Entrepreneurship in developing countries

Table of Contents

List of tables

List of abbreviations

1 Introduction

2 Entrepreneurship – Concepts and definitions
2.1 Behavioral definitions
2.2 Occupational definitions
2.3 Synthesis definitions

3 Entrepreneurship in theories of economic growth and development
3.1 The neoclassical and the new growth theory
3.2 Porters Diamond Model
3.3 Structural economic transformation
3.4 Unproductive and destructive entrepreneurship

4 Empirical evidence
4.1 Measuring entrepreneurship
4.2 The impact of entrepreneurship on economic growth and development
4.2.1 Self-employment
4.2.2 New firm entry
4.2.3 GEM data
4.2.4 Knowledge-spillovers
4.2.5 Country-specific evidence
4.3 Intermediate conclusion

5 Promoting high-growth entrepreneurship in developing countries
5.1 The role of formal institutions
5.2 Policy advice

6 Conclusion

References

Appendix

List of tables

TABLE 1: GEM INDIVIDUAL ATTRIBUTES OF A POTENTIAL ENTREPRENEUR

TABLE 2: GEM ENTREPRENEURIAL ACTIVITY INDICATORS

TABLE 3: THE EFFECT OF ENTREPRENEURSHIP ON ECONOMIC GROWTH AND DEVELOPMENT

TABLE 4: THE EFFECT OF INSTITUTIONS ON ENTREPRENEURIAL GROWTH ASPIRATIONS

List of abbreviations

Abbildung in dieser Leseprobe nicht enthalten

1 Introduction

At least since Schumpeter (1934) economists have been examining the effects of entrepreneurship on economic growth and development. Whereas, most of the theoretical approaches point towards a positive influence on the economy, the empirical evidence remains ambiguous. Meta studies from Van Praag and Versloot (2007) and Nyström (2008) demonstrate a positive relationship between entrepreneurship and economic performance observed in most of the economic literature. Unfortunately, except for three studies discussed in Nyström’s analysis, empirical evidence exclusively focuses on the context of developed countries. Economists commenced to realize the understudied phenomena of entrepreneurship in developing countries and started to produce theories and evidence from developing countries. Consortiums like the Global Entrepreneurship Monitor (GEM) began to include more and more developing countries in their analysis. Due to this new flow of research on entrepreneurship in developing countries, this thesis aims to answer the question whether entrepreneurship is an adequate tool for developing countries to propel economic growth and bring forth development. In doing so, Chapter two firstly presents various definitions and concepts of entrepreneurship that cover different behavioral and occupational aspects of entrepreneurial activities. Because the term entrepreneurship is very multifaceted, in an initial step it is important to establish a clear definition on which terms of entrepreneurial activity will be analyzed specifically. Chapter three presents well-known theories of economic growth and development and identifies those mechanisms within theory which are influenced by entrepreneurship. Several institutions are recognized to be important in enabling positive effects of entrepreneurship on economic growth and development. It is presumed that many developing countries lack a sufficient institutional framework which limits the impact of entrepreneurship on economic growth and development. Chapter four describes the difficulties of measuring entrepreneurship and presents empirical evidence on the relationship between entrepreneurship and economic growth chiefly focusing on a developing country context. It is shown that the majority of entrepreneurship in developing countries fails to generate economic growth and development. High-growth entrepreneurship that creates a certain amount of employment is identified as the only form of entrepreneurship, which may significantly increase economic growth. Therefore, Chapter five presents empirical evidence of institutional enhancements that are successful in promoting high-growth entrepreneurship in developing countries. The evidence is combined with findings from previous chapters and used to provide policy advise on how developing countries may increase their rate of growth-oriented entrepreneurship. The last chapter presents concluding remarks and discusses limitations.

2 Entrepreneurship – Concepts and definitions

One of the difficulties in linking entrepreneurship with economic growth and development is, that there are many different concepts and definitions of entrepreneurship in the first place. Thus, it is of paramount importance to clearly define which form of entrepreneurship is being investigated to the effect that comprehensive conclusions may be drawn. Similar to Naudé (2013;5) part 2.1 uses three different approaches to divide entrepreneurship into behavioral and occupational definitions as well as a synthesis between the two.

