Uncertainty in the economic landscape is the worst state for entrepreneurs. Recent gyrations in government policy due to the financial market crisis reinforce the lessons learned about entrepreneurship and the policy environment. Professor Maria Minniti of SMU Cox summarizes past research and enhances the ongoing debate in her article "The Role of Government Policy and Entrepreneurial Activity: Productive, Unproductive, or Destructive?"

Minniti says that the evidence we have shows productive entrepreneurship needs a level playing field. She states, "We observe in certain countries that certain environments seem to be more conducive to productive entrepreneurial activity. We are all entrepreneurial to some extent. The issue is to promote productive entrepreneurship as opposed to forms of entrepreneurship based on rent seeking and the exploitation of regulatory loopholes."

Minniti asks the question: What environments are more conducive? "Where there are clear property rights, intellectual property rights, patents, and guidelines, entrepreneurs can take advantage of their own work," she continues. "By definition, entrepreneurs deal with the uncertainty of novelty, they do not need the added risk of an unclear environment-clear monetary policy, low inflation, and everything that reduces uncertainty but at same time preserves the ability of the market to signal supply and demand helps. Over-regulation constrains this spirit." During the current crisis, Minniti notes that political intervention is generating uncertainty.


Entrepreneurs' changing nature

In the last decade or so, many governments have paid increasing attention to entrepreneurship and have implemented policies aimed at fostering it in their countries. The results of such policies have been mixed. In fact, a broad search of the literature reveals that the fundamental and general question of how, and if, governments are able to influence positively entrepreneurial activity is far from being resolved.

Recent studies have shown that the contribution of the entrepreneurial sector to employment and GDP is increasing. With entrepreneurial activity having important social implications, policy discussions have centered on the idea that governments seeking to stimulate their economies should reduce constraints on entrepreneurship.

The role of the entrepreneurial sector is said to have changed when industrial comparative advantages shifted toward knowledge-based economic activity. First, large firms in traditional manufacturing industries lost their competitive edge. Second, smaller and more flexible entrepreneurial firms gained new importance in an increasingly knowledge-based economy. In the last 20 years, industrial policies have experienced a significant shift in which smaller and more dynamic ventures have been acknowledged as drivers of innovation; and a new set of interventions designed to promote entrepreneurial activity has emerged.


The power to influence

In his classic 1990 research, Baumol argued that the supply of entrepreneurs and the nature of their motives undergo no significant change from one period to another: What matters, instead, are institutions-the rules of the game dictating the ultimate effect of entrepreneurship on the economy via the allocation of entrepreneurial resources. The contribution of entrepreneurial activity varies because of its allocations between desirable activities, such as innovation, and unproductive activities, such as rent seeking or organized crime. Thus, with the appropriate institutions, government policy can influence the allocation of entrepreneurship more effectively than its supply.

Institutions, such as the policy environment, influence the relative incentives and payoffs. Thus government policy has the power to influence entrepreneurial activity, but may not be necessarily desirable, as it may steer entrepreneurs toward actions that have negative socioeconomic consequences.

Policy strategies, with respect to entrepreneurship, need to be tailored to the specific institutional context of each economic region-"one size does not fit all." For example, the environments required for productive entrepreneurship are likely to differ significantly between a rural area, a high-technology cluster and a metropolitan area. Therefore, policy design needs to take account of local differences, and to adapt to the different scale and nature of existing resources, networks, and market capabilities. In spite of this need for diversity, entrepreneurship policies tend to be based on a handful of policy tools. Among them are financing, taxation, regulations on trade, and encouragement of innovation activities.

The empirical evidence on the effectiveness of financing support is mixed. While microfinance schemes are usually assessed positively, other forms of financing have been criticized. Some governments have also focused their efforts toward attracting new venture capital. The empirical evidence, however, is once again mixed. Research has shown that entrepreneurial activity attracts new venture funding, but the reverse is not true. Additionally, venture capital has been shown to account for only a very small amount of overall financing to entrepreneurship.

The policy instrument of taxation is shown to be less important to entrepreneurs than is often portrayed. Minniti says, "Of course entrepreneurs want lower taxes, but it's more important to have a favorable environment where one can make reasonable guesses about the future."

Barriers to trade are particularly costly and detrimental to the entrepreneurial sector. While internationalization (globalization) has been described as a gradual, sequential process, more recent research has shown that firms do not necessarily follow any consistent pattern in their internationalization. In fact, start-ups emerging in knowledge-based industries are likely to enter international markets directly and, as a result, are more likely to benefit from low trade barriers.


