Abstract
This paper reconsiders the predominant typology pioneered by Baumol (J Polit Econ 98(5):893–921, 1990) among productive, unproductive and destructive entrepreneurship. It is shown that the foundation of Baumol’s classification scheme is the restrictive concept of first-best outcomes, and therefore it easily fails to appreciate the true impact of entrepreneurship in real-world circumstances characterized by suboptimal institutions. We present an alternative way of generalizing the notion of entrepreneurship and show how and why it encompasses the Baumol typology as a special case. Our main distinction is between business and institutional entrepreneurship. We draw on Schumpeter and introduce the entrepreneur in an additional function: as a potential disturber of an institutional equilibrium. Various subsets of institutional entrepreneurship are posited and discussed. It is shown that changing the workings of institutions constitutes an important set of entrepreneurial profit opportunities. An implication of this is that entrepreneurial efforts to reform or offset inefficient institutions can, in many cases, be welfare-improving.
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Notes
This idea was concurrently pursued with respect to managerial talent by Murphy et al. (1991).
According to Schumpeter (1934, p. 66), entrepreneurial activities can consist of the: (1) introduction of a new good (or a new quality of a good); (2) introduction of a new method of production; (3) opening of a new market; (4) conquest of a new source of supply of raw materials or semi-manufactured goods; and (5) implementation of a new organizational form.
In addition to reducing the negative implications of unproductive entrepreneurship, one can also hypothesize that there exists a positive effect from poorly functioning institutions. This could be the case where institutional barriers function as a gate-keeping mechanism, only letting the most talented entrepreneurs through. De Meza and Webb (1999), for instance, study a setting in which banks have incomplete information about the ability of heterogeneous entrepreneurs. They show that, under these assumptions, too many agents of lower ability obtain funding. Hence, credit rationing may serve a gate-keeping function against low quality projects.
Of course, arguments have also been put forward against the “greasing the wheels” hypothesis. See Dreher and Gassebner (2007) for references.
See, e.g. Lewin and Phelan (2001), Alvarez (2007) and Henrekson (2007) for a discussion of entrepreneurial rents using the term as it is used here. An alternative is to define rent as the part of the payment for a resource that has no effect on its supply (Alchian 1987). However, on this definition, it is implicitly assumed that rents exist exogenously, while entrepreneurship in our theory entails the creation and/or discovery of rents, thereby influencing the supply of entrepreneurship and other complementary factors of production.
Few rents last forever, and the durability varies substantially. Rents decay rapidly when they are based on activities that are easy to imitate and when the knowledge or skill is not embodied in a specific individual or organization. In such cases, the rents are often called “Marshallian” or quasi-rents. Normally, imitating competitors enter the market, which increases the supply and lowers the price. Alternatively, the original entrepreneur cuts prices in order to deter entry. According to calculations by Nordhaus (2004), entrepreneurs retain on average a mere two percent of the surplus generated by their activities. Institutional entrepreneurs also face competition, as other agents learn and adopt their methods of using institutions for their own benefit.
We are only interested in rents earned by entrepreneurial—i.e., innovative—activity. One may argue that some resources that are not in limited supply, such as guns, are often used to appropriate rent through sheer force. However, in most instances, such activities are not innovative, and therefore not entrepreneurial. When an innovative activity requires the use of weapons (e.g., the Mafia), it is not the weapons in themselves which are unique, but the fashion in which they are put to use (e.g., in building the organization). This said, it is still true that many new military instruments have been innovative in themselves.
The term “institutional entrepreneurship” has previously been used by Daokui Li et al. (2006) in a sense that resembles but is less general than ours.
This could include informal institutions such as norms, value systems and codes of conduct, even though these are unlikely to have much relevance given the fact they are seldom, if ever, shaped by the acts of single agents.
This is comparable to the alignment of governance structures with transactions taking place at level 2 of the institutional hierarchy in Williamson (2000). Alternatively, if we consider the effects in a full-blown political economy system, it may be appropriate to see institutional entrepreneurship as taking place at level 3 (the institutional environment or the formal rules of the game).
This type of entrepreneurship may be labeled political entrepreneurship and treated as a subgroup of institutional entrepreneurship. Political entrepreneurship does not per se require that the individual is engaged in commercial activities, but refers primarily to innovativeness and motivation within the political sphere (Holcombe 2002; Wohlgemuth 2000). Our definition of entrepreneurship abstracts from this subset.
Lambsdorff (2002) questions the validity of treating lobbying as equally wasteful as corruption. However, although the distinction made in this paper between the two types of institutional entrepreneurship comes close to the distinction between corruption and lobbying, it is different in that we draw the distinction primarily with respect to whether codified or effective institutions are altered. There is no contradiction involved in assuming that corruption is used to wield influence over codified institutions and lobbying is directed towards changing effective institutions.
Institutions may arise as market outcomes when there is no formal governance. Formal institutions are important to mitigate market failures due to incomplete or asymmetric information and commitment and enforcement problems. Lack of public provision of such institutions provides ample opportunities for private agents to offer alternative solutions. This is neatly summarized by Dixit (2004, p. 97): “[E]very economic problem is an economic opportunity. Someone who can solve the problem, turning the potential gains into actual ones, may be able to charge a fee for this service.” This is a special case of type A.
We only consider partial equilibrium effects in the sense that the firm does not take into consideration positive externalities of taxes (e.g., provision of educated labor and infrastructure) and environmental legislation (e.g., long-run positive effects of a conserved environment and a sustained supply of resources).
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Acknowledgements
Robin Douhan sadly passed away on August 10, 2009. His friendship, kindness and talent will be deeply missed. Financial support from the Gustaf Douglas Research Program on Entrepreneurship at IFN and from the Jan Wallander and Tom Hedelius Research Foundation is gratefully acknowledged. We thank Selva Baziki, Aron Berg, Niclas Berggren, Dan Johansson, Henrik Jordahl, Erik Lindqvist and Tino Sanandaji for useful comments and suggestions on earlier versions of this paper.
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Douhan, R., Henrekson, M. Entrepreneurship and second-best institutions: going beyond Baumol’s typology. J Evol Econ 20, 629–643 (2010). https://doi.org/10.1007/s00191-010-0174-4
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DOI: https://doi.org/10.1007/s00191-010-0174-4