Entrepreneurs and Government Policy: How Two Forces Collide or ...

Entrepreneurs and Government Policy: How Two Forces Collide or Compliment
Uncertainty in the economic landscape is the worst state for entrepreneurs. Recent
gyrations in government policy due to the financial market crisis reinforce the lessons
learned about entrepreneurship and the policy environment. Professor Maria Minniti of
SMU Cox summarizes past research and enhances the ongoing debate in her article “The
Role of Government Policy and Entrepreneurial Activity: Productive, Unproductive, or
Destructive?”
Minniti says that the evidence we have shows productive entrepreneurship needs a level
playing field. She states, “We observe in certain countries that certain environments seem
to be more conducive to productive entrepreneurial activity. We are all entrepreneurial to
some extent. The issue is to promote productive entrepreneurship as opposed to forms of
entrepreneurship based on rent seeking and the exploitation of regulatory loopholes.”
Minniti asks the question: What environments are more conducive? “Where there are
clear property rights, intellectual property rights, patents, and guidelines, entrepreneurs
can take advantage of their own work,” she continues. “By definition, entrepreneurs deal
with the uncertainty of novelty, they do not need the added risk of an unclear
environment—clear monetary policy, low inflation, and everything that reduces
uncertainty but at same time preserves the ability of the market to signal supply and
demand helps. Over-regulation constrains this spirit.” During the current crisis, Minniti
notes that political intervention is generating uncertainty.
Entrepreneurs’ changing nature
In the last decade or so, many governments have paid increasing attention to
entrepreneurship and have implemented policies aimed at fostering it in their countries.
The results of such policies have been mixed. In fact, a broad search of the literature
reveals that the fundamental and general question of how, and if, governments are able to
influence positively entrepreneurial activity is far from being resolved.
Recent studies have shown that the contribution of the entrepreneurial sector to
employment and GDP is increasing. With entrepreneurial activity having important social
implications, policy discussions have centered on the idea that governments seeking to
stimulate their economies should reduce constraints on entrepreneurship.
The role of the entrepreneurial sector is said to have changed when industrial
comparative advantages shifted toward knowledge-based economic activity. First, large
firms in traditional manufacturing industries lost their competitive edge. Second, smaller
and more flexible entrepreneurial firms gained new importance in an increasingly
knowledge-based economy. In the last 20 years, industrial policies have experienced a
significant shift in which smaller and more dynamic ventures have been acknowledged as
drivers of innovation; and a new set of interventions designed to promote entrepreneurial
activity has emerged.

The power to influence
In his classic 1990 research, Baumol argued that the supply of entrepreneurs and the
nature of their motives undergo no significant change from one period to another: What
matters, instead, are institutions—the rules of the game dictating the ultimate effect of
entrepreneurship on the economy via the allocation of entrepreneurial resources. The
contribution of entrepreneurial activity varies because of its allocations between desirable
activities, such as innovation, and unproductive activities, such as rent seeking or
organized crime. Thus, with the appropriate institutions, government policy can influence
the allocation of entrepreneurship more effectively than its supply.
Institutions, such as the policy environment, influence the relative incentives and payoffs.
Thus government policy has the power to influence entrepreneurial activity, but may not
be necessarily desirable, as it may steer entrepreneurs toward actions that have negative
socioeconomic consequences.
Policy strategies, with respect to entrepreneurship, need to be tailored to the specific
institutional context of each economic region—“one size does not fit all.” For example,
the environments required for productive entrepreneurship are likely to differ
significantly between a rural area, a high-technology cluster and a metropolitan area.
Therefore, policy design needs to take account of local differences, and to adapt to the
different scale and nature of existing resources, networks, and market capabilities. In
spite of this need for diversity, entrepreneurship policies tend to be based on a handful of
policy tools. Among them are financing, taxation, regulations on trade, and
encouragement of innovation activities.
The empirical evidence on the effectiveness of financing support is mixed. While
microfinance schemes are usually assessed positively, other forms of financing have been
criticized. Some governments have also focused their efforts toward attracting new
venture capital. The empirical evidence, however, is once again mixed. Research has
shown that entrepreneurial activity attracts new venture funding, but the reverse is not
true. Additionally, venture capital has been shown to account for only a very small
amount of overall financing to entrepreneurship.
The policy instrument of taxation is shown to be less important to entrepreneurs than is
often portrayed. Minniti says, “Of course entrepreneurs want lower taxes, but it’s more
important to have a favorable environment where one can make reasonable guesses about
the future.”
Barriers to trade are particularly costly and detrimental to the entrepreneurial sector.
While internationalization (globalization) has been described as a gradual, sequential
process, more recent research has shown that firms do not necessarily follow any
consistent pattern in their internationalization. In fact, start-ups emerging in knowledgebased
industries are likely to enter international markets directly and, as a result, are more
likely to benefit from low trade barriers.

