An entrepreneur is someone who organizes, manages, and assumes the risks of a
business or enterprise. An entrepreneur is an agent of change. Entrepreneurship is
the process of discovering new ways of combining resources. When the market value
generated by this new combination of resources is greater than the market value
these resources can generate elsewhere individually or in some other combination,
the entrepreneur makes a profit. An entrepreneur who takes the resources
necessary to produce a pair of jeans that can be sold for thirty dollars and instead
turns them into a denim backpack that sells for fifty dollars will earn a profit by
increasing the value those resources create. This comparison is possible because in
competitive resource markets, an entrepreneur’s costs of production are determined
by the prices required to bid the necessary resources away from alternative uses.
Those prices will be equal to the value that the resources could create in their next-
best alternate uses. Because the price of purchasing resources measures
this OPPORTUNITY COST— the value of the forgone alternatives—the profit
entrepreneurs make reflects the amount by which they have increased the value
generated by the resources under their control.
Entrepreneurs who make a loss, however, have reduced the value created by the
resources under their control; that is, those resources could have produced more
value elsewhere. Losses mean that an entrepreneur has essentially turned a fifty-
dollar denim backpack into a thirty-dollar pair of jeans. This error in judgment is part
of the entrepreneurial learning, or discovery, process vital to the efficient operation
of markets. The profit-and-loss system of CAPITALISM helps to quickly sort through the
many new resource combinations entrepreneurs discover. A vibrant, growing
economy depends on the EFFICIENCY of the process by which new ideas are quickly
discovered, acted on, and labeled as successes or failures. Just as important as
identifying successes is making sure that failures are quickly extinguished, freeing
poorly used resources to go elsewhere. This is the positive side of business failure.
Successful entrepreneurs expand the size of the economic pie for everyone. Bill
Gates, who as an undergraduate at Harvard developed BASIC for the first
microcomputer, went on to help found Microsoft in 1975. During the 1980s, IBM
contracted with Gates to provide the operating system for its computers, a system
now known as MS-DOS. Gates procured the software from another firm, essentially
turning the thirty-dollar pair of jeans into a multibillion-dollar product. Microsoft’s
Office and Windows operating software now run on about 90 percent of the world’s
computers. By making software that increases human PRODUCTIVITY, Gates expanded
our ability to generate output (and income), resulting in a higher standard of living
for all.
Sam Walton, the founder of Wal-Mart, was another entrepreneur who touched
millions of lives in a positive way. His innovations in distribution warehouse centers
and inventory control allowed Wal-Mart to grow, in less than thirty years, from a
single store in Arkansas to the nation’s largest retail chain. Shoppers benefit from
the low prices and convenient locations that Walton’s Wal-Marts provide. Along with
other entrepreneurs such as Ted Turner (CNN), Henry Ford (Ford automobiles), Ray
Kroc (McDonald’s franchising), and Fred Smith (FedEx), Walton significantly
improved the everyday life of billions of people all over the world.
The word “entrepreneur” originates from a thirteenth-century French
verb, entreprendre, meaning “to do something” or “to undertake.” By the sixteenth
century, the noun form, entrepreneur, was being used to refer to someone who
undertakes a business venture. The first academic use of the word by an economist
was likely in 1730 by Richard Cantillon, who identified the willingness to bear the
personal financial risk of a business venture as the defining characteristic of an
entrepreneur. In the early 1800s, economists JEAN-BAPTISTE SAY and JOHN STUART
MILL further popularized the academic usage of the word “entrepreneur.” Say
stressed the role of the entrepreneur in creating value by moving resources out of
less productive areas and into more productive ones. Mill used the
term “entrepreneur” in his popular 1848 book, Principles of Political Economy, to
refer to a person who assumes both the risk and the management of a business. In
this manner, Mill provided a clearer distinction than Cantillon between an
entrepreneur and other business owners (such as shareholders of a corporation)
who assume financial risk but do not actively participate in the day-to-day operations
or management of the firm.
Two notable twentieth-century economists, JOSEPH SCHUMPETER and Israel Kirzner,
further refined the academic understanding of entrepreneurship. Schumpeter
stressed the role of the entrepreneur as an innovator who implements change in an
economy by introducing new goods or new methods of production. In the
Schumpeterian view, the entrepreneur is a disruptive force in an economy.
Schumpeter emphasized the beneficial process of CREATIVE DESTRUCTION, in which the
introduction of new products results in the obsolescence or failure of others. The
introduction of the compact disc and the corresponding disappearance of the vinyl
record is just one of many examples of creative destruction: cars, electricity, aircraft,
and personal computers are others. In contrast to Schumpeter’s view, Kirzner
focused on entrepreneurship as a process of discovery. Kirzner’s entrepreneur is a
person who discovers previously unnoticed profit opportunities. The entrepreneur’s
discovery initiates a process in which these newly discovered profit opportunities are
then acted on in the marketplace until market COMPETITION eliminates the profit
opportunity. Unlike Schumpeter’s disruptive force, Kirzner’s entrepreneur is an
equilibrating force. An example of such an entrepreneur would be someone in a
college town who discovers that a recent increase in college enrollment has created
a profit opportunity in renovating houses and turning them into rental apartments.