2.1 Behavioral definitions

One attempt to define entrepreneurship is to identify individual entrepreneurial behavior. The history of such behavioral definitions dates back to the year 1732 where Cantillon¹ used the term for the first time in a semblance of its modern form (Hébert and Link, 2006;589). The distinctive functions of Cantillon’s entrepreneur are identified by Brown and Thornton (2013;409). The Entrepreneur acts as a merchant or as a producer. Thus, he buys products in villages to sell them in cities or vice versa. Alternatively, he produces goods and services to be sold in the market town. Therefore, the entrepreneur acts speculative by anticipating regional price differentials and consumer demand without certainty about profits. Brown and Thornton (2013;416) argue that Cantillon’s theory can be utilized to explain the role of entrepreneurship in basic economic concepts like economic geography, labor markets and concepts of supply and demand.

Before attributing the invention of the term entrepreneur to Cantillon, Jean Baptiste Say (1823) was considered to be the first one who described entrepreneurial behavior. According to Say, the entrepreneur obtains and organizes production factors to create value which distinguishes him from the capitalist who mainly handles risk and uncertainty (Bruyat and Julien, 2001;167). This behavioral definition is one of the first ones that emphasizes the value-creating aspect of entrepreneurship and the importance of managerial and organizational skills².

Handling uncertainty remained the key function of entrepreneurship in economic literature for a long time. In his Ph.D. dissertation “Risk, Uncertainty and Profit” originally published in 1921 and reprinted in 1964, Knight defines the entrepreneur as a decision maker who is willing to make risky decisions with uncertain outcomes (Aidis, 2003). Knight describes profit as the reward to the entrepreneur for bearing costs of uncertainty (Smith and Chimucheka, 2014). Important is Knights distinction between risk and uncertainty. Whereas risk can be calculated with a certain probability of occurrence, the outcomes of uncertainty remain incalculable. Uncertain outcomes of any kind of change represent the profit opportunity for the entrepreneur.

Initially published in 1890, Marshall (1930) was the first one who covered the innovative character entrepreneurial activities seem to entail. In his work “the principles of economics” he outlined that an entrepreneur’s innovations consequently lead to economic progress. (Sciascia and De Vita, 2004;5). Furthermore, Marshall distinguishes between business owners that follow an already discovered path and entrepreneurs that pave the way for innovations.

The innovative character of entrepreneurship has been further evaluated by Schumpeter (1934). His famous study “Theorie der Wirtschaftlichen Entwicklung” (Theory of Economic Development) originally published in 1911 in German, is one of the first that links entrepreneurship to economic development. Although Schumpeter states in the introduction of his book that his biggest wish is, that his work will be overhauled and forgotten as soon as possible, the opposite was the case.

His theory is still one of the most influential works in the field of development economics. Schumpeter distinguishes between inventions and innovations. To him, an invention is merely the generation of a new idea whereas an innovation implies a profitable commercialization. According to Schumpeter, an industry is profitable in the long run only if it is open to innovations, which convince consumers in a saturated market to increase consumption. In his mind, inventors rarely become entrepreneurs because it takes different skills to realize and commercialize an idea. Schumpeter is very clear about his concept of a “dynamic” entrepreneur. Above all, Schumpeter’s dynamic entrepreneur has to be prepared to take risks in order to enter unknown economic territory, adapt quickly to new situations, perceive an invention as a possibility and not as a dream and learn to convince producers and consumers to accept the invention. In his early work from 1911, he grants entrepreneurs the role of breaking the circular flow of an economy which enables development. Later in 1939³ and 1942⁴ he further describes the relevance of innovation for economic development. The Schumpeterian entrepreneur enables economic development by pushing an economy away from the equilibrium. By creating new products, hitherto nonexisting markets or innovative production methods, a higher equilibrium is reached. Schumpeter calls this process “creative disruption”. It has been argued, that his view of entrepreneurship applies better to more developed economies because at later stages of development, economic growth tends to be driven by knowledge and competition (Naudé, 2013) instead of factor accumulation as it is the case in earlier stages (Ács and Naudé, 2013).

