The key subject of entrepreneurship theories
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Published: Mon, 5 Dec 2016
Entrepreneurship has been a key subject of interest in economic theory throughout the last decade (Marshall, 1980; Say, 1992). Many economists have incorporated entrepreneurs as a key facet of their models. Though both an important and exciting area of study; research in entrepreneurship has been distinguished by little consistency or little concrete theory (Herbert, 1989; VanPragg, 1996).
To date, there is no consensus among economist on the definition of entrepreneurship however the identification of economic functions of entrepreneurship has engaged many economists for more than two hundred years. Examples of economists who have contributed greatly to entrepreneurship in economic theory are Richard Cantillon and J. B. Say who belong to the classical era. Other economists in the early Neo classical era are; Alfred Marshall, F.B. Hawley, Joseph Schumpeter, Frank Hyneman Knight and Francis Ysidro Edgeworth. In the Mature Neo classical era, two economists renowned for their contribution to entrepreneurship theory are Maurice Dobb and Richard Cantillon. Tuttle. The modern neoclassical era has three economists who contributed to entrepreneurship in economic theory; they are, Israel Krizner, Mark Casson and William Jack Baumol.
Cantillon Richard has been credited with introducing entrepreneurial studies through his work “Commerce en General essai sur la nature du” published in the 18th century. He describes an entrepreneur as an observer in an uncertain environment. Another French economist, Jean Baptiste Say, demonstrated the entrepreneurial function as comprising of supervision, coordination and decision making. From the start of the nineteenth century till mid twentieth century, Alfred Marshall performed a crucial role in creating neoclassical economic thoughts of entrepreneurship. Even though Marshall understood the vital role of an entrepreneur he did not clearly define the functions of an entrepreneur, however he came up with entrepreneurial roles such as arbitrageur, innovator and coordinator (Barretto, 1998).
In the early nineteenth century, Fredrick Barnard Hawley stated that the role of entrepreneurs was to own output and uncertainty. To Hawley, entrepreneurship is not a productive means or factor; instead it’s a motivational force. (Thurick & Wennekes, 1999) Perhaps the most notable and best known contribution to the entrepreneurial theory was made by Schumpeter Joseph when he published The Theory of Economic Development (1913). He recognized the entrepreneur as a person who develops new combinations of innovation in the economy.
Through his business cycle theories Schumpeter demonstrates how innovations occur in swarms i.e. the original innovator (entrepreneur) is followed by a group of imitators undertaking the same venture which results to economic booms. According to Schumpeter, periods of innovation by entrepreneurs and lack of innovation lead to business cycles. In addition, an entrepreneur is not just an innovator but also has to have leadership qualities. Since the key characteristics of entrepreneurs are leadership and innovation, Schumpeter’s does not consider an entrepreneur as a person who necessarily creates his own business enterprise. In addition, the Schumpeter’s entrepreneur roles do not include the element of risk taking.
In his PhD dissertation, Frank Knight reintroduced the issue of uncertainty as an element to entrepreneurial functions (Knight, 1912). He concludes that entrepreneurs bear uncertainty so as to make profits. In addition, they dynamically shield other investors who are reluctant to take the same risks for unknown rewards.
Francis Edgeworth, argued that the entrepreneur is a coordinator (merging production factors) and a middleman or arbitrageur (connecting factor markets and product markets). It’s worth noting that Edgeworth did not completely develop his entrepreneurship theory. However as the foremost neoclassic economist, his recognition of the crucial role performed by entrepreneurs is significant since unlike his fellow neoclassic economists he did not do away with entrepreneurial considerations from his descriptive scheme.
In the mature neoclassic era, Dobb Maurice described the entrepreneurs as agents who create innovations which lead to economic development as well as create the driving force in capitalist economies (Barreto, 1998). In this context, an entrepreneur does not have to be the manager or owner of capital; he also doesn’t have to bear risk and uncertainty. Dobb details entrepreneurship as creative and active and in this sense he views an entrepreneur as an individual who performs a major function in the capitalist process. In contrast to other entrepreneurship theorists, Tuttle Charles used a very stringent description of entrepreneurship. He viewed the entrepreneur as being a responsible owner of uncertainty. Although he doesn’t demonstrate an extensive entrepreneurship theory, the entrepreneur forms a foundation for his analysis.
