The plight of underdeveloped countries.

• Author: Coyne, Christopher J.
• Position: Entrepreneurship and government policy

The question of the wealth of nations has been at the center of economics for more than two centuries. There is now increasing focus, both in academic and policy realms, on the entrepreneur as the driver of economic growth. For policymakers, the focus on entrepreneurship has been a recent phenomenon. In 1998, the OECD launched a program, "Fostering Entrepreneurship," to better understand the role of entrepreneurs in the economy at large. Governments throughout the world have launched various initiatives designed to promote entrepreneurship and economic growth (Reynolds, Hay, and Camp 1999). The importance of the entrepreneur in economic development has also been realized by the key international aid organizations. The World Bank, the U.S. Agency for International Development (USAID), and the International Monetary Fund (IMF) have all commissioned studies and undertaken initiatives to understand and promote entrepreneurship.

Although many articles in the academic literature recognize the importance of the entrepreneur (e.g, Kirzner 1973; Left 1979; Baumol 1990, 2002), this topic has not received the widespread attention that it deserves. This lack of focus results primarily from the fact that it is difficult to formally model entrepreneurial behavior. The entrepreneur has been characterized as an innovator (Schumpeter 1950, 1961), an arbitrageur (Kirzner 1973), one who bets on ideas (Brenner 1985, Mokyr 1990), and as a forecaster and capitalist (Rothbard 1963). Each of these interconnected elements undoubtedly plays an important role in the notion of entrepreneurship. However, for the purpose of our analysis, we are most interested in understanding entrepreneurship as alertness to and the seizing of profit opportunities.

It is typically assumed that a lack of economic growth means that there is a shortage of entrepreneurs and, more generally, "entrepreneurial spirit." This view, however, overlooks the essence of entrepreneurial alertness. Understanding alertness to profit opportunities as the central tenet of entrepreneurship makes clear that a lack of progress results from a lack of profit opportunities tied to activities that yield economic growth--not from a lack of entrepreneurial activity. Although it is usual to think that the existence of profit opportunities necessarily leads to economic growth, this may not be the case. Different institutional contexts create higher payoffs to differing sets of activities that may possibly lead to economic growth but may also lead to economic stagnation or even retrogression. In short, profitability is not synonymous with positive economic growth. Instead, what is important is the type of activity that yields profit opportunities to alert entrepreneurs.

Our core thesis is as follows: Institutionally dependent payoffs determine the direction of entrepreneurial alertness and efforts. In order to understand the plight of developing countries, it is critical to understand that it is not a lack of entrepreneurship that is the problem, but rather the institutional context directing entrepreneurial activities toward perverse ends. Specifically, some institutional regimes channel entrepreneurial activity into economically destructive avenues, while other frameworks direct this activity in a way that creates wealth.

We distinguish between productive, unproductive, and evasive entrepreneurship. After exploring this distinction, we present a general framework for considering the key institutions that constitute the social order. Original evidence from fieldwork in Romania is provided to support our claims. (1) We conclude with some general policy guidelines regarding entrepreneurship, institutional regimes, and economic growth.

Entrepreneurship: Productive, Unproductive, and Evasive

Entrepreneurs are present in every country and every cultural setting. We observe different outcomes from entrepreneurial activities because activities yielding the highest payoffs vary across societies. In countries with low growth, it is not that entrepreneurs are not acting. Rather, these countries are stymied by the presence of entrepreneurial profit opportunities counter to economic progress.

A complete theory of entrepreneurship must provide some understanding of factors that direct the alertness of individual entrepreneurs. In other words, entrepreneurs can engage in productive activities resulting in economic growth or they can engage in unproductive and evasive activities resulting in economic stagnation or retrogression. Baumol was the first to make the distinction between productive and unproductive entrepreneurship (1990, 2002: 59-61).

Productive activities--arbitrage and innovation--constitute the very essence of economic growth and progress. When engaging in productive activities, the entrepreneur has a dual role. The first involves discovering previously unexploited profit opportunities. This pushes the economy from an economically (and technologically) inefficient point toward the economically (and technologically) efficient production point. The second role takes place via innovation. Innovation results in a more efficient use of resources shifting the entire production possibility frontier (PPF) outward (Kirzner 1985). This shift represents the essence of economic growth--an increase in real output due to increases in real productivity. In short, productive entrepreneurship encompasses those activities that benefit both the entrepreneur and society at large. The entrepreneur benefits himself by benefiting others.

In contrast, unproductive activities include those that benefit the entrepreneur but harm society in general. Examples include crime, rent seeking, and other behaviors that destroy existing resources. In the case of unproductive entrepreneurship, it is possible that innovation is taking place, but these activities do not shift the PPF outward. As an example, consider new techniques for engaging in rent seeking. While such techniques lead to increased profit for the entrepreneur undertaking the activity, they result in a loss for society as a whole.

To productive and unproductive activities, we can add a third category: evasive entrepreneurship. Evasive activities include the expenditure of resources and efforts in evading the legal system or in avoiding the unproductive activities of other agents. Tax evasion is one readily apparent example of evasive activities, as are bribes paid to regulators or inspectors used to evade onerous regulations. Both productive and unproductive entrepreneurship involve the creation of deadweight losses--in both cases resources are expended solely to affect the distribution of existing wealth.

One of the central claims of this article is that institutionally dependent payoffs determine the direction of entrepreneurial alertness. Before moving on, we provide a general framework of institutions. In order to gain analytical traction, we consider three general formal institutional categories--economic, political, and legal--underlying any social order. (2) Each main category has several subcategories as shown in Table 1. These subcategories are conducive to productive entrepreneurship and sustainable economic growth. (3)

Admittedly, there is some overlap among these categories. For instance, enforceable property rights are a function of an accessible court system. Property rights will also be influenced by the stability of political institutions and the ability to place the appropriate checks on political agents. While recognizing this, these categories provide a framework for understanding the importance of institutions in achieving sustainable growth. In cases where payoffs to the unproductive or evasive activities are higher, we would expect the subcategories in Table 1 to...