Another behavioral concept of entrepreneurship, that seems more applicable to developing countries is from Kirzner (1973). Instead of pushing the economy away from the equilibrium to reach a higher one like Schumpeter’s entrepreneur does, Kirzner’s entrepreneur exploits market disequilibria. Whereas the Schumpeterian entrepreneur needs a certain amount of creativity to disrupt the economy, Kirzner’s entrepreneur is more an arbitrageur. His “alertness” allows him to spot market disequilibria which enables him to buy at a lower price than he sells. In a later work from 2009, Kirzner further describes his entrepreneur as someone who simply is alert to price differentials that others not yet noticed. He emphasizes that his concept in contrast to Schumpeter’s focuses on the existing market conditions and that his entrepreneur recognizes possibilities earlier than others, whereas Schumpeter’s entrepreneur creates new ones. Nevertheless, Kirzner mentions that his concept is far from ruling out Schumpeter’s because the alertness he describes, emerges from creativity. To separate both concepts, Kirzner mentions that his idea of alert entrepreneurs, who bring markets into alignment in the short run, coexist with Schumpeter’s dynamic entrepreneurs that disrupt economic cycles in the long run Kirzner (2009;149).

A similar concept that like Kirzner’s focuses on the existence of entrepreneurial opportunities on markets is from Shane and Venkataraman (2000). They describe these opportunities as “objective phenomena that are not known to all parties at all times”⁵. Furthermore, they try to answer the question why some people and not others discover particular entrepreneurial opportunities. Two possible reasons arise, firstly information asymmetries among people lead to different awareness about opportunities and, secondly a person possessing the necessary information to exploit an entrepreneurial opportunity is not necessarily able to value it. This view of an entrepreneur that acts as a capitalist who is able to forecast future prizes is shared by Rothbard (2009).

In summary, there are different behavioral definitions of entrepreneurship and therefore the entrepreneur takes up different roles within an economy. Besides being a risk-taking speculator and arbitrageur who is alert to price differentials to maximize profits, the entrepreneur acts as an innovator and organizer of production processes which (under certain conditions) has positive impacts on economic development.

2.2 Occupational definitions

Occupational definitions of entrepreneurship put distinctive characteristics of entrepreneurs in the background. Often someone is considered to be an entrepreneur if he or she is self-employed or starts a firm. This kind of definition causes problems for measuring and analyzing entrepreneurship as it neither differentiates between motives and opportunities behind entrepreneurship nor between the quality of entrepreneurs (Shane and Venkataraman, 2000;18). Therefore, this part of the paper presents approaches of entrepreneurial occupational choice that aim to explain why certain individuals engage in entrepreneurial activities and others do not. The particular focus is on external effects like institutions and labor market conditions that determine individual occupational choice and also entrepreneurial behavior.

Whether someone engages in entrepreneurial activities or not can be seen as a simple occupational choice between wage- and self-employment (Evans and Jovanovic, 1989;811). Hence, someone will become an entrepreneur if the benefits of possible self-employment exceed those from wage employment. Of course, not only financial but also non-pecuniary benefits and risks have to be taken into consideration. Empirical evidence shows that some entrepreneurs favor selfemployment even if the monetary returns are less than they would have obtained in wage employment (Hamilton, 2000).

Because of a lack of alternatives, the occupational choices in developing countries are composed differently than in more developed ones. People often choose to create their own business because they have no chance to be on a payroll. Thus, it can be distinguished between opportunity and necessity entrepreneurship. Acs (2006) examined the impact of both forms of entrepreneurship and found a positive relationship between opportunity driven entrepreneurship and income per capita. Whereas, countries with less income per capita tend to have much higher rates of necessity entrepreneurship. Additionally, Acs (2006;104) points out the importance of the “National Framework conditions”, which consist of a stable rule of law, labor market flexibility, infrastructure, financial market efficiency and management skills. If it is well established the focus on the “entrepreneurial framework conditions” becomes more important which strengthen technology transfer, start-up funding and entrepreneurial education.

