Entrepreneurial talent and reforms: New evidence

William Baumol (1968, p. 66) eloquently argued that “[i]f we seek to explain the success of those economies which have managed to grow significantly with those that have remained relatively stagnant, we find it difficult to do so without taking into consideration differences in the availability of entrepreneurial talent and in the motivational mechanism which drives them”. Indeed, the role of entrepreneurship in less developed economies was considered quite important in the early debates of economic development in the postwar period; see for example, Harbison (1956), Baumol (1968), and Leibenstein (1968). However, it was for the most part ignored in development research and in policy recommendations of the 1980s and 1990s. Yet, it is quite possible that the failure of institutional reform, and other potential determinants of growth, to produce expected economic growth and development could be explained by weak entrepreneurial activity, as in Iyigun and Owen (1999); or by the interplay of entrepreneurship, and policy and institutional reforms, as in Iyigun and Rodrik (2006).

 The primary goal of this paper is to explore the interplay of entrepreneurship and institutional and policy reforms and the effect of this interplay on development (proxied by the rate of growth in per–capita income). We do so by first outlining two propositions on the links between institutions and policy reforms, and entrepreneurial talent and examining how institutional and policy reforms influence growth in per–capita income through their effects on the availability (supply) and allocation of talent. Our model predicts that the impact of institutional reform is positive when the level of entrepreneurship is low and negative when it is high, whereas the effect of policy reform is negative when entrepreneurial activity is weak and positive when it is strong. We then perform Arellano-Bond GMM estimations on 1990-2002 data from a panel of countries at various levels of development and analyze the growth effects of entrepreneurship and reforms focusing in particular on the interplay of policy and institutional reforms, and entrepreneurship. The results we derive clearly support the predictions of the two propositions outlined in the paper. The empirical results indicate that entrepreneurship—proxied by the share of self-employed in total non-agricultural employment—influences the effectiveness of reforms. Policy reforms—proxied by openness to international trade—have stronger positive effects on growth of income when the level of entrepreneurship is high, while the impact of institutional reform—proxied by the composite ICRG index—on the growth effects of entrepreneurship is positive (negative) when the level of entrepreneurship is low (high). We outline the policy implications of these findings in the concluding section.

 We make two important contributions to the literature. First, we distinguish between the effects of institutions and economic policy at different stages of entrepreneurial activity. The second—and more significant—contribution is that we use a framework that clearly identifies the channels through which institutions and policy affect entrepreneurship. The effect of institutions is primarily on the supply of entrepreneurial talent, whereas policy reform affects mainly the allocation of entrepreneurial talent.