Reading: Lesson 5: Economic Growth and the Entrepreneur

Description:  

Entrepreneurship is the essential foundation for economic growth. Entrepreneurial discoveries and insights build on one another to create new and better products and processes. Entrepreneurship creates opportunities for more entrepreneurship. It is an ongoing process. However, in the general equilibrium models traditionally used in a macroeconomics classroom, there seems to be little room for entrepreneurship and the process of competitive discovery in the market.

In this lesson, students will compare and contrast ways in which economists think about entrepreneurship as a wealth creation process to the static models of economic growth beginning with a review of the three factors of production. Students will then read an article by Randall Holcombe on entrepreneurship and economic growth.

 

Time Required:

45 min

 

Required Materials:

Internet connection, writing instrument 

 

Prerequisites:         

Module 1 – What is Entrepreneurship?

Lesson 2.1 – Value is in the Eye of the Beholder

Lesson 2.2 – Value Must Be Produced

2.5.A – For this activity, review and discuss the following economic concepts as a group [10 min]:

 

Activity: The Role of the Entrepreneur in Economic Growth

1.  Three Factors of Production: Economists describe three basic factors of production as the inputs used in the production of goods and services. 

 

 

2.  The Classical economists of the 18^th and 19^th centuries understood economic output as a production function of the factors of production: land, labor, and capital.  Inputs are combined to produce outputs. According to the Classical economists, the engine of economic growth is better inputs.

 

3.  The Neoclassical economists of the 20^th Century emphasized the importance of technological changes as driving growth. According to the Neoclassical models, economic growth depends on advances in technology. As new technology is introduced, the labor and capital inputs are adjusted to maintain growth equilibrium. Technology and innovation are essential for economic growth, but this does not explain the full picture of what we see in the real world.

4.  The entrepreneur plays an essential role in economic growth. Entrepreneurship is a process of discovery. Entrepreneurs discover previously unnoticed profit opportunities. The entrepreneur’s discovery initiates a process in which these newly discovered profit opportunities are then acted on to bring available resources closer into harmony with the needs of people in society.

Additionally, entrepreneurship creates opportunities for more entrepreneurship. Entrepreneurial discoveries and insights build on one another to create new and better products and processes. This is the ongoing process that leads to economic growth.

Teacher Tip: This article is somewhat advanced and a bit technical. Some parts may be difficult to understand, but encourage students to focus on understanding the general difference between “the inputs” and “the processes” driving economic growth.   The remainder of the article can be assigned to students as an optional self-study.

2.5.B – Read the first half of the article up to the section titled “Implications for Kirzner’s Model of Entrepreneurship,” skipping the section “The Production Process.” Use the questions below to guide your discussion [35 min]:

 

Article: Entrepreneurship and Economic Growth – by Randall Holcombe (mises.org)

“What causes economic growth? At the risk of some oversimplification, the answers economists have given to this question can be divided into two broad camps, one following the ideas of Adam Smith (1776) and the other following the ideas of David Ricardo (1821). Smith, whose overriding goal was to understand the wealth-creation process, began his treatise with the lesson that the division of labor is limited by the extent of the market. As markets grew, entrepreneurship would lead to innovation, which would lead to an increasing division of labor and increased productivity. Ricardo, in contrast, envisioned economic output as being a function of the inputs of land, labor, and capital.” 

Discussion Questions: Entrepreneurship and Economic Growth

1.  Contrast Adam Smith’s (1776) and David Ricardo’s (1821) visions of what creates economic growth.

1. In short, Ricardo focuses on the inputs whereas Smith focuses on the process.
2. Ricardo envisions economic output as being a function of the inputs of land, labor, and capital. Since the factors of land are limited, Ricardo thinks population growth largely dominates economic growth. Thus, the potential for economic growth is ultimately limited by the availability of economic resources.
3. c.      Smith believes wealth creation is a process. As markets grow, entrepreneurship and innovation lead to an increasing division of labor and increased productivity. For Smith, the potential for economic growth is virtually unlimited.

 

2.  Explain the two shortcomings of analyzing economic growth using a traditional neoclassical (general equilibrium) framework as described in the section title “The Process of Entrepreneurship.”

1. First, the equilibrium models are not well suited for depicting the process of introducing new products and processes into the economy. “In the neoclassical framework, growth occurs by producing more of the old goods.”
2. Second, they do not depict the entrepreneurial discovery process where unnoticed profit opportunities entice innovation. In real life, entrepreneurs are often seeking to produce products that have never been produced or looking to enter markets that do not even exist.

3.  How do Israel Kirzner’s insights about entrepreneurship, as this author describes, “provide an engine to drive Smithian growth?”

