Foundations of Entrepreneurship and Economic Development

David A Harper

• Publisher: Routledge
• Year: 2003
• Print ISBN: 9780415153423
• eBook ISBN: 9781134741540
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This well-written book is the first to deal with entrepreneurship in all its aspects. It considers the economic, psychological, political, legal and cultural dimensions of entrepreneurship from a market-process perspective. David A Harper has produced a volume that analyses why some people are quicker than others in discovering profit opportunities

1 Introduction

A prominent feature of a competitive enterprise economy is the ability of people continually to seek out and seize opportunities for profitable new activities in local and world markets. Encouraging and releasing people’s entrepreneurial energies is an essential key to the achievement of greater economic prosperity in a country and to the continuing regeneration of its economy over time. Indeed, the economics of entrepreneurial discovery should be the hub of the economics of growth and development.

Economic development is essentially an evolutionary learning process that involves the growth and restructuring of knowledge and the overthrow of old ideas and organisations. It is a discovery process propelled by competition among alert entrepreneurs who, lured by the scent of profit, locate pockets of market ignorance and then exploit hitherto untapped opportunities for specialisation and trade in the network of economic transactions. The entrepreneurially driven process of economic development thus mobilises hidden and fragmented bits of knowledge in the economy that would otherwise lie dormant and unutilised.

Entrepreneurship is critical to enhancing the innovativeness and responsiveness of businesses, to boosting productivity and to improving cost structures and trade performance. The entrepreneurial spirit may manifest itself in the development of new markets, new products, new methods of production and management, the discovery of new inputs and the establishment of new businesses and even new organisational forms. Entrepreneurship is pertinent to the analysis of how new ideas or ‘recipes’ for reconfiguring objects in the material and social world can be harnessed to enhance a nation’s wealth.

In the longer term, a country’s economic progress depends on its ability to increase the value of what it produces with its resource base (people, land and capital). The point cannot be emphasised too strongly, however, that neither the ends to which these resources are put nor the means for achieving these ends (i.e. the set of resources and how they are used) are given or fixed. They are the result of entrepreneurial choices and are open to entrepreneurial initiative. Individual entrepreneurs and entrepreneurial teams bring to light the resources, technologies and trading opportunities that make economic development possible. Indeed, whenever entrepreneurs are the first to discover the availability and potential economic value of new resources, they are in effect bringing those resources into existence in economic terms (Kirzner 1989). The process of economic development is the overall, unintended outcome of a complex myriad individual acts of entrepreneurial discovery. It entails much more than the efficient allocation of given and known means among people’s given and known ends.

As a result, entrepreneurship (within an appropriate institutional framework) may in effect override resource endowments and scarcity as the prime determinant of economic performance.¹ As Romer (1993) has pointed out in another connection, ideas are not scarce, they are almost limitless. ‘The world, in Romer’s view, isn’t defined by scarcity and the limits on growth. Instead, it’s a playground of nearly unbounded opportunity, where new ideas beget new products, new markets, and new possibilities to create wealth’ (Kelly 1996: 148). Moreover, entrepreneurship itself often generates more entrepreneurship, so that economic development is a process that can be kept in motion by endogenous economic forces rather than exogenous shocks (say, in resource availabilities). Every entrepreneurial act of discovery generates at least some unintended consequences, including the creation of new value scales (i.e. unexpected changes in consumer tastes) and new technologies, so that each entrepreneurial action has the potential to create new markets for new goods and services.

Seen in this light, the development process and the growth of our knowledge do not converge towards an end state but remain open-ended: ‘We never know what real possibilities remain to be discovered; we never know what the real limits are to the elasticity of the resource constraints that circumscribe our existence’ (Kirzner 1984a: 43). Of course, recognising the primacy of entrepreneurship in economic development does not mean that resource constraints do not matter at all. Indeed, a thorough explanation of economic development requires an understanding of how entrepreneurship interacts with the discovery and amelioration of resource constraints (Irigoin 1990: 204). Entrepreneurs find out what the relevant constraints are and develop innovative ways to alleviate them, thereby enhancing the range of effective options available to people.

