Where Einstein Meets Edison

Are Entrepreneurs the Source of Economic Crises?

Are Entrepreneurs the Source of Economic Crises?

Sep 14, 2010

Entrepreneurship is often depicted as the solution to society’s problems, the sure path to higher economic growth for nations. Countless journal articles and books have glorified entrepreneurs, turning the Gateses and Zuckerbergs of the world into celebrities and icons. In this concert of praises, casting a critical eye onto entrepreneurship has become a taboo. Yet Madoff was an entrepreneur, too.

How does this change what we think of entrepreneurs and entrepreneurship? Could it be that entrepreneurs are also the agents of economic ailments, the precursors, the drivers, and even the beneficiaries of crises? Truth be told, the link between entrepreneurship and economic crises is not obvious to all. However, to the extent that entrepreneurs constantly experiment with market structures, few would contest the idea that entrepreneurs, by the very virtue of their actions, contribute to destabilizing the established economic order.

In order to go beyond the usual stereotypes about entrepreneurship, it might be worth taking a step back to look at the entire picture. Entrepreneurs constitute a fundamental source of change. Opposite them, powerful forces drive societies toward stability. Let’s try to understand these first.

Establishing social order: the role of institutions 

Order is not the necessary state of societies. On the contrary, it can emerge over time as the result of a process that social scientists call “institutionalization.” The basic idea is that certain aspects of society – such as the social structure, organizations, norms, or behaviors – over time become legitimate and begin to be taken for granted, that is, institutionalized. For instance, at the beginning of the 20th century, the existence of cars was the subject of hot disputes between its proponents and opponents, with the latter liking to call the new machine the “devil wagon”1. Of course, few would think about cars in those terms today – by now they have been accepted as part of society, and so the process of institutionalization as it pertains to cars is largely over.

Researchers have conceptualized this phenomenon of institutionalization as a truce between conflicting forces2, which over time becomes progressively incorporated by individuals, enabling communication and coordination in society. Institutionalization is therefore a major source of continuity and stability over time. The famous economist Douglas North wrote: “Institutions are the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction”3. In other words, societies place onto themselves rigid frames, or institutions, which are taken for granted in daily life. Laws are perhaps the most obvious example of institutions, but the “look and feel” of markets (from the neighborhood flea market to the Dow Jones), organizations, and industries also become taken for granted over time, or institutionalized.

The intrinsic rigidity of institutionalized behaviors and organizations is reinforced by the “nested” nature of institutions. Indeed, institutions do not exist in isolation: they are part of a broader system, they are systemic in nature. The whole system of which they are part is itself often institutionalized and therefore rigid. Lehman Brothers’ bankruptcy had disastrous consequences because it was part of a broader taken-for-granted financial system: the failure of one institution (here, a bank) could easily trigger the failure of other players and even the downfall of the whole system.

Entrepreneurship: challenging the established order 

While institutionalization drives society toward order and more efficient communication and coordination in the economy, it is constantly countered by another powerful economic force: entrepreneurship – in other words, the attempts by individuals to experiment in pursuit of economic rents beyond the routines and practices that have existed thus far.

Entrepreneurs are deviant — they challenge the taken-for-granted social and economic orders. Defined this way, entrepreneurs are not only economic actors, they can also be rent-seeking bureaucrats and criminals4. In the collapsing Soviet Union, dozens of very entrepreneurial characters, later called “Oligarchs”, amassed billions of dollars through their bold undertakings. Thus, entrepreneurs see and act beyond what is established and do not hesitate to break norms, customs, or traditions.

Entrepreneurs, then, are fundamentally a force for change in society. If equilibriums exist in the economy, entrepreneurs constantly challenge them. Entrepreneurs go beyond the beaten path to experiment in search of profit. They display alertness5 – in other words, imagination and boldness – to make discoveries, enhancing awareness of opportunities in the market for potential followers6.

At times, entrepreneurs go beyond pure discovery of opportunity, adopt more proactive behavior, and build narratives to “define the new venture in ways that can lead to favorable interpretations of the wealth-creating possibilities of the venture”7. Entrepreneurs can actively construct their entrepreneurial opportunity using technical, legal, regulatory, and market evidence. For instance, the biotech industry largely appeared because the first entrepreneurs of this industry fought and won a legal battle to be allowed to patent living organisms (e.g. Diamond v. Chakrabarty case)8.

Should we ban entrepreneurs?

Let’s be clear, the economy is not a zero-sum game. Often, experimenting entrepreneurs — especially entrepreneurs in high-tech industries – do find and establish better economic organizations that increase the size of the economic pie. For example, the work of Prof. Joe Jacobson and his team on electronic ink at MIT Media Lab and their consecutive founding of E-Ink in 1997 showed the world the existence of an opportunity to improve existing practices of public display and publishing. Following their lead, a whole industry emerged around the commercialization of electronic ink technology.

Institutionalization and entrepreneurship are two opposing forces that respectively act for stability and change in society. Institutionalization allows coordination and drives efficiency. Entrepreneurs experiment with new practices, often at the risk of destroying what had previously been institutionalized. This phenomenon of destabilization and destruction of the established economic order was best described by Schumpeter: “Capitalism, then, is by nature a form or method of economic change and not only never is but never can be stationary (…). This process of Creative Destruction is the essential fact about capitalism”9. The case of the Soviet Union clearly shows that this process of creative destruction led by entrepreneurial forces does not necessarily lead to higher levels of social welfare.

Entrepreneurs are a very powerful engine of economic growth and increased welfare…but they also are a major source of destruction and economic downturns. The recent mortgage crisis ought to remind us of Baumol’s lesson that the entrepreneurial energy in societies should be channeled toward the most socially useful ends. Such a goal, however, can only be reached if one accepts to challenge our assumptions about entrepreneurship. Casting an honest, dispassionate look on entrepreneurship therefore bears immense potential.

This is precisely the goal that MITER has set for itself.

 


References

  1. Kline, Ronald, and Trevor Pinch. 1996. Users as Agents of Technological Change: The Social Construction of the Automobile in the Rural United States. Technology and Culture 37, no. 4 (October): 763-795. doi:10.2307/3107097.
  2. Nelson, R. R., and S. G. Winter. 1982. An evolutionary theory of economic change. Harvard University Press.
  3. North, D. C. 1990. Institutions, Institutional Change and Economic Performance. Cambridge University Press.
  4. Baumöl, W. J. 1990. Entrepreneurship: Productive, Unproductive, and Destructive. The Journal of Political Economy 98, no. Part 1: 893-921.
  5. Kirzner, I. M. 1973. Competition and entrepreneurship. University of Chicago Press.
  6. Kirzner, Israel M. 1997. Entrepreneurial Discovery and the Competitive Market Process: An Austrian Approach. Journal of Economic Literature 35, no. 1 (March): 60-85.
  7. Lounsbury, Michael, and Mary Ann Glynn. 2001. Cultural Entrepreneurship: Stories, Legitimacy, and the Acquisition of Resources. Strategic Management Journal 22, no. 6/7 (July): 545-564.
  8. Kaplan, S., and F. Murray. 2008. Entrepreneurship and the Construction of Value in Biotechnology.
  9. Schumpeter, J. A. 1942. Capitalism, Socialism and Democracy

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