Entrepreneurship And Macroeconomic Activity

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Since Schumpeter's 1934 classic work, the study of possible linkages between entrepreneurship and economic growth has remained the domain of economists. The topic, however, has been largely ignored for a long time as neo-classical growth theory concentrated mainly on the contribution of labor and capital to the growth process (Denison, 1985; Solow, 1970). Since it did not fit in standard neo-classical systems, theorists working with analytical models neglected entrepreneurship and simply treated it as part of the residuals that cannot be attributed to any measurable productive input (Baumol, 1983, 1993a). Only recently, new growth theory has provided ways to endogenize the long-run rate of economic growth and, as a result, entrepreneurship has been considered explicitly as a form of human capital accumulation usually linked to the long run size of the firm (Bates, 1990; Iyigun & Owen, 1998; Otani, 1996; Schmitz, 1989) or as the engine for innovation and productivity increases (Aghion & Howitt, 1992; Calvo & Wellisz, 1980).

Baumol (1983, 1990, 1993b) provides a comprehensive approach to the study of entrepreneurship and its relationship to economic growth. Baumol's theory unites entrepreneurs in their common motivation, but segregates them based on their contribution to society. In particular, Baumol (1990) classifies entrepreneurs into the three distinct groups of productive, unproductive and destructive. When linking entrepreneurship to economic growth, Baumol relies on productive entrepreneurs and identifies the two main contributions of entrepreneurship to economic activity as the productions of new entry and of innovation. Also, Baumol (1993a) convincingly argues that, as a result of entry and innovativeness, the channel through which entrepreneurship influences growth is productivity. He identifies entrepreneurship, investment in innovation, and technology transfers, together with contextual variables such as capital investment and education, as the endogenous variables in an iterative process in which the first group of variables affect productivity, which, in turn, influences the contextual variables after some lag.

In the wake of the new growth theory literature, a few complementary models have been proposed for the study of entrepreneurship and its impact on macroeconomic variables. Iyigun and Owen (1998) propose variations of endogenous growth models in which entrepreneurship appears as a special form of human capital. Aghion and Howitt (1992), instead, build directly on Romer's (1990) classic model of endogenous growth and focus on the role played by the R&D sector in providing new production techniques. In their view, a producer adopting an innovation is rewarded with economic profits until a new technique is found which replaces his innovation. The intermediate variable of innovativeness, because of its ability to produce change, is shown to be an engine of growth. To some extent, Aghion and Howitt capture the substance of Schumpeter's idea of creative destruction. In other words, the fact that economic change results from the actions of profit-seeking entrepreneurs, whose quest for monopoly rents produces innovation, new products, and, indirectly, economic growth (Wennekers & Thurik, 1999).

Since Aghion and Howitt, much of this literature has come to identify entrepreneurship with the engine behind innovation. Lumpkin and Dess (1996) argue that a key dimension of an entrepreneurial orientation is an emphasis on innovation. Wennekers and Thurik (1999) claim that the ability to produce innovation is the main contribution of entrepreneurship to macroeconomic dynamics. Finally, Acs (1992) identifies the entrepreneurial sector with small firms and argues that the latter play an important role in the economy because of their ability and propensity to innovate, their contribution to employment, and their ability to stimulate industry evolution.

Unlike previous neoclassical models, the endogenous growth literature allows the study of entrepreneurial behavior because of its ability to move beyond representative agent models and to include issues related to increasing returns, spillovers and multiple equilibria. The introduction of increasing returns and spillovers allows the construction of formal models that can account for entrepreneurial learning and for the role of social capital on entrepreneurial decisions. The possibility of multiple equilibria, instead, allows the construction of formal models in which entrepreneurial behavior and the resulting level of entrepreneurial activity emerge as the unintended and unpredictable consequences of the norms and history of a community. Combined, these features allow economics models to incorporate insights from sociology and evolutionary psychology into the study of entrepreneurship. In fact, increasing returns and multiple equilibria have both been used to study the relationship between entrepreneurship and economic growth in alternative approaches that complement the neoclassical view.

Minniti (1999, 2001, forthcoming) links complexity theory to the study of entrepreneurship. Her work provides a model of the relationship between entrepreneurial behavior and aggregate entrepreneurial activity in which increasing returns to local knowledge and social capital spillovers create non-pecuniary externalities that reduce ambiguity and encourage entrepreneurship. These dimensions are consistent with Hayek's notion of spontaneous order in the sense that, as in many complex phenomena, the aggregate outcome "cannot be reduced to the regularities of the parts" (Hayek, 1967, p. 74). In particular, Minniti (forthcoming) shows that, when information is evenly distributed, the number of entrepreneurs remains low even when agents are highly alert, whereas, when information is asymmetrically distributed, entrepreneurship increases and concentrates geographically. Her results are consistent with observed clustering of entrepreneurial activity in otherwise similar regions.