Murphy et al. (1991) mention that if a country’s markets are large enough and people can easily organize firms and retain their profits, more talented people become entrepreneurs. Murphy et al. (1991) argue that talented people seek jobs in sectors where they can benefit most. If the highest benefit lies in rent-seeking activities like joining the government bureaucracy or the army as it is the case in some African countries, talented people will choose these occupations. These rent-seeking activities redistribute wealth rather than creating it. In contrast, if talented people decide to become entrepreneurs and not rent-seekers, they improve productivity and income growth which leads to development (Murphy et al., 1991).

Occupational choice is not only happening between wage and self-employment but also between different forms of entrepreneurship. The form of entrepreneurial activity an individual engages in is strongly influenced by a country’s institutions as Baumol (1990) points out. He emphasizes that not the supply of entrepreneurs is important for a country’s development but their allocation towards productive or unproductive activities. This allocation is determined by “the rules of the game” Baumol (1990;894). The hypothesis is, that there is always the necessary supply of entrepreneurs within a society but the rules and the reward structure of an economy determine how these entrepreneurs act and hence decide whether entrepreneurship is productive, unproductive or even destructive for an economy.

This hypothesis is supported by Coyne and Leeson (2004). They make the point that institutions determine the direction of entrepreneurial alertness and efforts. Under this paradigm in developing countries, there is hence not a lack of entrepreneurial activity, but a lack of profit opportunities tied to activities that yield economic growth. The authors further distinguish between productive, unproductive and evasive entrepreneurial activities. Productive entrepreneurial activities imply a dual role of the entrepreneur. On the one hand the entrepreneur discovers previously unexploited profit opportunities to increase the individual profit and on the other hand, increases productivity and therefore output which leads to economic growth. In this manner, the entrepreneur engaging in productive activities “benefits himself by benefiting others” Coyne and Leeson (2004;237). In contrast, unproductive activities like crime or rentseeking behavior are beneficial for the entrepreneur but harmful to the economy. The third category, evasive activities, describes efforts leading to avoidance of the legal system, which include bribes or tax evasion. Hence, it becomes desirable for a country to ensure that it is beneficial for entrepreneurs to engage in productive entrepreneurial activities by designing the institutional framework accordingly.

The occupational choice definitions of entrepreneurship show that not only an entrepreneur’s characteristics determine their impact on economic development. Instead, a country’s developmental stage, market conditions and institutional setting likewise play a crucial role. In particular, they determine whether an individual engages in entrepreneurial activities or not, as well as define the trajectory of entrepreneurial efforts towards either productive or unproductive activities. The advantage in explaining entrepreneurship as an occupational choice is that external factors are taken into consideration, which shape entrepreneurial behavior, instead of conversely assuming a certain behavior possibly exerting an influence on their developmental state. Without distinguishing between necessity and opportunity entrepreneurship, it is difficult to measure developmental impacts caused by entrepreneurial activity in developing countries because both types of entrepreneurship vary widely in their economic effects.

2.3 Synthesis definitions

The synthesis definition combines occupational and behavioral views of entrepreneurship (Naudé, 2013). Describing who an entrepreneur is or what he or she does is not enough to explain the effects of entrepreneurship. Venkataraman (1997;120) mentions that defining the entrepreneur is not useful. Instead, entrepreneurship as a scholarly field “seeks to understand how opportunities to bring into existence future goods and services are discovered, created and exploited, by whom and with what consequences.” Furthermore, he states that entrepreneurship consists of two phenomena: the existence of profitable opportunities and the presence of individuals exploiting them. A key question in analyzing entrepreneurship is how these two phenomena interact. Is it the existence of opportunities that enable entrepreneurship, or is it entrepreneurship that creates those opportunities? This question appears rather philosophical and is as hard to answer as the question of the chicken and the egg but thinking about it helps to understand the mechanisms of action of entrepreneurship. Holcombe (1998;54) dealt with this question and states that “entrepreneurship leads to more entrepreneurship”. If someone exploits an opportunity, new opportunities are created for other individuals to exploit. Hence, it is not the opportunity itself that creates other opportunities but the exploitation in the form of entrepreneurship that creates new opportunities and therefore more entrepreneurship. Holcombe uses the example of the computer industry where the invention of a microchip processor led to the invention of personal computers which enabled the discovery of computer mice as adequate control instrument that in turn has been advanced to cordless computer mice. Without the previous entrepreneurial efforts, the exploitation of the opportunity to invent a cordless computer mouse would have been impossible. Hence, although there has to exist an initial opportunity for an entrepreneur in order to practice entrepreneurship, it is entrepreneurship itself that creates more opportunities.

