How Entrepreneurship Affects the Economy

It promotes economic growth, even if positive effects are sometimes overhyped.

Entrepreneurship is a blanket term related to starting a business. Howard Stevenson of Harvard Business School, for example, has defined entrepreneurship as the “pursuit of opportunity beyond resources controlled,” considering it as a kind of managerial approach rather than a specific time, like a business's creation, or a specific person within a business, such as its founder.

While there are some complicating factors to the relationship between entrepreneurship, economic growth, development, and welfare, discussed below, the increase in economic growth from entrepreneurship is considerable. It is not, however, a magic bullet, and as discussed below broader economic conditions outside of entrepreneurship are important in determining whether economic growth occurs.

Entrepreneurial efforts have forced new social, political, and economic changes, holding out the promise for new innovations that will address intractable social problems such as climate change and structural racism. Notably, however, the results can vary, sometimes not creating as much social justice or positive development outcomes as initially promised.

Key Takeaways

  • Entrepreneurship refers to the “pursuit of opportunity beyond resources controlled.”
  • Entrepreneurship has become increasingly socially conscious, taking stock of the impact of entrepreneurial activity on societal issues and tending to view the possibility of addressing those issues as an important function of entrepreneurship.
  • The impact of entrepreneurs on economic growth is overall positive, though it may be more mixed than its proponents realize with evidence pointing towards widely different results within different sectors of the economy.
  • The evidence of how effective socially-conscious innovations have been at solving the issues they tackle historically has been mixed.

Entrepreneurs and Economic Growth

Innovation and entrepreneurs undeniably contribute to economic growth and they are a particular area of concern for policymakers. However, scholars say that the economic growth offered by entrepreneurship can be exaggerated.

Growth from entrepreneurial activity doesn't occur evenly across sectors of the economy. Studies of economic growth have pointed towards an apparent paradox where productivity growth has been “at best modest in recent years,” despite the pervasiveness of innovation, entrepreneurs, and innovation ideology. According to research from the National Bureau of Economic Research, this is because innovation affects industries very differently, meaning that it has a large impact on the growth of some sectors of the economy but not across all sectors. 

While generally positive, the link between entrepreneurship and improving welfare is also complicated, influenced by factors such as regional population, entrepreneurship density, and the specific industry in which the entrepreneurial activity is taking place, according to reviews of the scholarly literature.

"Necessity" Entrepreneurship vs. "Opportunity" Entrepreneurship

Entrepreneurship can fall into the categories of "necessity entrepreneurship," which is caused by the lack of other opportunities, or "opportunity entrepreneurship," which is driven by an apparent business opportunity.

If entrepreneurial activity is a signal that the economy isn't creating enough jobs or wage opportunities, as in necessity entrepreneurship, it may even be connected to slow economic growth or lagging economic development, scholars say.

Inequality and Economic Growth

Some studies have also suggested that economic growth may be correlated to an increase in overall inequality in certain circumstances. In the US, for example, scholars say that income inequality and economic growth have been linked since the 1970s.

Stages of Economic Development

The level of economic development of a country will affect whether entrepreneurship will lead to greater economic growth. 

It seems as though the relationship between economic growth and entrepreneurship may be U-shaped, according to the economist Zoltan Acs. In countries in the early or middle stages of economic development, economic growth is negatively connected to entrepreneurship; the two are positively connected in highly developed economies, a trend that emerged in the second half of the twentieth century.

In the twentieth century, fueled by the decline in manufacturing and the shift towards a service economy, industrialized market economies in later stages of economic development—like the United States and areas of western Europe such as Germany and Sweden—were able to benefit greatly from entrepreneurship, Acs' writings have indicated. Those countries saw a rise in the amount of entrepreneurship, starting in the 1970s, which reversed the previous trend of those economies which was towards larger firms and less self-employment as workers tried to get high-paying managerial jobs with large firms.

Other factors may be relevant as well. Scholars point out that the US, in particular, has benefited from a large and competitive domestic market, a highly developed financial system, and a high level of long-term government support for basic science.

For developing countries, on the other hand, entrepreneurship isn't a panacea to growth. A study of 74 economies across a six-year period concluded that less developed countries should not base their economic policy on “generic entrepreneurship” if they desire to stimulate economic growth. The authors argue that focusing on programs that develop human capital, take advantage of economies of scale, and entice foreign capital are more effective in leading to economic growth.