Supporting innovation
Though globalization extends the frontier for entrepreneurs, another common type of
policy has focused on local interventions. The best known example of such policies are
the creation of formal and informal support mechanisms (for example, chambers of
commerce and training programs), publicly sponsored incubators, and, most of all,
science, technology, and research parks. Entry, growth, survival, and the way firms and
industries change over time are linked to innovation. Thus, the performances of regions
and even entire economies have been linked to how well the potential from innovation is
expressed in the economy. Rather than importing successful policies from other areas,
direct subsidies for R&D and support of linkages between universities and the private
sector should reflect and respond to the needs of specific localities or regions to be
effective.
Local entrepreneurial policies are still evolving, but are clearly gaining in importance and
impact in the portfolio of policy instruments. In roughly the last 20 years, governments
have become increasingly active in assisting entrepreneurs at the regional level and
fostering industrial clusters, technology transfer, and high-tech start-ups under the
assumptions that these sectors will be competitive in the future. Researchers provided
considerable evidence that knowledge spillovers result in both a geographic clustering of
innovative activity, as well as an increase in start-ups across innovative industries, such
as semiconductors and biotechnology.
Knowledge is inherently different from traditional factors of production, such as land,
labor and capital, and is more difficult to evaluate. While the contribution of innovation
policy to entrepreneurship has become a mantra for today’s policy makers, the
implementation and assessment of policy remains problematic because many of these
initiatives are still too young to be assessed.
Research found that states with both economic and science and technology (S&T)
initiatives have six times as many new firms than states without such initiatives. But
economic initiatives have a stronger effect than S&T initiatives. States with the earliest
innovation policies, as evidenced by first-mover advantages, also have higher rates of
related firm founding over time. States that are most attractive to entrepreneurs pursue
technological innovation but also encourage and legitimize commercial development.
What matters, researchers say, is not the type of industries that develop, but the
environment in which entrepreneurship takes place. A good regional context for
innovation might resemble a diversified city made up of many specialized clusters—the
birth, life, and death of diversified urban centers being part of a spontaneous order that
rests on entrepreneurship.
Minniti comments on the case of New York City. “Crime used to be the main problem.
This applies also to some areas of Dallas.” She speaks of how New York is now
completely different than it was 20 years ago. The main thing, she relays, was cleaning
up the streets. Crime is the single most important factor because people are then afraid to
work, live, and do business with its associated costs. She adds, “Resources are scarce so a

city cannot do all of the proposed initiatives at the same time. Giuliani did this type of
concentrated intervention to reduce crime. You cannot address everything at same time.”
There was a big payoff for New York in focusing their resources. She mentions that once
the crime was gone, businesses returned and dilapidated streets were beautified. “People
respond to incentives, not necessarily monetary ones. A similar process seems to be
happening in Newark, NJ.”
Governments are not able to make any prediction about what type of entrepreneurial
activity is more desirable, nor about how to make it emerge; to do so would require them
to perform an impossible calculation. But governments can create a reliable set of
institutions in which the entrepreneurial spirit of people may flourish. Policies that ensure
institutional transparency, predictable taxation, and secure property rights do not require
computations of specific outcomes.
Conclusion
Effective entrepreneurship policy cannot be one that limits itself to business subsidies or
imposes top-down strategies. The fact that entrepreneurship is positively linked to
performance does not justify public policy intervention. The mandate for public policy
intervention can only be the result of fundamental market failures. Entrepreneurship is
there, whether we like it or not. Governments can only provide an environment
conducive to productive rather than unproductive entrepreneurship. Thus, government
should create enabling environments conducive to the division of labor, the
commercialization of invention, and exchange. Too much public involvement can hinder
entrepreneurs by creating possible market distortions.
In the end, government policy should not aspire to the elimination of new venture
failures. Although painful at the microeconomic level, business churning is part of a
healthy economic system. Most important, only the market can determine what the
optimal amount of entrepreneurship is — and which firms to target for success or failure.
In this current business climate, Minniti elaborates on the idea of allowing business to
reconcile their mistakes: “My impression is that small business will fare better because
they are more flexible, nimble, and can adjust better. The main crisis we’re seeing is of
very large companies. They would have probably been in difficulties regardless of the
situation because of their structural and competitiveness issues.” She continues, “At the
micro-level, there is a cost when there is a downturn in the business cycle. But at the
economy level, subsidizing failure too long may cause a long-term effect. For example, if
we transfer bad debt and make it good because of a government guarantee, I don’t see
any incentive for people in the market to start responding again to what the economy
requires.” She adds that given the size of the deficit, “ I don’t see how we cannot have
inflation. There is a strong risk of making things worse.”
The recent financial crisis provides a real-time textbook example of the effects of
government policy interventions and its role in entrepreneurship.

“The Role of Government Policy and Entrepreneurial Activity: Productive,
Unproductive, or Destructive?” by SMU Cox Chair of Entrepreneurship Maria Minniti
was published a special issue of Entrepreneurship Theory and Practice (September
2008).
Summary by Jennifer Warren.