Entrepreneurialism is overrated.

What inputs are required for the production of goods and services?  All modern economics textbooks agree that labor and capital are fundamental factors of production.  Some textbooks also include land which is usually a shorthand for all natural resources including agriculture, minerals, fuels, and sometimes environmental resources like clean air and water.  Modern growth models typically ignore natural resources and include technology as the third factor of production.  Other growth models include human capital, a measure of labor quality that is mainly determined by education.

But the cult of the entrepreneur has infected some economics textbooks.  This tradition ignores human capital and technology and glorifies entrepreneurship instead.  For example, Wikipedia, the Fed, and several textbooks list four factors of production:  Land, Labor, Capital, and Entrepreneurship.

Why elevate the status of entrepreneurship to be a fundamental means of production when technology and human capital are more important?   Karayiannis is a member of the cult of entrepreneurship who traces this tradition back to J.B. Clark in the late 1800s.  Karayiannis laments that the study of entrepreneurship was mostly abandoned by economists by the middle of the 20th century.  But there is good reason that economists de-emphasized entrepreneurship.  It is clearly less important than technology or education for explaining economic growth and there is no evidence that entrepreneurship was ever in scarce supply anywhere.

Entrepreneurship is also just a small fraction of another factor: labor.  For example, Roland Mortimer drew a picture of the four factors of production, but both ‘labor’ and ‘entrepreneur’ are embodied in the same person.

factors_of_production

Mortimer’s definition of entrepreneurship is also an odd departure from the dictionary definition.  What he describes is really more like technology and/or human capital both of which really are important determinants of economic growth.

Some economists think that barriers to entrepreneurship were the main impediment to economic growth.  This is one reason why Muhammad Yunus won the Nobel Peace Prize for helping encourage millions of entrepreneurs with microloans.  Unfortunately, his huge boost to entrepreneurship did not increase wages nor prosperity.  He succeeded in creating millions of entrepreneurs, but they just ended up competing with each other in low-profit businesses that didn’t increase productivity.

Similarly, when the Soviet Union collapsed, there was an explosion of entrepreneurship because most entrepreneurialism had been illegal under communism and the huge state-run enterprises laid off millions of workers who then became entrepreneurs.  Small businesses sprang up everywhere to fill market needs.  But this flourishing of entrepreneurship was part of an economic catastrophe.  Production and incomes fell and the economic depression was so bad that it even caused life expectancy to collapse.  As the graph below shows, it took eighteen years for incomes to recover back to where Russia had been in 1989 before the flourishing of entrepreneurship and even longer for life expectancy to swing back up.  No doubt an important part of Russia’s recovery has been the rebuilding of large organizations that have reduced entrepreneurship again by turning former entrepreneurs back into employees.

russia gdp vs lifespan

The big problem for devotees of the cult of the entrepreneur is that countries with a larger percentage of entrepreneurs are poorer and have lower economic growth.  This is because in economics, small is ugly.  The more entrepreneurs, the smaller the businesses and smaller businesses have lower average productivity per worker which means lower wages.

If anything, we need fewer entrepreneurs and bigger economic organizations with better central planners (managers), but nobody has figured out how to optimize central planning for society.  Economists should shift their focus from entrepreneurship to venerating the effective management of large organizations instead.

My list of the most fundamental factors of production is simpler:

  1. Labor & human capital.
  2. Natural resources (such as land, & energy)
  3. Technology including social technologies like management, debt (financial capital), & governance.
  4. Capital goods.

Entrepreneurship is just one aspect of management skill.  I wouldn’t make it a separate category because it isn’t as important as management nor as scarce relative to the need. Nations with more entrepreneurs are poorer than nations with more managers.  Almost everyone is an entrepreneur in the poorest nations.

When immigrants leave countries with poor governance and go to countries with better governance, their entrepreneurial abilities suddenly become far more productive because good government is required to make entrepreneurs productive.  And nations with good government don’t need as many entrepreneurs because large organizations are more efficient when a society is good at producing bureaucrats.  So there is no shortage of supply of entrepreneurs that holds back any nation.  A much bigger problem is developing quality management & governance.

Management is also the key skill for an entrepreneur to get rich.  Most entrepreneurs are poor and the most successful entrepreneurs that the business press admires are the ones who succeed in transitioning from being an entrepreneur to becoming a good manager of bureaucracies. That is much more difficult than just being an entrepreneur and very few entrepreneurs succeed at the transition.

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Posted in Development, Managerial Micro

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