The fundamental work of David Birch (1980) signified the importance of entrepreneurship in small and micro enterprises. Birch identifies entrepreneurship as a catalyst for job creation; in addition, recent studies correspond to Birch’s analysis since new findings reveal that small firms perform a key economic role as agents of change through innovative as well as entrepreneurial activity.(Audretsch, 1995; Audres & Acs, 1990) This leads to several effects such as stimulation of industrial revolution, job creation and reduction of unemployment levels. (Thurik, 2000) Small firms are therefore viewed as drivers of entrepreneurial culture.
Humbert (2002) argues that in modern microeconomic theory, the entrepreneurship function seems to have reappeared in modern economic theories. This is due to the fact that in the modern theory of the firm, there are four core assumptions: perfect information, rational choice, entrepreneurship and production function. The development of the endogenous growth theory by Peter Drucker has also contributed to understanding the concept of entrepreneur. This theory has developed new possibilities for combining innovation and entrepreneurship into macro economic growth models. Nevertheless, within endogenous growth theory the concept of entrepreneurship has remained explicit because the theory provides insight to the fundamental environment of entrepreneurial activity and its relation to innovation as well as capital formation (Thurik, 1999).
The modern neoclassical economists have contributed greatly to entrepreneurship research. Neoclassical economists such as Mark Casson, Israel Kirzner and William Baumol follow the practices of neo- Austrian school; Kirzner describes the entrepreneur as an individual who is ‘alert to opportunities which are profitable’ in his book, Entrepreneurship and Competition (1973), the entrepreneur does not bear risk or uncertainty and he does not take the role of manager or coordinator in the production process.
Economist Mark Casson has also made substantial contribution to understanding the concept of entrepreneur. He defines the entrepreneur as, “a person with different skills which give him the ability to coordinate the exploitation of scarce resources.” Casson argues that an entrepreneur operates in technological conditions which require him to make difficult judgmental decisions so as to gain profit. Thus the entrepreneur has to coordinate supply and demand under uncertainty (Deakins, 1996).
William Baumol presented a more detailed analysis of the concept of entrepreneur. He incorporates 2 functions of the entrepreneur: a manager and a Schumpeterian innovator. Baumol argues that the entrepreneur doesn’t disappear or appear but it’s the number of unproductive and productive entrepreneurs that changes in terms of structures of incentives (Baumol, 1992). According to Baumol, productive entrepreneurial actions refer to any actions which add directly or indirectly to economic output. Productive output does not necessarily need to produce tangible products; nevertheless, a productive activity ought to produce positive marginal product without regards to the method used.
On the other hand, an unproductive entrepreneur carries out innovative activity but does not make any contribution to real economic output. Baumol also analysis the concept of entrepreneur through resource allocation criteria; he states that a rent seeking or destructive entrepreneur carries out innovative activity which leads to misallocation of precious resources.
Schumitz and Holmes (1990) integrated the concept of entrepreneur into mainstream theoretical literature. Their research revealed that entrepreneurship had massive implications for exit and entry of firms as well as business transfers. In their model, Schumitz and Holmes revealed that business transfers occur when entrepreneurs engage in new ventures and later hand over management to other individuals. This concept was further developed by other economist such as Thomas Prusa, Glenn MacDonald and Boyan Jovanovic. They found that entrepreneurial activity had substantial impact on future business output as well as consumer demand variability. In addition, their model proved that entrepreneurs are able to interpret industrial key factors as well as adapt to changing economic environments. They used GRE scores supported by national data to conclude that entrepreneurs generated high output variance in businesses.
