Relationship Between Innovation and Economic Growth

Relationships between Entrepreneurship and Economics
Oyvin Kyvik1
- 16.06.2009 The following is written as an introduction to the role as co-chair for the track on Entrepreneurship and Economics at the ICSB World Congress, Seoul, Korea – 2009.

1. Entrepreneurship and Economics – An Economic Perspective This is written based on the conviction that both entrepreneurship and economics are important phenomena, both in theory and in practice. It is further deduced that less entrepreneurship has as a consequence less innovation and fewer business start-ups with its consequences on employment and economic growth. In this context, entrepreneurs are needed to organize, manage and assume the risks of business or enterprise which represent processes which are positive for society. The perspectives on entrepreneurship as a phenomena in social, business and economics are varied, and ranging from the processes individuals go through from becoming “motivated to discover” an innovation and converting it into something of value to themselves and to society, to the managed entrepreneurial processes in large firms and further to the macro-economic impacts on economic growth through innovation. Entrepreneurship thus is personal and individual, but with a local, regional and national impact. Also the taxonomy of the consequence of entrepreneurial activities varies, from value created in a small business start-up to the collective creation of economic value on the level of society, the latter with obvious more complex measurement and even political consequences. Traditionally, that is in classical economics, three means of production are usually discussed, namely capital, labor and land – and to this many would add entrepreneurship and possible competence or knowledge to coordinate and organize the value creation process. Neo-classical economics and its positivistic and rational market assumptions, however, do not have space for the entrepreneur beyond the role of allocation of existing resources. However, as we now know, decision makers suffer from bounded rationality, markets do fluctuate and market opportunities and “temporary monopolies” indeed do occur. And this is where the entrepreneur enters in his role as an opportunist (Coase, 1937 – transaction costs) or
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alternatively as an arbitrageur (Kirzner, 1997 – the Austrian School). In Kirzner´s perspective entrepreneurs drive the market by being vigilant to new opportunities (for entrepreneurial profits). The Austrian school assumes subjectivism and is similarly opposed to the positivist and mathematical modeling of neo classical economics (methodological subjectivism: focus on knowledge, beliefs, perceptions and expectations of individuals). Schumpeter (1942) sees the entrepreneur as an innovator and as the motor force of growth, technological change and economic development, partly through creative destruction (with a gradual changing focus on the individual person, innovator and entrepreneur in direction of a wider social perspective in course of his scholarship). Later, Penrose (1959), Barney (1991) and Wernerfelt (1984) introduced a resource-based view with entrepreneurship and innovation in a more social perspective including notions of networking and social interactions between actors. Knight (1921) introduced the relationship between the entrepreneur, risk, uncertainty and profit to shed light on the dynamics of entrepreneurship. In a similar manner as Schumpeter, Knight finds it difficult to consider an entrepreneurial role within the strict assumptions of neoclassical economics. In Knight´s perspective, only the entrepreneur´s ability to handle uncertainty generates profit. In their review of recent developments in the economics of entrepreneurship, Minniti and Lévesque (2008) argue the emergence of a new heterodox mainstream and claiming a move from Homo Economics to Homo Sapiens with a declining distance between economics and the other social and management sciences. First and foremost in the new research era is the acceptance of bounded rationality which thus opens up the field to notions from cognition and cognitive psychology. With more emphasis on cognition and psychology, economics and entrepreneurship research will likely take a more human and less positivistic approach to management – this will make management sciences also more accessible and relevant for practicing managers and make it easier to make comparisons between theory and practice. 2. Entrepreneurship and Economics - a Managerial Perspective The fundamental idea of the concept of entrepreneurship in management is that the individual or a group of individuals by their own motivation, knowledge and initiative manage to create and grow organizations and thus create added value in the society. The motivation for an entrepreneurial act or process maybe many faceted and complex, ranging from a strong desire to create something useful or valuable, because it does not exist, or due to extreme need or despair – the motivations vary and may even be beyond monetary motives and rather driven by higher-level needs such as need for recognition or self-realization. Societies´ level of entrepreneurial activity also vary, apparently influenced by factors ranging from socio-cultural history and climate to political stability, social order and legal system. Thus
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the potential entrepreneur´s capability to perceive opportunities for innovation and motivation will in general depend on personal characteristics in addition to (local, regional or national) her or his cultural embeddedness. The entrepreneurial act and processes once an entrepreneurial idea has been recognized, depend on a more or less conscious cognitive process of testing and trying out ways of implementing the idea and this trial and error process frequently takes place in a solitary manner or some times in a small group of collaborators unifying their resources towards a common objective. However, usually, there is one lead-entrepreneur who directs the process. It is this creative activity or what Schumpeter calls “creative destruction” (destruction of the old ways of doing and introducing more efficient new methods). This often takes place in the form of technical or organizational innovations (“economic growth occurs whenever people take resources and rearrange them in ways that are more valuable…”, Paul Romer, Stanford University cited in the Economist, March 2009) and by several individual entrepreneurs more or less simultaneously which on a collective level and over time leads to economic development and eventually economic growth. The process implies the creation of new knowledge and leads to increased learning, value creation and higher welfare on a macro level. As illustrated in Figure 1, there are likely to exist causal relationships between the individual entrepreneur
SOCIETY
(INSTITUTIONAL STRUCTURES)