A definition that combines the behavioral and occupational definitions with the importance of entrepreneurial opportunities from Gries and Naudé (2011;217) states that “entrepreneurship can be defined as the resource, process and state of being through and in which individuals utilize positive opportunities in the market by creating and growing new business firms.” Positive opportunities have a similar meaning to the productive form of entrepreneurship described by Coyne and Leeson (2004). To promote such a form of entrepreneurship, it is important to match positive (productive) opportunities with capable entrepreneurs. Therefore, it is crucial to diminish unproductive opportunities as entrepreneurs might favor individual over general welfare (Baumol, 1990). To further enhance the matching process, it helps to increase individual entrepreneurial capabilities in terms of human as well as financial capital.

Therefore, when talking about entrepreneurship and its effects on developing economies, it is not enough to simply focus on new firm creation and calculate possible outcomes on GDP. Instead, one needs to distinguish between those businesses which are created to exploit a certain business opportunity rather than those which are created simply out of necessity. The opportunity based form of entrepreneurship might help developing economies to become developed if these opportunities are tied to economic development. Hence, to examine the effect of entrepreneurship in developing countries it is important to observe existing opportunities, entrepreneurial capabilities and the matching process between them.

To define a desirable form of productive entrepreneurship in developing economies this thesis will use a definition that is based on Wennekers and Thurik (1999), Coyne and Leeson (2004) and Aidis (2003):

Productive entrepreneurship is the willingness and capability of individuals or firms, that in the face of uncertainty perceive and create, innovative economic opportunities by introducing hitherto nonexisting products, production methods, organizational schemes or product combinations that result in a viable business and contribute to national output and personal welfare.

3 Entrepreneurship in theories of economic growth and development

To understand the impact of entrepreneurship in developing countries it is necessary to analyze different theories of economic growth and development to identify the mechanisms within these theories, which are influenced by entrepreneurial activities. Although the term economic development is much more multifaceted, it is often equated with economic growth. Whereas economic growth is mostly measured in terms of outputs and calculated as GDP growth, economic development has multiple repercussions. Besides financial wealth, the quality of life plays an important role in development. Therefore, economists like Stiglitz (1998) identified broad goals of economic development such as improvements in income distribution, environment, health, and education. Likewise, the World Bank’s Development Report (1991) mentions that better education, higher standards of health and nutrition, equality of opportunity and a cleaner environment are crucial for a country’s development. On top of that, economic development implies a certain process of change such as the structural transformation of business sectors for example.

Nevertheless, economic growth is often a prerequisite for achieving economic development and also much easier to measure than development as a whole. Hence, the next section of this thesis firstly analyzes different theories of economic growth and seeks to find impacts of entrepreneurship within these theories. This section is then followed by a closer look at models and theories of structural economic transformation that describe economic development.

3.1 The neoclassical and the new growth theory

The starting point of the neoclassical growth theory arose out of a discussion concerning the models of Harrod (1939) and Domar (1946) (Solow, 1999;640). Independently from each other, Harrod and Domar developed extensions of John Maynard Keynes’s General Theory (1937). Their aim was to extend Keynes’s analysis into the long run and evaluate conditions under which an economy could realize full employment (Hagemann, 2009). Among their discoveries was that the economy must invest the amount of savings resulting from full-employment income per year, fully utilize production capacities and ultimately synchronize the capital accumulation with labor force growth. In contrast to Keynes, investment in the Harrod-Domar model not only generates income it also increases the economies productive capacity⁶. Unfortunately, the Harrod-Domar model fails to explain the reasons for the growth of an economy. The model only explains how in equilibrium of supply and demand, the increased savings (that are entirely invested) and a lower capital-output ratio represent a higher output growth rate. To remain in equilibrium, the output growth rate (also warranted growth rate g_w ) has to coincide with the natural growth rate g_n which is determined by the labor-augmenting technical process and population growth which are both exogenously given. As the determinants of the warranted output rate are also exogenously given, the accordance of the natural and the warranted growth rate is only a lucky coincidence (Hagemann, 2009;72). Consequently, there occurs a secular instability problem, if g_n > g_w there is a tendency towards unemployment. If the opposite is the case and g_n < g_w , the full-employment condition will be achieved and once it is overcome, there will be a shortage of labor. This would negatively impact investment and prevent the economy from growing at the warranted rate which in turn, negatively impacts employment (Hagemann, 2009;72). To prevent this, the model calls for adjustment policies to align the natural and the warranted growth rate. The model only tells us that an economy can increase its output growth rate if it increases savings and therefore investment or if it increases the productivity of capital.

