverts valuable resources away from real investments. High returns of rent seeking also attract the nation’s best talents away from becoming originators of innovation. Moreover, entrenched power could use rent seeking to manipulate the rules of the game so that they are most favorable to their interests, block entry and competition, and preserve their economic and social status. In all, a government carrying on the mercantilist heritage generally does not provide fertile grounds for entrepreneurship.
While corruption raises the cost of doing business for every firm, entrepreneurial firms can be particularly vulnerable. New entrants might fall prey to the grabbing hand of corrupted bureaucrats over licensing, registration, and inspections. Small business owners might be asked for side payments to avoid being assessed with extravagant tax bills. They might also need to buy connections to obtain permits for importing or exporting. While similar problems might confront owners of larger businesses, newly minted entrepreneurs lack the status, connection, and personal wealth to weather through the hostile environment.
It is not uncommon for entrepreneurs to find themselves in a situation such as that in China, where someone dressed in official uniform, be it the fire inspector, someone from the health and safety commission, a tax collector, or the police, shows up at the premise and in no time finds a reason why the company does not meet the standard and deserves a fine. Most of the time, the fine in its official form will not be paid. Instead, either the inspector, or his or her superior, or someone connected to one of them receives a handsome personal gift and the case is then closed. It is no wonder that the most desirable jobs in China are found in the large hierarchy of government.
Friedman, Johnson, Kaufmann, and Zoido-Lobaton (2000) study the underground economy in 69 countries and show that more entrepreneurs choose to operate underground in countries where regulation and bureaucracy burdens are more onerous, not where marginal tax rates on the book are higher. However, excessive bureaucratic procedures coupled with a corrupted crew of tax collectors might amount to a much higher tax rate that forces businesses to dodge into the informal sector. Friedman et al. also noted that corruption undermines the total tax revenue the government collects, reduces the government’s abilities to provide efficient administration and other productivity-enhancing public goods, and further makes it unattractive to operate in the official sector.
A government’s effort to eliminate corruption therefore boosts entrepreneurial formation in a number of ways. First, it lowers the direct costs associated with entry and makes entry more affordable. Entrepreneurs tend to start out poor and less connected. Lowering initial capital requirement enlarges the pool of potential entrants. Second, entrepreneurs will work hard if they know that their future property rights are relatively secure. A hostile environment imposed by corrupted officials increases uncertainty and business risk. Third, it levels the playing field. Entrepreneurs with no connections are more likely to invest and pursue their dream if they can envision moving their way up socially through hard work and business acumen.
Universal Education, Diversity, Freedom Of Press, And Capital And Trade Openness
Literacy is one basic requirement for entrepreneurs. To handle any business transactions effectively, an individual needs the basic skills of literacy and math. Successful government policy aiming at providing low-cost, universal education to the entire population increases the supply of entrepreneurs. Universal education is particularly important to the disadvantaged population such as ethnic minorities or those at the bottom of the income distribution.
A better-educated population supports entrepreneurship in knowledge-based economy and improves national competitiveness over the long run. Analyzing the determinants of new firm formation across regions in the United States, Acs (2006) finds that measures of human capital, such as the number of college graduates as a percentage of the total adult population, can explain the regional difference in the rate of new business formation. A local population’s level of education attainment particularly affects market entry of new enterprises founded by highly educated entrepreneurs. Acs proposes that education is the greatest barrier to entry.
Ethnic and cultural diversity and the rights of free expression of ideas promote diversity in views and opinions and support the discovery of information and new ideas that lead to entrepreneurial creation. The freedom of mass media imposes constraints on the government and business elites and discourages deceit, self-dealing, and corruption. Corruption can be found in a democracy or a dictatorship; the difference is that dishonored officials in a democracy are exposed and likely removed from office, whereas their counterparts continue to receive unanimous praise and find deeper pockets to pick.
Free capital and trade flows across borders introduce firms to expanded profit opportunities, more readily available capital, and more intensive competition. A global market reduces entrenched firms’ market power and incumbents’ abilities to preserve the status quo. International capital flows circumvent inadequate indigenous institutions to supply capital to entrepreneurial firms (Fogel et al., 2006a). Zhao, Fogel, Morck, and Yeung (2006) argue that where entrepreneurs are abundant, trade and capital flow liberalization facilitate institutional development, reduce the cost of doing business, and promote entrepreneurial entry.
An entrepreneur creates new business organizations to identify market opportunities, carry out new combinations of the productive elements, and actively engage in risk taking. In doing so, the entrepreneur invents new products and new business processes to fulfill market deficiencies and arbitrage away any inefficiency. The innovative nature of entrepreneurship thus dictates that it is the fundamental engine for economic growth. Aghion and Howitt (1992) show that innovations that involve creative destruction drive growth. Fogel, Morck and Yeung (2007) show that economies whose new, innovative firms continue to rise to eclipse larger firms enjoy faster GDP, productivity, and capital accumulation growth, holding each country’s initial levels of per capita GDP, per capita capital stock, and human capital constant.
This research-paper discusses various measures governments could use to facilitate the formation of entrepreneurial firms. Entrepreneurial activities would boom when the government stands on firm ground to protect private citizens’ property rights, reduce bureaucratic delays, boost bureaucratic efficiency, restrict its presence in the private sector, and curtail corruption. Entrepreneurship would also enjoy a lift where the government toughens up legal enforcement on IPR protection and loosens its control on mass media and international trade and capital flows.
A few years after the World Bank Doing Business project published national rankings in formal start-up procedures and costs, many national governments started political and legal reforms aimed at tackling bureaucratic inefficiencies and providing more streamlined service to citizens to comply with legal and administrative requirements. Between January 2005 and April 2006, 213 regulatory reforms took place in 112 economies (World Bank, 2007). Many of these reforms focus on strengthening private-property rights protection, simplifying entry regulations, and reducing tax burdens. For example, one reform in Georgia (independent since 1991 from the Soviet Union) dropped the minimum capital required to start a new business from 2,000 lari to 200 ($85). Entrepreneurs enthusiastically embraced this change by raising business registrations by 55% between 2005 and 2006. The evidence clearly supports the notion that governments’ actions matter in entrepreneurial creation.
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