1. Kirzner describes entrepreneurship as the process of discovering and acting upon unnoticed opportunities.
2. Acting on entrepreneurial insights of unnoticed profit opportunities, entrepreneurs produce more of what consumers want at lower cost. In doing so, entrepreneurs make the economy more productive.
3. The previously unnoticed opportunities have to come from somewhere, and the most common source is the insights of other entrepreneurs!
4.  “Acts of entrepreneurship create an environment within which innovations build on themselves, leading to continually increasing productivity.”
5. Entrepreneurs combine ideas from earlier entrepreneurs to produce new processes or products.  For example, “Steve Jobs could not have built a personal computer had not Gordon Moore invented the microprocessor.”
6. A free market that encourages entrepreneurship is conducive to economic growth.

 

4.  In what ways do entrepreneurial insights build on one another leading to more entrepreneurship and ultimately to economic growth?

1. Entrepreneurship creates opportunities for more entrepreneurship. Entrepreneurial discoveries and insights build on one another to create new and better products and processes. Entrepreneurial activity is dynamic and leads to changes in the economic environment, creating new profit opportunities.
2. Entrepreneurship generates wealth and increase the volume of goods produced. This creates the opportunity for greater specialization and more entrepreneurship.
3. Entrepreneurship creates new market niches that go along with innovation. This creation of new markets is the key link between entrepreneurship and economic growth.

 

Lesson Recap

• David Ricardo envisions economic output as being a function of the inputs of land, labor, and capital.  The traditional classical and neoclassical production process models do not sufficiently account for the role of the entrepreneur.

 

• Adam Smith believes wealth-creation is a process.

 

• “The engine of economic growth is not better inputs, but rather an environment in which entrepreneurial opportunities can be capitalized upon….the straightforward prescription for economic growth is to create an institutional environment that encourages markets and rewards productive activity.” – Randall Holcombe

 

• “Entrepreneurship is the foundation for economic growth. Entrepreneurial insights lay the foundation for additional entrepreneurial insights, which drive the growth process.” – Randall Holcombe

 

• Entrepreneurship leads to more entrepreneurship:

ü  Entrepreneurship alters the economic environment, creating new profit opportunities

ü  Entrepreneurial activity generates wealth

ü  Entrepreneurial insights create new market niches

 

• “Increasing returns occur because the more entrepreneurial activity an economy exhibits, the more new entrepreneurial opportunities it creates.” – Randall Holcombe

 

Additional Resources

Article: Education, Creativity, and Prosperity: East versus West by Christopher Lingle (FEE.org)

“Educational systems that encourage a submersion of the individual in a collective (such as the Confucionist-inspired notions of “society above self” and unquestioning acceptance of authority) will unavoidably inhibit the emergence of indigenous entrepreneurs. These individuals are a key ingredient for sustained economic progress through creative and independent thinking. By definition, their search for profit opportunities requires that they constantly take risks and undertake challenges to the economic order and, if need be, to the political status quo.”

 

Article: Entrepreneurs Make Science Work by Matthew McCaffrey (FEE.org)

“In other words, if we are going to be serious about scientific progress, we have to realize it goes hand in hand with entrepreneurial progress. When barriers to entry are eliminated and individual sovereignty rules the market, entrepreneurs can increase welfare using whatever scientific means are at hand. What’s more, their success in turn encourages the production of more and better research.”

Article: How Cities Put the Brakes on Taxicabs by Samuel R. Staley (FEE.org)

“The lifeblood of any economy is its people. Human progress ultimately springs from the inspiration of people who transform their ideas into goods and services that others can use every day. That is why entrepreneurship is critical to the success and growth of a community and economy.”

 

Video: “The Role of Entrepreneurship After a Natural Disaster”  (The Mercatus Center, 9:36 min)

“Virgil Storr discusses the role of entrepreneurship after a natural disaster for the New Media Project at Universidad Francisco Marroquín.”

 

Article: “Entrepreneurship is the Key to Economic Growth and Job Creation” by John Dearie (The Manhattan Institute)

“To tackle many of our nation’s most pressing challenges—the ongoing jobs crisis, our long-term debt, stagnant middle-class wages, the income and opportunity gaps—America needs faster economic growth. Start-ups drive innovation, which drives productivity, which drives economic growth.”

 

Article: “Entrepreneurs Have the Potential to Create 10 Million Youth Jobs in G20 Countries, New Accenture Research Finds” by Matt Samuel (Accenture)

“As business leaders seek growth, they are increasingly finding the need to look beyond their shores and beyond their existing products and services,” Berthon said.   “This underscores the importance of policies that support risk and enterprise as a route to sustainable economic recovery in many markets that are experiencing sluggish growth today.   More countries are adopting entrepreneur-friendly policies, but many of these policies are still largely fragmented, and many of the entrepreneurs we surveyed consider them insufficient. Entrepreneurs are seeking a simplified regulatory environment that encourages open innovation, and offers them a combination of tax incentives and access to better and more flexible financing.”

 

Website: HumanProgess.org

“Explore the state of humanity with data, charts, and maps.”