What Do Scholars Say About The Conceptual Relationship Between Regulation And Entrepreneurship?


We know that “Institutions Matter” when it comes to governance and prosperity. They have to, because the phrase returns over 200,000 Google search results.

But seriously, as Margareta Drzeniek-Hanouz of the World Economic Forum put it, “If you want to predict the prosperity of a country, just look at its institutions.”

In pondering job creation and entrepreneurship, there rightly exists abundant interest in “how scholars can theorize and study the effects of institutions and institutional change on entrepreneurship, and the effects of entrepreneurship on institutions, at and across different levels of analysis” as Steven W. Bradley and Peter Klein put it in their article, “Institutions, Economic Freedom, and Entrepreneurship: The Contribution of Management Scholarship.”

Similarly, Anna Maria Zárate Moreno stressed that regulation, specifically, “as an important part of the institutional environment, is a central aspect of the ecosystem for innovation and entrepreneurial engagement.”

In surveying this landscape, Zárate Moreno stressed the particular vulnerability of entrepreneurs to “administrative regulation that creates entry barriers,” and quoted the OECD’s Entrepreneurship at a Glance:

A combination of opportunity, capabilities and resources does not necessarily lead to entrepreneurship if opportunity costs (e.g. forgone salary and loss of health insurance) and start-up costs outweigh the potential benefits. The regulatory framework is therefore a critical factor affecting countries’ entrepreneurial performance.

The concern and support for loosening constraints on enterprise is global. Despite millennial support of the welfare state and large government programs, and some “Eurocrat” dreams of more regulation, “Across Europe more voters would rather Brussels return power to the member states than increase its own.” Similarly a 2011 Gallup Poll found small businesses putting government regulation at the top of a list of complaints, while the latest National Federation of Independent Business’s Small Business Optimism Index shows “soaring optimism, in not-insignficant part related to the Trump Administration’s roll-back of Obama-era regulations.”

Of course, it is impossible to collect statistics and opinions from businesses that never formed thanks to regulation. This is one of our measurement problems in assessing the depth of linkages between regulation and entrepreneurship, and meanwhile one of the factors that makes measuring regulation impossible.

Favorable institutions, with rule of law and property rights preeminent among them, can enable and advance liberty and entrepreneurship/innovation—and poor institutions can curtail these values. For example, in Why Nations Fail: The Origins of Power, Prosperity, and Poverty, Daron Acemoglu and James Robinson (2012) demonstrate the power of political and economic institutions in contributing to economic success or failure (the North and South Korea contrast features prominently).

There exists an expansive scholarly literature (pioneered by Douglass C. North) on informal and formal rules; that is, norms, customs, taboos and conventions, as well as constitutions, laws/regulations and court rulings that provide the “constraints” that allow stable market economies to expand and urbanize.

Alongside, there is also a rich history of private institutions and rules as alternatives to governmental ones in influencing entrepreneurship. These include early stock markets evolving via entrepreneurial choices rather than planning and regulation as Edward Stringham describes in Private Governance: Creating Order in Economic and Social Life, and voluntary and private ordering of the commons, as shown in work by Elinor Ostrom (described here by my colleague Ivan Osorio).

With respect to the policy preconditions enabling sprightly entrepreneurship, and the cultural factors that lie even deeper, Joel Mokyr asserts that “culture is not independent of political and institutional circumstances.” He gives the example of Europe’s historical fragmentation relative to China, a condition which meant that those with radical ideas could “pack their suitcase and go across the border.” Reformations occurred, Mokyr noted, not just in religion but also in “astronomy, chemistry, medicine, mathematics and philosophy” that filtered down to the manufacture of everyday goods. The change and the difference, Mokyr maintained, was the emphasis on everyday betterment: “Before the Industrial Revolution, learned people in Europe changed the agenda. They say, ‘Look, we should study nature, but we should do so to improve our material welfare’.”

Obvious now, not so much in 1600, notes Mokyr.

While most assert that institutions matter, the sentiment is not universal. Dierdre McCloskey emerges to say, no, it is “Not Douglass North and his institutions,” but rhetoric and the power of language and ideas to convert rude middle class material strivings into talked-about virtues, or, put another way, Bourgeois Dignity. (For a real treat of a debate, see the Cato Unbound exchange on this topic between McCloskey, Gregory Clark, Matt Ridley and Jonathan Feinstein.)

Likewise ensnared in the entrepreneurship debate, especially with respect to declines in entrepreneurship in wealthier nations in modern times, is the broader dispute over whether homo sapiens has already grabbed the low-hanging economic-growth fruit. This debate was typified in a Federal Reserve Bank of Richmond discussion of “gloomy” Robert J. Gordon’s Rise and Fall of American Growth and Tyler Cowen’s The Great Stagnation, in contrast to the “we’ve-only-just-begun” attitude of cornucopian economists like Culture of Growth author Joel Mokyr.