To maintain the growth in the long run it is necessary to align the output growth with the natural growth rate. As this happens rather coincidentally it is not possible to formulate a growth strategy. Instead, the focus is to implement policies responsive to the natural growth rate. Besides the fact that innovativeness could enhance capital productivity and the labor-augmenting technological process, there is no space for entrepreneurship in this model.

The secular instability problem motivated Solow to enhance the Harrod-Domar model and create an updated neoclassical growth model. The decisive adjustments made by Solow are to introduce two important assumptions: the substitution between the two factors of production (capital and labor) and the flexibility of factor prices (Hagemann, 2009;75). Solow’s Nobel price work from 1956 is the groundwork for many textbook models of neoclassical economic growth⁷.

The output in the Solow Model is created through a production function containing variables measuring physical and human capital as well as technological advancement. Physical capital underlies the assumption of diminishing returns. Hence, every increase of the same amount of physical capital generates less output, which is called negative marginal returns to capital. Another property of physical capital is, that it depreciates over time at a constant rate which means the higher the capital, the higher the depreciation. Capital in the Solow model is accumulated through investment, which is determined by savings. The savings are a constant proportion of the output, which is not consumed. As depreciation grows with investment, at some point, the investment equals depreciation, which is called the steady-state of capital. At this point, all the investment is used to repair and replace the existing physical capital and no new capital is accumulated. If we assume that the production function is only affected by physical capital, holding all other factors constant, the steady-state level of capital represents the steady state level of output. Once the steady state-level of capital is exceeded, the depreciation is higher than investment, thus converging back to the steady steady-state level of capital. So an increase in physical capital increases output as long as the investment is larger than depreciation. If depreciation is larger than investment, the capital stock is decreasing and output is shrinking. In both cases, the production function converges to the steady state level of output. This means for an economy with a very low initial capital stock, that an increase in physical capital creates a substantial augmentation of output. Hence, a lot can be saved and invested in the next period and the economy grows more rapidly. Due to increased depreciation and diminishing returns to capital, this positive effect will slow down over time until the steady-state level is reached. An increase in the savings rate would, of course, increase investment and therefore increase output growth but only until investment again equals depreciation and a higher steady-state level of output is reached. Thus, an increase in the savings rate and the resulting capital accumulation, only increases output growth in the short run. In the long run, the economy will always converge to the steady-state level.

Human capital in the model includes the amount of labor and labor’s productivity. It is, however likewise plagued by depreciation and diminishing returns. At some point, every investment in human capital is absorbed by maintaining the current level of human capital. The existing human capital stock grows older and has to be replaced and educational institutions have to be maintained. On top of that an infinite increase in human capital does not yield infinite returns. Hence, the effects of physical and human capital on output growth are similar. This realization leads to an important prediction the Solow model makes, that of conditional convergence (Solow, 1999). According to this principle, poor countries with a relatively lower capital stock grow faster than relatively richer countries and therefore must catch up. History has shown that some poor countries especially in Asia or countries like Germany and Japan after World War II indeed managed to catch up exerting higher growth rates, but other poor countries maintained their low capital stocks and growth rates. Hence, the Solow model can only predict convergence for countries that are similar in most of their conditions such as the institutional framework for example.

