Entrepreneurship and the Process of Economic Development

Why do some nations become rich while others remain poor? Traditional mainstream economic growth theory has done little to answer this question during most of the twentieth century the theory focused on models that assumed growth was a simple function of labour, capital, and technology.
Yet is vitally important for the millions who reside in underdeveloped regions of the world, economic freedom and private-property rights are essential for promoting the productive entrepreneurship that leads to economic growth. In countries where this institutional environment is lacking, sustained economic development remains elusive. When countries make pro-market reforms that enhance their institutional environment, growth improves, sometimes dramatically.
Differences in resource endowments, physical and human capital, or access to current technology explain why disparities between rich and poor nations persist. Instead, the main culprits are counterproductive laws, public policies, customs, and attitudes that affect the profit opportunities available to entrepreneurs.
Entrepreneurs play both a direct and indirect role in fostering economic progress. By innovating, an entrepreneur creates new opportunities for other entrepreneurs, setting in motion an upward spiral of specialization, productivity, and wealth creation. Unfortunately, not all entrepreneurship is economically productive. Institutions can discourage entrepreneurs from introducing new products or new methods of production to instead encourage them to pursue non-productive activities, such as lobbying government officials for special subsidies or protection from competitors.
Economic freedom and property rights best foster productive entrepreneurship and material progress. More property-rights protections, personal choice, voluntary exchange, and free entry into markets lead to higher per capita income, faster economic growth, more productive entrepreneurship, greater foreign and domestic investment, better access to safe water, and longer life expectancies. Poor countries that move toward greater economic freedom and better property-rights protections tend to improve faster than rich countries that don't improve their institutional environments.
Barriers to entrepreneurship have impeded economic progress in many of the world's poorest regions. Sub-Saharan Africa has actually become poorer since gaining independence, as many countries have become "vampire states" that enrich their rulers but drain the lifeblood from productive indigenous institutions. The West could help developing countries bolster local entrepreneurs and attract investment by ending aid to kleptocrats and encouraging reforms that strengthen property rights, the rule of law, and economic freedom.
While many countries have failed to strengthen private-property rights and expand economic freedom, others have done so and consequently have experienced faster economic growth. China still ranks low in international comparisons of economic freedom, but its score in 2002 showed a 66 percent improvement from 1980.
Although much of India's economy remains heavily regulated, this fast-growing country has also significantly expanded economic freedom. India's reforms and the regulatory and societal changes needed to enable entrepreneurs to bring Indians more economic benefits.
Over the past fifty years, Ireland has enjoyed a far higher standard of living than have China and India, but by European standards it was considered underdeveloped. In the late 1980s, however, its economy began to experience dramatic growth. Large cuts in both taxes and government spending fostered increases of foreign direct investment and entrepreneurship, which led to Ireland's economic rebirth.
Botswana is a noteworthy exception to the African economic malaise. After gaining independence in the early 1960s, it cut the size of government significantly, transforming the nation from one of the world's poorest into an upper-middle-income nation.
Economists have often grappled with the question of how to help impoverished countries prosper, but they frequently overlook the central driver of economic growth: the entrepreneur. A close examination of entrepreneurship is especially timely, since the effectiveness of traditional development aid is increasingly being debated. Government-instituted economic reforms intended to stimulate economic growth often succeed or fail due to the extent that they help or hinder entrepreneurship. An international and historical comparison of policies and institutions that affect the productivity of entrepreneurs is invaluable for understanding how to make poor nations rich.
After more than a decade of research, the empirical evidence is clear: economic freedom fosters economic growth. Countries that have climbed the Economic Freedom Index (e.g., China, India, Ireland, and Botswana) have brought more prosperity to their people, whereas countries that have reduced economic freedom (e.g., Venezuela, Zimbabwe) are poorer than they were a generation ago.
Western aid policies toward Africa have failed to reverse the continent's economic decline. Most aid programs were crafted in Western capitals with little input from the people they were intended to benefit. Aid was used to support grandiose projects with little economic value and sometimes aid funds were looted. Rather than clean up their own houses, African leaders prefer to badger the West for more money. And the West, burdened by guilt over the iniquities of the slave trade and colonialism, obliges.
Latin America drew the wrong conclusions from the poor results of the process of reform in the 1990s. Despite some early successes (e.g., in reducing inflation, attracting foreign investment, and spurring the economy by lowering some barriers to trade), a great opportunity was missed. What really took place in those years was crony capitalism, not the decentralization of power through the desocialization of the economy, the spread of property, or the elimination of barriers to entry in all markets.
While Sweden and Romania differ in many ways, both underperform economically due to policies that impede entrepreneurship. In 1970, Sweden was the fourth richest country in the OCED; three decades later it had fallen to fourteenth. Since 1991, Romania's economy has grown about 0.15% per year roughly half the rate of slow-moving Kazakhstan (0.29%), and only a tiny fraction as fast as Albania (2.7%). Whereas Sweden needs to implement several reforms, such as opening access to markets, cutting taxes, and relaxing labour market restrictions, Romania has reformed too often. The frequent changes Romania has made to its legal and regulatory environment have caused confusion and uncertainty among its would-be entrepreneurs.
Although further improvements in economic freedom could be made, strides toward liberalization in China and India have probably lifted more people out of poverty than all other government anti-poverty programs combined. On a smaller scale, Ireland, New Zealand, and Botswana have also improved economic growth by making their countries more hospitable to entrepreneurship. Unfortunately, without a stronger commitment to private-property rights and economic freedom, continued improvements are precarious.