Italy may provide an additional example of a place where high levels of self-employment have proved to be inefficient for economic development. Research has shown that Italy has experienced large negative impacts on the growth of its economy because of self-employment.

Entrepreneurs and Social Progress

With concerns over sustainability, inequality, and social impact generally, many entrepreneurs have become more intensely interested in the social consequences of their economic activity. In particular, the rise of social awareness among entrepreneurs has led to many attempts to use entrepreneurship to create a more just and sustainable world. Since the protests over the death of George Floyd, entrepreneurs have also looked to combat systemic racism through their work.

Social entrepreneurship, which has been around as a concept since the 1950s, has become increasingly common. It describes a category of entrepreneurship that attempts to both make a profit and solve societal problems. It has become a way of pushing for social change within the social justice and entrepreneurial frameworks, but it differs from the typical nonprofit model in that it pursues both profits and socially desirable ends simultaneously.

Societal Impact

That businesses ought to consider and deeply care about their impact on society, in general, has not always been an uncontroversial point. Economists in the 20th century like Milton Friedman, for example, famously argued that businesses should rather focus solely on their duty to improve returns to shareholders.

Innovations in Investing

In investing, socially responsible investing (SRI) and environmental, social, and governance (ESG) criteria have promised to spur on more socially conscious results especially as regards sustainability, while other innovations look to address the root causes of societal problems.

Although, neither are without their controversies.

ESGs, for instance, have caused skepticism from some investors, including former chairman of the board of visitors for Japan’s Government Pension Investment Fund, Eiji Hirano, who has warned of the risk these investments may bring. SEC Commissioner Hester Pierce has commented that she believes mandating ESGs would violate the agency’s authority and could also "undermine financial and economic stability."

Upsides and Downsides

From the perspective of social justice, which prizes a world with equal rights and access to opportunity, the reliance of the economic system on entrepreneurship presents both upsides and downsides.

Theoretically, socially conscious entrepreneurship offers the opportunity to generate solutions for marginalized communities, and the motivations for social entrepreneurs around the world tend to come from a genuine desire to uplift communities and to fix serious problems.

Entrepreneurship (construed broadly), then, offers the opportunity to catalyze creative solutions to long-standing problems, promote research, and energize social change. However, it's important to note that sometimes attempts to solve the underlying structural problems lead to murkier results. The dual motives of profit and social good can sometimes clash, as the example of microfinancing in India reveals.

Microfinancing's Mixed Legacy

Some of the innovations that were initially praised as radically effective for creating positive social change have not lived up to their billing. Microfinancing, for example, was once popular in international circles but is now seen as having a more limited impact on eradicating poverty, sometimes even increasing indebtedness. The practice may have also led to a series of suicides for farmers in Andhra Pradesh in the 2000s.

The connection between inequality and economic growth, discussed above, also clouds the picture of using entrepreneurship to drive societal solutions.

What Is Entrepreneurship?

Entrepreneurship is a broad term that encompasses a lot of definitions. The definition given by Howard Stevenson of Harvard Business School defines entrepreneurship as the “pursuit of opportunity beyond resources controlled," which implies some creativity in the approach to generating innovations.

Why Is Entrepreneurship Important for Social Justice Goals?

Traditional arguments hold that entrepreneurship allows new innovations to occur, ensuring that resources are efficiently used within the market. This article focused more on the association between social justice goals and entrepreneurship and therefore emphasized the role of societal benefit in innovative changes. Towards that end, entrepreneurship (construed broadly) allows for creative solutions to long-standing problems, promotes research, and energizes social change.

What's a Social Entrepreneur?

A social entrepreneur is someone who launches a business not just to make profits but also to address some larger social issue. They are interested in promoting social good.

The Bottom Line

Entrepreneurship presents an important aspect of the current economic model, especially in post-industrial economies like the US where the “knowledge economy” and platform-driven companies, often relying on specific inventions or “disruptions,” have captured large shares of the market.

The relationship between entrepreneurship and economic development is important to understand for policymakers and business owners. Understanding the benefits and drawbacks of entrepreneurship allows a balanced approach to nurturing entrepreneurship to be taken, which can, if handled correctly, result in a positive economic and societal impact.

Article Sources
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