Institutions and Entrepreneurship: Context Matters
The concept of entrepreneurship started to overtake the world beginning in the twentieth century, notably with the works of economists Joseph Schumpeter and Israel Kirzner, at a time of increased focus on demystifying the wealth of nations and economic growth in the world.
For Schumpeter, entrepreneurship is the process of implementing new ways to combine ideas and resources to produce value in society by entrepreneurs-innovators who discover new products and services, new methods of production, new technologies, new markets, etc. (Schumpeter 1942). In Schumpeter’s view, creativity is personal trait necessarily possessed by entrepreneurs-innovators. One requires a certain degree of creativity to discover new ideas valuable for the economy. Creativity and innovation go together, and Schumpeter coined the term “creative destruction”, a process of economic growth over the long run whereby talented entrepreneurs use their creativity to innovate, rendering the old structure of resources and technologies in the economy obsolete (Schumpeter 1942, 83). The old-vs-new tradeoffs are well worth it in a capitalist system because the entrepreneurs as innovators advance the frontier of the economy to unprecedented levels, toward more diversified and better quality products, services, and markets, better technologies, and greater economic possibilities translating into increased standards of living over the long run. For Kirzner, entrepreneurship is a broader, all-encompassing concept, accounting for both the “Schumpeterian” or creative type of entrepreneurship and the “Kirznerian” or simple type of entrepreneurship (Kirzner 1999, 2009). The simple entrepreneurs, as small-scale arbitrageurs, discover ways to create new market value by allocating existing resources, in productive, yet not necessarily innovative ways, in order to match previously unmatched buyers with sellers at potentially better prices (Kirzner 1978, 1999; Boettke and Coyne 2009). Kirzner coined the concept of “entrepreneurial alertness” defined as the innate human propensity to notice that which is in one’s best interest to notice and ultimately to pursue, whether it is profit opportunities in a market context or non-profit opportunities in other contexts (Kirzner 1978). In Kirzner’s theoretical approach, entrepreneurship is an omnipresent and endogenous phenomenon in human societies. Because individuals are endowed with an element of entrepreneurial alertness, the supply of entrepreneurship in any society can be hypothesized as constant across time. What matters then, for how this entrepreneurial supply manifests, is the make-up of the context of policies and institutions within which individuals manifest their entrepreneurial alertness and the corresponding institutional stimuli they respond to (Sautet 2002; Kirzner 1979,1997; Minniti 2008). William Baumol pioneered the use of historical examples to illustrate the power of the prevalent context of institutions and policies in channeling a society's supply of entrepreneurship toward productive, unproductive, or even destructive endeavors (Baumol 1990). Context matters because it is comprised of the set of all formal and informal institutions or “rules of the game” dictating the structure of incentives, and associated payoffs, at any point in time in society (Baumol 1990; Boettke and Coyne 2009; North 1990; Boettke and Fink 2011). The allocation of entrepreneurial talent in society will then depend on the relative payoffs signaled by the local institutions and policies at a particular point (or over a period) in time, with some societies rewarding entrepreneurial ingenuity, while others reward rent-seeking (e.g. Shughart and Thomas 2015; Boettke et al. 2005; Kreft and Sobel 2005; Baughn and Neupert 2003; Murphy et al. 1991; Baumol 1990; Olson 1996; Minniti 2008; Hall and Jones 1999). At the cross-country level, sound economic institutions and policies matter for entrepreneurship because they can mitigate cognitive inclinations, such as one's fear of failure, providing entrepreneurs with a boost in confidence grounded in the stability and reduced uncertainty of the institutional environment within which they decide to pursue their profitable endeavors (Boudreaux et al. 2019). Furthermore, we can see how cross-country differences in institutions might also affect the decisions of entrepreneurs directly through perceived differences in prosperity (a potential wealth effect), and through many other interlinked channels, including perceived differences in corruption, weak property rights, and encumbering business regulations (Faria and Montesinos 2009; Faria et al. 2013; Faria et al. 2012; Hall and Lawson. 2014; Hall and Jones 1999).What also matters are a country's informal institutions, comprised of the cultural and social-moral “rules of the game,” including norms, morals, and attitudes toward the entrepreneurial, productive, and innovative members of society (Hofstede 2001; McCloskey 2011; Storr 2009; Baughn and Neupert 2003; Boettke 1996). The more proentrepreneurship and pro-innovation the culture and morality in a society, the more likely its individuals will undertake productive and innovative activities. Several cross-country studies measure the cultural dimensions relevant to entrepreneurship. The Global Entrepreneurship Monitor (GEM), for example, gathers countr y-level survey data on three entrepreneurship-related cultural factors: (1) cultural and social norms toward entrepreneurship, (2) innovation, (3) the perception of entrepreneurship as a desirable career choice, and (4) high status to successful entrepreneurs. Countries across the globe differ in their cultural attitudes toward entrepreneurship and innovation in different dimensions, which can help us understand why some countries experience higher levels of entrepreneurialism and innovativeness. Overall, at the national level, it seems that the discovery and pursuit of mutually beneficial gains from trade by alert and creative local entrepreneurs are best fostered by the mix of inclusive culture, policies, and institutions conducive to productive and innovative forms of entrepreneurship.