Recognition of the pivotal role of entrepreneurship in development leads us to emphasise the importance of institutions that engender processes of entrepreneurial discovery. It motivates us to enquire into the institutional conditions that are highly conducive to entrepreneurship and to investigate the institutional changes necessary in moving towards a more marketoriented economy. Indeed, differences in the nature of institutions and in the structure of incentives they create for entrepreneurship explain much of the variation in the wealth of nations.

A better appreciation of entrepreneurship is required if we are to be able to understand market processes and to explain how economies, individual markets and business organisations adjust to new circumstances. Such knowledge is needed to account for the coherence of market-based economic systems and for the continuous tendency towards economic balance and coordination of economic plans.

Although entrepreneurship is the main mechanism that creates wealth, explanations of economic growth and development often ignore (or fail to acknowledge explicitly) the entrepreneurial forces of change and adaptation that underlie economic performance.² Surprisingly, the role of entrepreneurship in economic development has attracted less professional interest than the role of other factors, such as the accumulation of physical capital, expansion of the labour force, R&D, technological progress and education. Entrepreneurship is something we ignore at our peril.

The distinctive approach in this book

This book is intended to reassert the role of entrepreneurship as the ‘prime mover’ in the process of economic growth and development. It is the first book to deal with entrepreneurship in all its aspects within a unified analytical framework. It considers the economic, psychological, political, legal and cultural dimensions of entrepreneurship from a market-process (or entrepreneurial-discovery) perspective.

The entrepreneurial-discovery approach argues that what is important for economic development is how an economic system identifies and responds to disequilibrium (i.e. a breakdown in the coordination of economic plans). Unlike most contributions to the economics of development, the entrepreneurial-discovery approach is a disequilibrium, process-oriented approach that depicts entrepreneurship as the real engine of economic transformation. Entrepreneurship is a process of discovering profit opportunities inherent in disequilibrium situations. The specific ‘talent’ that entrepreneurs possess is an acute alertness to as yet unexploited opportunities for mutually beneficial exchange.

The upshot is that we should judge the performance of an economic system not only by the degree of efficiency with which it allocates available and already known resources but also, and more importantly, by the speed with which the system discovers and reduces the excesses and discoordination of economic disequilibria over time. Consequently, the book’s focus is upon the potential of different types of institutions to evoke entrepreneurial discovery of genuine market error (i.e. hitherto unsuspected profit opportunities).

Unlike many economics contributions to the field, this book analyses the antecedents of entrepreneurship more so than its consequences. It explains the causal mechanisms that generate entrepreneurial discovery. In particular, it examines the causal paths from culture, institutions and individual psychology to entrepreneurial alertness. Although most economists concede that social, cultural and high-level institutional factors are more far reaching in their effects than regulatory and tax policies, they usually assume that these factors are intractable and not amenable to economic analysis.

Another distinguishing characteristic is that the approach is highly cognitive. The analysis of the antecedent conditions of entrepreneurship makes use of a simple but important psychological conjecture about the cognitive determinants of entrepreneurship. It argues that our expectations about the causes of what happens to us are the fundamental drivers that switch on entrepreneurial alertness. These cognitive representations of cause–effect relations are referred to as ‘personal agency beliefs or judgements’. They are a core element in our understanding of the world and how we live in it. They are not personality traits: the perception of personal agency is a cognitive process. (Alertness too, of course, is a perceptual and cognitive phenomenon.) To form their judgements about the causal sources and controllability of what happens to them, people must integrate their perceptions of the contingency of events upon action with their perceptions of their competence to carry out those very actions. Individuals who have a strong sense of their own causal power over events will be the persons whose alertness is the most highly developed.

This psychological insight is used to investigate the environmental conditions that are most conducive to a robust sense of personal agency and a blossoming of the entrepreneurial drive. The approach requires us to identify the fundamental, institutional principles that define the basic structure of people’s rights in a society and to identify the general character of the political and legal system. It spurs us to examine how institutions mould people’s expectations of action–reward sequences. The approach considers how constitutional, legal, economic, political and ethical rules of the game affect people’s perceived causal capabilities, the degree of their alertness and the directions in which their entrepreneurial energies are channelled.