Minniti (2001) also shows that if the entrepreneur is a catalyst of further economic activity then entrepreneurship breeds entrepreneurship, the aggregate level of entrepreneurial activity within an economy is uncertain, and that the level of entrepreneurship is determined through a path dependent process. Along similar lines, Holcombe (1998, 2003) argues that every time an entrepreneur seizes a new opportunity, the possibility for new markets is created. When an entrepreneur fills a niche in his market, resources are mobilized, the possibility of complementary products or services is created and, as a result, new entrepreneurial opportunities exist. Thus, the entrepreneur is an equilibrator within his market and, simultaneously, a catalyst of activity for the economy as a whole.

An additional framework helpful when analyzing the relationship between entrepreneurship and the macroeconomy is the evolutionary approach developed by Nelson and Winter. Nelson and Winter (1982) argue that technical change is the driving force of long-run growth and that, in order to understand their interdependence, it is necessary to consider the variety of behavior and performance of individual firms, as well as the dynamics of the competitive process. Although they do not consider entrepreneurship explicitly, Nelson and Winter's argument relies on Schumpeter's (1934) view of economic development and Simon's (1991) explanations of human and organizational behavior. Instead of the standard neo-classical concept of equilibrium and optimization, they take an evolutionary approach and use the concepts of tendencies and decision rules. Nelson and Winter borrow from biology and view firms as possessing a genetic endowment of technical routines and procedures that, over time, evolve and adapt. In the end, the competitive process at the sector level selects the most successful routines and weeds out the routines, which are no longer suitable. So innovation and selection are the engines of growth. The process of allocating resources and their distribution through the entry and exit of firms constitutes the mechanism of competitive selection among different business ideas and projects.

The evolutionary approach of Nelson and Winter is complementary to Audretsch and Thurik's (1997) argument that economic growth results from the straggle of the managed and the entrepreneurial sectors. Audretsch and Thurik (1997) is just an example of a small but significant body of recent literature addressing explicitly the relationship between the small business sector and economic growth (Acs & Audretsch, 1993; Acs et al., 1999; Carree et al., 2000; Thurik, 1996; Wennekers & Thurik, 1999). Like Acs (1992), these works identify entrepreneurship with the small business sector and study industry dynamics and the contribution to GDP growth of various groups of firms classified by size. These works take an economic approach and contribute significantly to our understanding of the dynamic of business ownership and its impact on development, of the relationship between employment, self-employment and development, and of firm-size distribution and economic growth.

Finally, when discussing the relationship, if any, between entrepreneurship and macroeconomic activity, it is important to consider the role paid by government regulation and public policy. In addition to the cultural norms discussed in Section 3, governments and political activity in general also influence the context within which individuals make entrepreneurial decisions. Government actions and political events create new institutional structures for entrepreneurial action, encouraging some activities and discouraging others (Dobbin & Dowd, 1997).

Public policy shapes the rules of competition and creates niches where investment and entrepreneurial activities may be perceived as being more or less attractive. Harper (1998) argues explicitly that the nature of our political and economic institutions influences alertness. Those institutions and policies that improve transparency and entitlement tend to increase the subjective perception of the link between actions and outcome. They increase, therefore, the number of individuals who have an internal locus of control. Harper's central argument is that "an environment of freedom is more likely than other environments to generate internal locus of control beliefs and acute entrepreneurial alertness" (1998, p. 253). Government regulation also affects the fate of individual organizations and entire industries as well, for example, by disrupting established ties between organizations and resources (Carroll, Delacroix & Goodstein, 1988; Stinchcombe, 1965). Finally, Baumol (1990) argues that institutional arrangements affect the quantity and type of entrepreneurial efforts and that "...the exercise of entrepreneurship can sometimes be unproductive or even destructive, and that whether it takes one of these directions or one that is more benign depends heavily on the structure of payoffs in the economy - the rules of the game" (Baumol, 1990, pp. 898-899).

In general, the legal and institutional framework is crucial in determining the quantity and quality of entrepreneurial behavior. Legal incentives for en-trepreneurship are mainly rooted in the fiscal regime and in the laws concerning bankruptcy, they also influence individuals' perceptions of legal transparency and entitlement. Competition rules, instead, address the regulation of entry, trade barriers and anti-trust policy. Overall, the institutional framework defines the incentives for individuals to transform perceived opportunities into actions, and contribute significantly to determine to what extent the external environment is supportive of and conducive to entrepreneurial behavior.

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