Robert Lucas contributed to understanding economic aspects of entrepreneurship through his classical occupation model. This model separated the workforce into two distinct groups: individuals who excel by undertaking entrepreneurship and those who excel by undertaking alternative occupations such as paid employment or safe investment. Lucas argued that people have different entrepreneurial abilities. One key assumption he made was that entrepreneurial abilities are distributed evenly across the workforce.
Secondly, he assumed entrepreneurs have both ownership and control of factors of production in a business. Lucas also analyzed the concept of ‘marginal entrepreneur’ and defined it as individuals who have the ability to undertake entrepreneurial ventures as well as paid employment (Lucas, 1978). He also demonstrated that many able entrepreneurs result to running the largest firms in capitalist economies. Lucas’ entrepreneur models formed the basis for subsequent occupational models. One interesting insight from Lucas’ model was the impact of economic growth on the scale of entrepreneurship. Lucas proved that when economies accumulate capital it causes a shift of workers from paid employment to entrepreneurship. Over time, firms increase in size as small scale entrepreneurs invest greater amounts of capital.
Patrick Murphy and Robert Sobel also contributed to understanding the term entrepreneurship in a business context. They analyzed the effects created by entrepreneurs when they undertake unproductive rent seeking instead of productive entrepreneurship. They also developed the second occupational model in which he assumed that the economy was in a constant state of disequilibrium. According to Murphy, entrepreneurs are exposed to new opportunities continuously which are brought about by technological progress; Murphy and Sobel investigated the circumstances that motivated entrepreneurs to either continue financing a venture or sell it to another entrepreneur so as to have time for new opportunities. The Murphy- Sobel model has been influential because of many reasons. One key reason is that it combines the main ideas of Kirzner and Schumpeter in regards to recognition of entrepreneurial opportunities. Another reason is that the model forms a foundation for understanding why individuals become ‘portfolio entrepreneurs’ or buy businesses founded by others (Murphy & Sobel, 1996).
Laffont and Kihlstrom contributed to understanding the concept of entrepreneur by developing an entrepreneurial model which was an advancement of Knight’s model. Their model perceived entrepreneurial choice as being a tradeoff between returns and risk. According to Laffont and Kirhstrom (1979) “risk aversion parameters are distributed across the workforce. In addition, their analysis revealed the existence of welfare loss due to a lack of risk sharing which deter entrepreneurial activities” p.112 As in the Lucas model, this model explains the co existence of businesses of varied sizes. Laffont and Kirhstrom also analyzed the relationship between income risk and entrepreneurial decisions. They concluded that optimal time allocation in entrepreneurial activities occurred when the entrepreneur engaged himself in ventures with medium risk.
Other economist such as Stiglitz and Weiss came up with highly influential theoretical literature and models which have greatly increased our understanding of the concept of entrepreneurship in a business context. Stiglitz and Weiss analyzed the effect of public policy, credit rationing and efficient investment on entrepreneurship. They assumed asymmetric information in the sense that entrepreneurs are more informed about their ventures than financing institutions. They also assumed that entrepreneurs differ in terms of risk. One key implication of the Stiglitz-Weiss model is that banks do not fully invest in entrepreneurial activities.
Richard Scase (2001) was one of the first economists to make a distinction between proprietorship and entrepreneurship. Scase argues that entrepreneurship is based on an individual’s commitment to creation of wealth, business growth and capital accumulation. The entrepreneur foregoes present consumption so as to expand entrepreneurial activities (Weber, 1999). Proprietorships are characterized by the likely hood to utilize and consume economic surpluses so as to maintain specific lifestyle or living standards instead of reinvesting the funds in firms and businesses. Richard further argues that the primary motive of proprietors isn’t business growth or capital accumulation but rather to meet direct consumption needs.