ECONOMIC DEVELOPMENT

Personal motivations

Cognition INDIVIDUAL ENTREPRENEURS Bounded rationality Figure 1: Entrepreneurship and economics SOCIAL NETWORK

Cultural embeddedness

Resources

(motivation, culture and resources), the entrepreneurial process involving social interaction (often through a network), degree of support through society´s institutional structures and long-term effect on collective innovation, creativity and economic growth. Similarly, it is reasonable to argue that there exists a spiral effect between economic development (increased economic resources due to economic growth), increased welfare and resources leading to continuation of the positive effects of entrepreneurship. An improved educational system as

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result of increased welfare should, ceteris paribus, positively influence the level of knowledge available and the access to innovation and entrepreneurship through R&D. References:
Barney, J.B. (1996) The Resource-based Theory of the Firm, Organization Science, 1996 Vol. 7, No. 5, September-October 1996 Coase, R. (1937) The Nature of the Firm, Economica Vol. 4, No. 16, pp. 386-405 Kirzner, I. (1997) Entrepreneurial Discovery and the Competitive Market Process: An Australian Approach, Journal of Economic Literature Vol. 35, pp. 60-85 Knight, F.H. (1921) Risk, Uncertainty and Profit, Houghton Mifflin, Boston Minniti, M. and Lévesque, M. (2008) Recent developments in the economics of entrepreneurship, Journal of Business Venturing 23, Editorial, pp. 603-612 Penrose, E.T. (1959) The Growth of the Firm, John Wiley, New York Schumpeter, J. (1942) Capitalism, Socialism and Democracy, Harper, New York Wernerfelt, B. (1984) A Resource-based View of the Firm, Strategic Management Journal, Vol. 5, pp. 171-180.

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References: Barney, J.B. (1996) The Resource-based Theory of the Firm, Organization Science, 1996 Vol. 7, No. 5, September-October 1996 Coase, R. (1937) The Nature of the Firm, Economica Vol. 4, No. 16, pp. 386-405 Kirzner, I. (1997) Entrepreneurial Discovery and the Competitive Market Process: An Australian Approach, Journal of Economic Literature Vol. 35, pp. 60-85 Knight, F.H. (1921) Risk, Uncertainty and Profit, Houghton Mifflin, Boston Minniti, M. and Lévesque, M. (2008) Recent developments in the economics of entrepreneurship, Journal of Business Venturing 23, Editorial, pp. 603-612 Penrose, E.T. (1959) The Growth of the Firm, John Wiley, New York Schumpeter, J. (1942) Capitalism, Socialism and Democracy, Harper, New York Wernerfelt, B. (1984) A Resource-based View of the Firm, Strategic Management Journal, Vol. 5, pp. 171-180. 4