Unlike the new institutional economics and economic theories of entrepreneurship, this book delves into the most fundamental levels of social analysis in its examination of the antecedents of entrepreneurship. In addition to higher-order institutions that frame market processes, such as constitutions and property rules, this book also examines the cultural dimension of entrepreneurship. More specifically, it investigates the cultural lenses that orient entrepreneurial vision. It explains how different cultural value systems affect the profile of the discoverer of profit opportunities and the types of opportunities to which people are most attuned.

The approach rejects aggregate notions of national culture that depict a culture as inherently pro- or anti-entrepreneurship. In contrast to the conventional wisdom, the book argues that individualist cultural values are not categorically superior to group-oriented values in terms of their consequences for entrepreneurial discovery. Rather, we can expect some group-oriented cultures to exhibit considerable entrepreneurial talent. The book also rejects the received view that group-oriented cultures inevitably converge towards a uniform set of individualist values as they develop economically.

This is a work in applied economics, not pure economic theory. Although this book is not intended to deliver a detailed policy statement, the analysis has important practical and policy implications for the design of institutions that stimulate (or at least release) entrepreneurship. It is the first book to flesh out fully a uniquely market-process perspective for developing public policy. Instead of listing specific policy prescriptions or laissez-faire rules of thumb, the approach identifies the key assumptions and specific rules for doing policy analysis. It supplies general instructions on how market-process economists should go about identifying and defining policy problems and choosing the most appropriate analytical methods for informing their policy analyses.

The emphasis of this book is upon a broad coverage of issues rather than a narrow concentration. The analysis is wide ranging in the intellectual wells that it draws from. The approach involves a comprehensive synthesis of ideas derived from the theory of market processes, new institutional economics, social learning theory, legal scholarship, cross-cultural psychology and the field of ‘entrepreneurship studies’ in business administration.

Analytical conception of entrepreneurship

Entrepreneurship is connected with change, but there are many kinds of change, and correspondingly many concepts of the entrepreneurial function.

(Loasby 1982b: 244)

Standard economic theory has developed along lines that virtually exclude the entrepreneurial role. This has largely been a result of the tendency to exclude all elements of unexpected change, to focus attention almost exclusively on equilibrium states of affairs, and to treat individual decisions as immune from the hazards of error. Taken together, these features mean that mainstream (neoclassical) economics provides a very distorted picture of the competitive market process and of the process of economic adjustment. Economic decision-makers are assumed to respond mechanistically and automatically to the signals of the market. There is no spotting a gap in the market, no exercise of initiative. Entrepreneurial characteristics are specifically excluded from the model.

If it were appropriate to examine only equilibrium (market-clearing) levels of prices and output, we would not need a theory of entrepreneurship. But if we want to explain the disequilibrium process by which prices and outputs adjust in markets, then we must have a theory of the entrepreneur. The market process cannot function, even within the market for a single commodity, if all market participants are assumed to be non-entrepreneurial maximisers who react mechanically to changes enforced upon them by external circumstances over which they have no control (Kirzner 1962). A theory of entrepreneurship is a prerequisite to any theory of the dynamics of the market process.

The absence of a neoclassical theory of the entrepreneur has been investigated at length within the economics literature and need not be discussed in detail here.³ At this juncture, it is sufficient to mention that the standard economic theory of competition cannot explain market processes – the way in which market forces bring about adjustments in prices, quantities and qualities and the introduction of new products and processes. At best, neoclassical theory describes the conditions for competitive equilibrium (economic balance), without explaining adequately if or how equilibrium may be reached. (For an exception, see Fisher 1983; 1987.)

Economic theories of entrepreneurship, of course, do exist but there is little consensus as to what constitutes entrepreneurship and the entrepreneurial function. There is no uniform treatment of the role that entrepreneurship plays in the operation of the market system. In the economic literature, the entrepreneur is portrayed, among others, as a heroic innovator who carries out ‘new combinations’ and initiates discontinuous change (Schumpeter 1934), as an economic leader who directs novel, non-routine activities of business organisations (Baumol 1993; 2002), as the person who takes highly uncertain decisions associated with unique business situations (Knight 1921), as a specialist who takes judgemental decisions about the allocation of scarce resources (Casson 1982), as a Popperian-style decision-maker who formulates conjectures and then tests them in the market environment (Harper 1996), as a ‘gap filler’ and ‘input completer’ who creatively responds to ‘X-inefficiency’ by plugging up holes in markets for the resources required to carry out a venture (Leibenstein 1968).