The fundamental work of economists like Bruno Dallago (1999) show the importance of entrepreneurship in centrally planned economies. He identified 4 types of entrepreneurs: foreign, returning migrants, domestic and elite entrepreneurs. According to Dallago, the elite entrepreneurs are extremely competitive in the distribution practice but not in production process. He classifies elite entrepreneurs as rent seeking and unproductive. On the other hand domestic entrepreneurs comprise of indigenous individuals. Returning migrants refers to citizens who emigrated from the country. Dallago’s argument agrees with Baumol’s model of economics of entrepreneurship. In this sense, it isn’t the number of entrepreneurs that matters but rather the activities of the entrepreneur. He concludes that, “it’s the rules of the game that determine economic performance as well as the efficiency of the economy through the distribution of entrepreneurship to productive and unproductive uses” (Dallago, 1999. p 106).
Carl Menger carefully distinguished the concept of entrepreneur from the concept of capitalist. He also criticized neoclassical economists because the classified the two as being similar. According to Menger (1910), an entrepreneur does not have to own capital or even engage in activities which confine him to a business firm. While the entrepreneur could be the owner of the business, he is more likely to be involved in independent contractual work or craftsmanship. Menger argues that a person should be considered to be an entrepreneur when he undertakes new business ventures and loses his entrepreneurial character when the business matures (Hebert and Ekelund, 1990). This shows a rather weak relationship between entrepreneurs and their firms. Menger also argues that entrepreneurship occurs when individuals and firms develop new products, strategies and processes, but not otherwise. In addition, he supports Schumpeterian entrepreneurship by agreeing that entrepreneurial innovations are independent from the environment.
Other economists who have contributed to the understanding of the concept of the entrepreneur are Friedrich Hayek, Bryan Caplan and Eugen Von Bohm. The approach the issue of entrepreneurship by incorporating insights from sociology and economics and their work was heavily influenced by Max Weber. Their approach considers entrepreneurs as charismatic leaders who have the ability to articulate their visions, strategies and plans. Caplan (1994) refers to these strategies as “mental model”. Moreover, their approach emphasize that successful entrepreneurs perform extremely well at imposing these models on others who share the entrepreneurs vision. Hayek (1998) describes the entrepreneur as an individual with cognitive leadership abilities. He summarizes the entrepreneurial theory of the firm which combines cognitive leadership with Kirzner’s concept of alertness to profitable opportunities. According to Hayek, entrepreneurs need complimentary factors of production which he coordinates. For the firm to excel, the entrepreneur has to establish tactics and goals.
Harper and Folsom distinguished between market entrepreneurs and political entrepreneurs. They defined political entrepreneurs as individuals who are dependent on political influence for success i.e. relying on federal and state government for subsidies, tariffs or other political advantages. On the other hand, market entrepreneurs are individuals who excel by developing high quality products at affordable prices (Harper, 1996). Harper and Folsom criticize Schumpeterian economist for their failure in recognizing the link between institutions and entrepreneurs and how they influence each other.
Paul Krugman contributed to economics of entrepreneurship through his publications. His contribution to understanding the concept of entrepreneurship is also evident through his models which were based on environmental factors that influence entrepreneurship e.g. macro and micro environment as well as cultural and personal factors e.g. personal characteristics, values, norms, values and skills. According to Krugman, all these factors combined change an entrepreneur’s decision making. He further analyses the role of government policy and programs in the development of legitimate (productive) and illegitimate (non productive) entrepreneurship. His model emphasizes on the important roles which government policies play in determining entrepreneurial outcomes as either unproductive or productive. Krugman’s model incorporates three key elements i.e. risk taking, innovation and market oriented behavior of entrepreneurs. In his analysis the entrepreneur is the focal point of social economic development and the entrepreneur takes the role of a social economic leader. It’s worth noting that Krugman sharply distinguishes his perception of the functions of entrepreneurs from Neoclassic-Marshallian theories. Krugman’s entrepreneur performs the role of a revolutionary who develops new production methods and functions. In addition, he argues that entrepreneurs cause disequilibrium which lead to creative distruction especially in capitalistic economies. Krugman also argues that since the entrepreneur fuels economic progress, particularly in capitalist systems it’s an indicator that monopolies out to be encouraged in leading new innovations.
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