As human and physical capital only explain economic growth in the short run, the only way to reach continuous economic growth, is to increase technological advancement. Technological advancements or sometimes simply referred as ideas are the only way in the model to counteract depreciation and diminishing returns, because they increase the productivity of labor and capital so that the same amount of labor or capital produces higher outputs in the future. Hence, recurring technological advancements are the only way to achieve output growth in the long run. To produce technological advancement and ideas, entrepreneurship or at least innovative entrepreneurship in the form described by Schumpeter plays a very important role and hence directly affects economic growth. Unfortunately, in the Solow growth model, technological advancements are exogenously given and “fall like manna from heaven” leaving policymakers in the dark on how to control it (Baumol et al., 2007). Technological advancement in the Solow model is treated like a public good. Therefore, long-term growth is exogenously given in the Solow growth model. Nevertheless, the model points towards a substantial effect, innovation has on long-run economic growth.

Baragheh et al. (2009) demonstrate a strong link between entrepreneurship and innovation in the economic literature. By analyzing 60 definitions of entrepreneurship from seven different disciplines, they find nine definitions of innovations within the entrepreneurship literature. Their aim was to establish a multidisciplinary definition of innovation. Combining all seven literature disciplines they create the following definition of innovation (Bargheh et al., 2009;1334): “Innovation is the multi-stage process whereby organizations transform ideas into new/improved products services or processes, in order to advance, compete and differentiate themselves successfully in their market place.” Because the term organizations refers to business organizations, it becomes clear that entrepreneurship is an important part of innovations in this definition. Also empirically, there exists a link between entrepreneurship and innovations. As Van Praag and Versloot (2007;365) show by analyzing 19 empirical studies, entrepreneurial firms are more efficient than established firms in producing high-quality innovations. Additionally, they play a very important role in the commercializing of innovations.

Hence, if someone acknowledges the link between entrepreneurship and innovations, it is to some extent possible to incorporate entrepreneurship into the Solow growth model, although it is still difficult because the neoclassical principle of perfect competition implies the nonexistence of entrepreneurial profit opportunities (Wennekers and Thurik, 1999;36).

For the purpose of circumventing the issue of exogeneity in the discussion surrounding long-term economic growth Romer (1990) created an endogenous growth model, which is often referred to as the starting point of the new (endogenous) growth theory. Whereas knowledge and technological advancement have been treated as a public good (non-rivalrous and non-excludable) in previous economic growth models, Romer treats it as a non-rivalrous but partially excludable good. Non-rivalry implies that a good has high fixed costs and zero marginal costs of production. One can think of an instruction on how to combine raw materials, which is hard to create but once created can be used by various people without additional costs. Excludability prevents other people from using the good. In the case of ideas and knowledge, excludability is mostly realized through patents i.e. intellectual property. Ideas are only partially excludable because others might build own ideas up on old ones without violating the intellectual property.

These characteristics of ideas within the Romer-Model allows to deduct that private firms generate technological change to maximize production (Romer, 1990;76). Therefore, technological change within the Romer-Model is endogenous and occurs through firms undertaking research and development activities, which become profitable by securing their intellectual property through patents and therefore may act as monopolies. Hence, growth in the model is driven by monopoly rents earned by the introduction of new products. This implies that economic change is the result of profit-seeking entrepreneurial activities (Wennekers and Thurik, 1999;36).

An increased human capital stock represents higher returns of research and development. Hence, the Romer-Model predicts that economies with a relatively higher amount of human capital grow faster than those with a relatively smaller human capital stock. As in the Solow model, it is innovation that determines the growth rate although in this case it is created through firms investing in R&D. Even though, individual entrepreneurial activities are not taken into consideration in the Romer-Model, it underlines the importance of innovative inputs for an economies growth process.

As an extension to Romer (1990), Aghion and Howitt (1992) created an endogenous growth model containing creative destruction, as it was introduced by Schumpeter (1934). The model concludes that growth exclusively results from technological progress, which is created among innovation-generating firms. They state that firms engaged in research are motivated by innovations that create monopoly rents until these rents are destroyed by the next innovation. Like in the Romer-Model the monopoly rents represent profit opportunities for entrepreneurs which they seize by introducing creative destruction that fosters technological advancement.