Entrepreneurial alertness and discovery

For the purposes of this book, the emphasis is upon Kirzner’s conception of entrepreneurial discovery and the market process. The key concept in Kirzner’s theory is alertness. ‘The idea of alertness forms the basis of a radically different outlook on the market: one that eschews the equilibrium-always formulation of neoclassical economics’ (Rizzo 2002: 3).

Alertness to profit opportunities is the essence of entrepreneurship. Alertness is the entrepreneurial element in economic decision-making. It is a human propensity. What entrepreneurs do is identify opportunities for gain that others (and even they themselves) have earlier overlooked. The entrepreneur recognises something that others have failed to recognise: that there is an opportunity waiting to be snapped up. Often located between different markets, alert arbitragers are the individuals who first sense emerging trends and find ‘ten dollar bills lying on the sidewalk’. More specifically, entrepreneurship involves the discovery of opportunities to buy one thing (e.g. a resource) at a low price in order to sell it (or its resulting output) at a high price. The price discrepancy occurs because many market participants simply overlook opportunities for mutually beneficial exchange.

Alertness is to be distinguished from the standard optimising behaviour of decision-makers in mainstream economic models. The latter is the allocation of given means to achieve a set of given ends. It does not involve the discovery of previously unperceived opportunities. In contrast, alertness involves the identification of which (new) ends to pursue and the discovery of which (new) means are available. It is not limited to optimisation within a presupposed ends–means framework. Entrepreneurial alertness involves the discovery or perception of the ends–means framework within which allocation and optimising are to take place.

A simple example can serve to clarify the difference between entrepreneurial alertness and optimisation. Consider R&D in a private firm. Optimisation is concerned with how a research manager allocates the R&D budget among competing given research projects. But entrepreneurial alertness is concerned with how a particular research manager identifies before others that a project idea is worth putting on the research agenda.

The propensity to be alert manifests itself in spontaneous discovery of profit opportunities and arbitrage activity. Arbitrage is one of three classes of entrepreneurship – the other two being speculation and innovation.⁴ In Kirzner’s system, speculation and innovation are analytically equivalent to arbitrage. Pure arbitrage involves the simultaneous coordination of transactions in different parts of the market within a single time period. No uncertainty is implied by arbitrage: the arbitrager captures profits arising from existing interlocal price differences. Speculation (or intertemporal arbitrage) involves discovering and exploiting perceived opportunities created by different market transactions entered into at different dates. Speculators plan to make gains from intertemporal price differences that arise from forces over which they have no control (such as shifts in demand or exogenous supply shocks). Innovation concerns the introduction of new goods and services, new methods of production, new ways of organising transactions and new forms of industrial organisation. These of course are the activities performed by the Schumpeterian innovator.⁵ The innovator hopes to capture profits from the introduction of a new product (or process). Profits are made if the innovator is able to sell the new product over a future time period at a price–quantity configuration that brings revenue greater than the sum of production and transaction costs. Innovation entails making gains from intertemporal revenue–cost differences but, unlike speculation, innovation implies bringing about the revenue–cost differential by means of the entrepreneur’s own actions.

For Kirzner, each of these kinds of entrepreneurship tends to coordinate decisions towards a more favourable pattern of resource allocation:

Pure arbitrage tends to ensure the exploitation of all available opportunities for mutually profitable exchange; intertemporal arbitrage tends to avoid ‘wasteful’ intertemporal allocation (and thus, where warranted, to build up towards the optimal capital structure); the entrepreneurship exercised in innovative production tends to generate technological progress.

(Kirzner 1992: 50)

Chapter 2 examines the theory of entrepreneurial discovery and the concept of alertness in more detail. It also looks more closely at the issue of whether the entrepreneurial market process generates superior coordination of economic plans and tends towards equilibriu...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Illustrations
• Preface
• 1 Introduction
• 2 The theory of entrepreneurial discovery
• 3 Psychological determinants of entrepreneurial alertness
• 4 Institutions I
• 5 Institutions II
• 6 Culture and alertness
• 7 The market-process approach to public policy
• 8 Empirical testing and conceptual development
• 9 Concluding remarks
• Notes
• Bibliography