Supporting innovation

Though globalization extends the frontier for entrepreneurs, another common type of policy has focused on local interventions. The best known example of such policies are the creation of formal and informal support mechanisms (for example, chambers of commerce and training programs), publicly sponsored incubators, and, most of all, science, technology, and research parks. Entry, growth, survival, and the way firms and industries change over time are linked to innovation. Thus, the performances of regions and even entire economies have been linked to how well the potential from innovation is expressed in the economy. Rather than importing successful policies from other areas, direct subsidies for R&D and support of linkages between universities and the private sector should reflect and respond to the needs of specific localities or regions to be effective.

Local entrepreneurial policies are still evolving, but are clearly gaining in importance and impact in the portfolio of policy instruments. In roughly the last 20 years, governments have become increasingly active in assisting entrepreneurs at the regional level and fostering industrial clusters, technology transfer, and high-tech start-ups under the assumptions that these sectors will be competitive in the future. Researchers provided considerable evidence that knowledge spillovers result in both a geographic clustering of innovative activity, as well as an increase in start-ups across innovative industries, such as semiconductors and biotechnology.

Knowledge is inherently different from traditional factors of production, such as land, labor and capital, and is more difficult to evaluate. While the contribution of innovation policy to entrepreneurship has become a mantra for today's policy makers, the implementation and assessment of policy remains problematic because many of these initiatives are still too young to be assessed.

Research found that states with both economic and science and technology (S&T) initiatives have six times as many new firms than states without such initiatives. But economic initiatives have a stronger effect than S&T initiatives. States with the earliest innovation policies, as evidenced by first-mover advantages, also have higher rates of related firm founding over time. States that are most attractive to entrepreneurs pursue technological innovation but also encourage and legitimize commercial development.

What matters, researchers say, is not the type of industries that develop, but the environment in which entrepreneurship takes place. A good regional context for innovation might resemble a diversified city made up of many specialized clusters-the birth, life, and death of diversified urban centers being part of a spontaneous order that rests on entrepreneurship.

Minniti comments on the case of New York City. "Crime used to be the main problem. This applies also to some areas of Dallas." She speaks of how New York is now completely different than it was 20 years ago. The main thing, she relays, was cleaning up the streets. Crime is the single most important factor because people are then afraid to work, live, and do business with its associated costs. She adds, "Resources are scarce so a city cannot do all of the proposed initiatives at the same time. Giuliani did this type of concentrated intervention to reduce crime. You cannot address everything at same time." There was a big payoff for New York in focusing their resources. She mentions that once the crime was gone, businesses returned and dilapidated streets were beautified. "People respond to incentives, not necessarily monetary ones. A similar process seems to be happening in Newark, NJ."

Governments are not able to make any prediction about what type of entrepreneurial activity is more desirable, nor about how to make it emerge; to do so would require them to perform an impossible calculation. But governments can create a reliable set of institutions in which the entrepreneurial spirit of people may flourish. Policies that ensure institutional transparency, predictable taxation, and secure property rights do not require computations of specific outcomes.


Conclusion

Effective entrepreneurship policy cannot be one that limits itself to business subsidies or imposes top-down strategies. The fact that entrepreneurship is positively linked to performance does not justify public policy intervention. The mandate for public policy intervention can only be the result of fundamental market failures. Entrepreneurship is there, whether we like it or not. Governments can only provide an environment conducive to productive rather than unproductive entrepreneurship. Thus, government should create enabling environments conducive to the division of labor, the commercialization of invention, and exchange. Too much public involvement can hinder entrepreneurs by creating possible market distortions.

In the end, government policy should not aspire to the elimination of new venture failures. Although painful at the microeconomic level, business churning is part of a healthy economic system. Most important, only the market can determine what the optimal amount of entrepreneurship is - and which firms to target for success or failure.

In this current business climate, Minniti elaborates on the idea of allowing business to reconcile their mistakes: "My impression is that small business will fare better because they are more flexible, nimble, and can adjust better. The main crisis we're seeing is of very large companies. They would have probably been in difficulties regardless of the situation because of their structural and competitiveness issues." She continues, "At the micro-level, there is a cost when there is a downturn in the business cycle. But at the economy level, subsidizing failure too long may cause a long-term effect. For example, if we transfer bad debt and make it good because of a government guarantee, I don't see any incentive for people in the market to start responding again to what the economy requires." She adds that given the size of the deficit, " I don't see how we cannot have inflation. There is a strong risk of making things worse."

The recent financial crisis provides a real-time textbook example of the effects of government policy interventions and its role in entrepreneurship.


"The Role of Government Policy and Entrepreneurial Activity: Productive, Unproductive, or Destructive?" by SMU Cox Chair of Entrepreneurship Maria Minniti was published a special issue of Entrepreneurship Theory and Practice (September 2008).

Summary by Jennifer Warren.