Let us just say that whatever the root influences of institutions and culture, and whatever becomes of the stagnation debate, societies and entrepreneurship fare better with the institutions of economic freedom, asJoshua Hall, Robert A. Lawson and Saurav Roychoudhury aptly summarize. Wise policies will open up opportunities for all, and allow people to learn, across borders and oceans, from one another’s successes.

Fortunately, today’s entrepreneurs largely operate in a world that wishes them the best, as seen for example in the European Commission’s “Eurobarometer” surveys of social attitudes, and in the Global Entrepreneurship Monitor (The GEM is an intercollegiate-consortium based, encyclopedic survey covering over 60 countries, now for nearly two decades). Entrepreneurs, in turn, anticipate creating jobs in the coming five years at rates of between 44 and 46 percent (GEM 2017, p. 9). Notable, however, is how developed, wealthier countries fare worse by some metrics.

The GEM survey measures:

  • Societal values about entrepreneurship. Generally entrepreneurs are well-regarded by 60 percent or more in poorer and wealthier societies alike;
  • Entrepreneurship as a career-choice. An interesting contrast is that three-fourths of working age respondents in Africa consider entrepreneurship a good career choice, but less than 60 percent in Europe does.
  • Self-perceptions about entrepreneurship. A healthy 40 percent overall appear to perceive opportunities for entrepreneurship, with 22 percent across all economy types saying they intend to act. Europeans express the lowest intent to act.
  • Phases/types of entrepreneurial activity. Interestingly, the greater the level of economic development, the lower the “Total Early-stage Entrepreneurial” (TEA) activity. “[T]he average TEA rate for the factor-driven economies in 2016 was almost double that for the innovation-driven economies (17% compared to 9%).” In Latin American and Africa/Caribbean, “just under a fifth of working-age adults are engaged in early-stage entrepreneurial activity,” while the rate for Europe is lowest of all, “in line with its low entrepreneurial intention rates.”

[A note on terms in the foregoing: The GEM uses World Economic Forum (WEF) classifications: (1) factor-driven (subsistence agriculture and extraction businesses dominance, high unskilled labor (2) efficiency-driven (more efficient production processes and better product quality; (3) innovation (knowledge-intensive, expanded service sector) (p. 13).]

Precisely where entrepreneurship takes place varies across economies, and is likely heavily influenced by regulation. “Around half of the entrepreneurs in factor- and efficiency-driven economies operate in the wholesale/retail sector compared to a third of entrepreneurs in innovation-driven economies. In contrast, 46% of entrepreneurs in the innovation-driven economies are in information and communications, financial, professional and other services—twice as many as in the other two development groups” (GEM 2017, p. 10).

Employee “entrepreneurship” and where it happens is noteworthy, too.  According to the GEM survey, “Entrepreneurial Employee Activity (EEA) is negligible in both the factor- and efficiency-driven economies: however, it accounts for a substantial portion of entrepreneurial activity in the innovation-driven group [highest in North America and Europe], reaching more than half the average TEA level in this group” (GEM 2017, p. 8). Despite regulatory barriers to employment, it turns out employees are important to innovation.

Also important for regulators is a finding concerning “The Divide between Subsistence and Transformational Entrepreneurship,” a paper that describes “two very distinct sets of entrepreneurs” (Antoinette Schoar, 2010). Policymakers should recognize that “evidence suggests that…only a negligible fraction of them transition from subsistence to transformational entrepreneurship” and that the two dissimilar groups respond differently to “policy changes and economic cycles.” The challenge according to this line of research is that “most development policies aimed at fostering entrepreneurship focus on subsistence entrepreneurship in the hope of creating transformational entrepreneurs,” (p. 57) which could misfire.

A related concept in pondering the regulatory framework is that of opportunity-motivated entrepreneurial activity (OME) and necessity-motivated entrepreneurial activity (NME). One study called “Economic Freedom and the Motivation to Engage in Entrepreneurial Action” (McMullen, Bagby and Palich 2008) looked at the effect on these of an assortment of 10 factors representing economic freedom, as well as gross domestic product (GDP) per capita for 37 countries. The study found OME and NME to be negatively associated with GDP per capita (this seems to conform with Europe scoring lower than Africa in some respects in the GEM survey, and with entrepreneurship rates being lower in wealthier counties) and positively associated with labor freedom. Others results also find entrepreneurship sensitive to particular local circumstances: OME “was positively associated with property rights, while NME was “positively associated with fiscal freedom and monetary freedom.” The authors concluded that “governmental restrictions of economic freedom appear to impact entrepreneurial activity differently depending on the particular freedom restricted by government and the entrepreneur’s motive for engaging in entrepreneurial action.”

The foregoing represents conceptual linkages posited between regulatory institutions and entrepreneurship according to some scholars in the field. A great body of research also explores the empirical linkages (and there is perhaps an infinity to consider). A common thread, however, seems to be that Louder Applause + Less Regulation = Greater Entrepreneurship.

(Note: this article is in part based on a slice of my chapter in the Fraser Institute’s new book  Demographics and Entrepreneurship. Readers will find all the authors and their chapters at the volume’s landing-page here.)

Originally published at Forbes.