The endogenous growth models have been used to create knowledge spillover theories of entrepreneurship such as Acs et al. (2004,2005), Acs and Sanders (2013). These models at their core identify entrepreneurship as the missing link in knowledge spillover theories. Research and development is undertaken by incumbent firms creating opportunities for entrepreneurs who identify and exploit these opportunities for profits. In these models, entrepreneurs are not creating ideas themselves, they are sensitive to profit opportunities, which are created through the R&D departments of larger firms. Thus knowledge spills upwards, in terms of opportunities towards entrepreneurs and downwards, back to the firms, when these opportunities are utilized.

One might argue that explaining entrepreneurship within the neoclassical and endogenous growth theory is inadequate for explaining entrepreneurship in developing countries. The main reason is that these growth theories are explicitly designed to explain growth in developed countries and on top of that do not deal with specific entrepreneurship at all. Nevertheless, the aim of this section remains to point out that capital accumulation on its own, regardless whether it is physical or human capital, does not lead an economy to accomplish long-term growth. Innovation is the core of economic growth in the long-term. Additionally, the endogenous growth models demonstrate the need for property rights. Without legal protection of intellectual property, there might be not enough motivation for firms to invest in research and development.

Of course, innovation can occur in existing firms without entrepreneurship in terms of new firm creation. But without new entrepreneurs entering the market, there might not be enough pressure on existing firms to innovate. This is also hypothesized in Porter’s theory: “The Competitive Advantage of Nations” which will be shortly discussed in the next section.

3.2 Porters Diamond Model

Porter created his model to explain why certain economies have a competitive advantage over others. He claims that it is neither the natural endowments and the labor pool, nor the interest rates and the currency value, that determines a country’s competitive advantage. Instead, it is the capacity of its industry to innovate and upgrade (Porter, 1990;73). To establish a lasting competitive advantage a nation has to rely on four specific attributes, which are all displayed in figure one and will be shortly explained in the following.

Traditional economists like Adam Smith suggest that a country is endowed with certain Factor Conditions such as labor, land, natural resources, capital, and infrastructure. A country will trade those factors that it is relatively well endowed with. Porter states that a country does not inherit but creates the most important factors of production such as skilled human resources or a scientific base (Porter, 1990). In fact, countries can create a competitive advantage out of an initial disadvantage. If a country, for example, lacks a certain raw material to produce a good, it might find an innovative alternative that has an international competitive advantage.

Abbildung in dieser Leseprobe nicht enthalten

Figure 1 Porters Diamond-Model (Porter,1990)

Another important aspect is represented by the Demand Conditions, with specific emphasis on the domestic demand conditions. Porter states that especially in times of globalization the domestic demand conditions are crucial for companies’ global success. Hereby the focus is on the quality and not on the quantity of demand. The more sophisticated the buyer’s needs, the higher is the pressure for companies to innovate in order to satisfy them.

Related and Supporting Industries help a nation to create a competitive advantage by building an innovative industry sector. Close working relationships of home-based suppliers help an industry to foster innovation. The short lines of communication ensure a quick and constant flow of information as well as an ongoing exchange of ideas and innovations. On top of that, the presence of related industries stimulates rivalry which further increases the pressure to innovate.

Firm Strategy, Structure and Rivalry determine how companies are created, organized and managed and how the nature of domestic rivalry comes into play. Porter gives the example of the German management style that is best-suited for technical or engineering industries, where precision manufacturing is required. But in general, no managerial system is universally appropriate. Besides, Porter states that domestic rivalry is the most important aspect, which combined with geographic concentration, transforms the diamond model into a system. The domestic rivalry induces companies to constantly innovate in order to stay competitive. Additionally, it stimulates the development of specialized factors, upgrades domestic demand, and promotes the formation of related and supporting industries.

[...]

¹ Cantillon (1755)

² Pelletier (1990;188) points out that Turgot was the first one to distinguish between capitalist and entrepreneur in 1766.

³ Schumpeter (1939)

⁴ Schumpeter (1942)

⁵ Shane and Venkataraman (2000:175)

⁶ Supply and demand effect (Hagemann,2009;69).

⁷ The following description is a simplified version which refers directly to Sollow (1999) and to the textbook version of Blanchard and Illing (2009).