Economists in the modern AUSTRIAN SCHOOL OF ECONOMICS have further refined and
developed the ideas of Schumpeter and Kirzner.
During the 1980s and 1990s, state and local governments across the United States
abandoned their previous focus on attracting large manufacturing firms as the
centerpiece of economic development policy and instead shifted their focus to
promoting entrepreneurship. This same period witnessed a dramatic increase in
empirical research on entrepreneurship. Some of these studies explore the effect of
demographic and socioeconomic factors on the likelihood of a person choosing to
become an entrepreneur. Others explore the impact of taxes on entrepreneurial
activity. This literature is still hampered by the lack of a clear measure of
entrepreneurial activity at the U.S. state level. Scholars generally measure
entrepreneurship by using numbers of self-employed people; the deficiency in such
a measure is that some people become self-employed partly to avoid, or even evade,
income and payroll taxes. Some studies find, for example, that higher income tax
rates are associated with higher rates of self-employment. This counterintuitive
result is likely explained by the higher tax rates encouraging more tax evasion
through individuals filing taxes as self-employed. Economists have also found that
higher taxes on inheritance are associated with a lower likelihood of individuals
becoming entrepreneurs.
Some empirical studies have attempted to determine the contribution of
entrepreneurial activity to overall ECONOMIC GROWTH. The majority of the widely cited
studies use international data, taking advantage of the index of entrepreneurial
activity for each country published annually in the Global Entrepreneurship
Monitor. These studies conclude that between one-third and one-half of the
differences in economic growth rates across countries can be explained by differing
rates of entrepreneurial activity. Similar strong results have been found at the state
and local levels.
Infusions of venture capital funding, economists find, do not necessarily foster
entrepreneurship. Capital is more mobile than labor, and funding naturally flows to
those areas where creative and potentially profitable ideas are being generated. This
means that promoting individual entrepreneurs is more important for economic
development policy than is attracting venture capital at the initial stages. While
funding can increase the odds of new business survival, it does not create new ideas.
Funding follows ideas, not vice versa.
One of the largest remaining disagreements in the applied academic literature
concerns what constitutes entrepreneurship. Should a small-town housewife who
opens her own day-care business be counted the same as someone like Bill Gates or
Sam Walton? If not, how are these different activities classified, and where do we
draw the line? This uncertainty has led to the terms “lifestyle” entrepreneur and
“gazelle” (or “high growth”) entrepreneur. Lifestyle entrepreneurs open their own
businesses primarily for the nonmonetary benefits associated with being their own
bosses and setting their own schedules. Gazelle entrepreneurs often move from one
start-up business to another, with a well-defined growth plan and exit strategy.
While this distinction seems conceptually obvious, empirically separating these two
groups is difficult when we cannot observe individual motives. This becomes an even
greater problem as researchers try to answer questions such as whether the policies
that promote urban entrepreneurship can also work in rural areas. Researchers on
rural entrepreneurship have recently shown that the INTERNET can make it easier for
rural entrepreneurs to reach a larger market. Because, as ADAM SMITH pointed out,
specialization is limited by the extent of the market, rural entrepreneurs can
specialize more successfully when they can sell to a large number of online
customers.
What is government’s role in promoting or stifling entrepreneurship? Because the
early research on entrepreneurship was done mainly by noneconomists (mostly
actual entrepreneurs and management faculty at business schools), the prevailing
belief was that new government programs were the best way to promote
entrepreneurship. Among the most popular proposals were government-managed
loan funds, government subsidies, government-funded business development
centers, and entrepreneurial curriculum in public schools. These programs, however,
have generally failed. Government-funded and -managed loan funds, such as are
found in Maine, Minnesota, and Iowa, have suffered from the same poor incentives
and political pressures that plague so many other government agencies.
My own recent research, along with that of other economists, has found that the
public policy that best fosters entrepreneurship is ECONOMIC FREEDOM. Our research
focuses on the PUBLIC CHOICE reasons why these government programs are likely to
fail, and on how improved “rules of the game” (lower and less complex taxes and
regulations, more secure PROPERTY RIGHTS, an unbiased judicial system, etc.) promote
entrepreneurial activity. Steven Kreft and Russell Sobel (2003) showed
entrepreneurial activity to be highly correlated with the “Economic Freedom Index,”
a measure of the existence of such promarket institutions. This relationship between
freedom and entrepreneurship also holds using more widely accepted indexes of
entrepreneurial activity (from the Global Entrepreneurship Monitor) and economic
freedom (from Gwartney and Lawson’s Economic Freedom of the World) that are
available selectively at the international level. This relationship holds whether the
countries studied are economies moving out of SOCIALISM or economies of OECD
countries. Figure 1 shows the strength of this relationship among OECD countries.
The dashed line in the figure shows the positive relationship between economic
freedom and entrepreneurial activity. When other demographic and socioeconomic
factors are controlled for, the relationship is even stronger. This finding is consistent
with the strong positive correlation between economic freedom and the growth of
per capita income that other researchers have found. One reason economic freedom
produces economic growth is that economic freedom fosters entrepreneurial
activity.
