The key to entrepreneurship is freedom

Eamonn Butler

April 15, 2020

I’ve written before about the huge benefits of entrepreneurship and innovation, which account for most of the world’s economic growth. And I have pointed out how inept governments are at creating and maintaining the conditions under which these good things flourish. So, how should we do it?

Are education and research the answer? Well, there is no obvious link between entrepreneurship and spending on research. It is remarkable how many super-entrepreneurs dropped out of college (eg Facebook’s Mark Zuckerberg, fashion designer Ralph Lauren, Microsoft founder Bill Gates, Apple co-founder Steve Jobs) or never went at all (eg inventor Sir Clive Sinclair, designer Coco Chanel, serial entrepreneur Sir Richard Branson).

Or is market size important, with a large domestic market helping entrepreneurs to win customers and expand? Well, the US, with a population of 325 million, is very entrepreneurial. But the EU, of 445 million, is not, so that can’t be the answer either. Other factors, such as access to capital, freedom of innovation and action, culture, taxation, regulation and the country’s legal and other institutions actually seem much more important.

The true key is freedom. The statistics show that freedom and entrepreneurship go hand in hand. The countries at the top of the Fraser Institute’s Economic Freedom of the World index also excel in entrepreneurship measures.

There is also a strong correlation (0.87) between countries’ freedom scores on the 2019 Heritage Foundation Index of Economic Freedom and their entrepreneurial dynamism as measured by the Legatum Institute Prosperity Index business environment pillar score. And there is a strong correlation (0.77) too between countries’ overall score in the Index of Economic Freedom and their score on the Global Innovation Index published by Cornell University, INSEAD and the World Intellectual Property Organization.

But then, as Matt Ridley says, “inventions and discoveries emerge by serendipity and the exchange of ideas, and are pushed, pulled, moulded, transformed and brought to life by people acting as individuals, firms, markets…” In other words, innovation is an evolutionary process that works best if people are free to look for new and better ways of doing things.

An open culture is vital too. Economic historian Deirdre McCloskey argues that positive attitudes towards business encourage entrepreneurship, and always have. Such “bourgeois values”, she says, explain the expansion of commerce in England before and during the Industrial Revolution and the success of the US today. Entrepreneurs flourish where they are generally admired, not resented.

Common law legal systems also seem to be very much better at encouraging entrepreneurship than others. Entrepreneurship is twice as prevalent in the English legal tradition than the German, for example. It is three times greater in the English tradition than the Scandinavian, and five times greater than in the French.

Put simply, English common law allows “permissionless innovation”. People are generally free to do whatever they want, as long as it does not harm others. They don’t have to wait to get permission from some bureaucratic and risk-averse government.

Tax policy is vital too. Entrepreneurs live in an uncertain world. They cannot accurately predict whether their investments will pay off or not. Countless events, such as new competition, changing customer demand, supply shortages and management errors, can turn potential future profits into real and present losses. Tax, therefore, makes a big difference to their calculations. Higher taxes mean higher risks, and fewer people taking them.

So-called windfall taxes are particularly damaging. Mainstream economists think you don’t discourage entrepreneurship by taxing lucky accidents (say, a virus alert allows people who supply hand sanitiser to make extra profits). But if entrepreneurs come to realise that they will bear their bad luck losses but lose their good luck gains, that is a serious discouragement. And small businesses in particular cannot simply rejig their production to avoid the taxes.

Regulation can discourage innovation too. In Venezuela, it takes 230 days to register a new business; in the Lao People’s Democratic Republic, it is 173 days; in Cambodia, 99 days. At the other end of the scale, it takes only four days to start a business in the US, two in Australia, Canada, Hong Kong and Singapore, and just one in Georgia and New Zealand. In Estonia, businesses can be established online in seconds. Guess which are more entrepreneurial and innovative.

Heavily regulated economies have two to three per cent lower economic growth than less heavily regulated ones. But developed economies are going the way of Venezuela. Opening a restaurant in San Francisco, for example, requires 14 different permits, including planning, building, fire, public utilities and others. These different processes can take nine months to complete, often costing the entrepreneur thousands of dollars in rent on premises that cannot be used until every last permit is signed off by officials.

There is a positive correlation between the strength and security of property rights in a country and its entrepreneurship rate. Given the uncertainty facing any business, both secure property rights and the rule of law are vital to people’s decision to risk their money and effort. There is no point in farmers planting a crop, for instance, if they expect that the harvest is likely to be stolen from them at gunpoint.

The need for secure property rights, including copyrights, patents, brands and other “intellectual” properties, is even greater for entrepreneurs. Most ventures fail, and most entrepreneurial investments do not pay off. So, if people are to take those entrepreneurial risks, they need to be confident that they can reap the reward from the few that succeed.

Another important factor is a country’s openness to foreign capital and migration. Many entrepreneurs are immigrants. They have had the bravery, energy and enterprise to leave their homeland and start afresh somewhere else, all traits that are useful to an entrepreneur. And they are more likely to see opportunities that the locals, bound up in the prevailing culture and imagination, might miss.

Policies to attract (and retain) entrepreneurial immigrants may include work visas for students so that they can study in the host country and stay on to work for a firm in their field of interest. Or even to start their own enterprise. Several countries have special visas for foreign entrepreneurs, and even more have special visas granting residence to investors.

But an open immigration policy that attracts and retains any worker, skilled or not, has a disproportionately high chance of attracting people with an entrepreneurial spirit and, more generally, promoting prosperity and reducing poverty.

Despite everything the state does (not always intentionally) to suppress it, the entrepreneurial spirit is strong almost everywhere. Even in the most highly regulated countries, people show remarkable ingenuity in getting around the official rules in order to improve life for themselves and their families. People are hugely resourceful at coping with problems and taking opportunities; their entrepreneurship is quite easily unleashed. So, anything that can be done to unleash it, and turn it from unproductive to productive, can deliver large benefits to the community.

Peace, low taxes, sensible regulation, liberal trade and commerce, and an open, competitive business environment are crucial to the spread and success of entrepreneurship. There is no need for government to set up small-business bureaucracies just to remove barriers to international trade, welcome migrants, end discrimination against women and minorities who may bring new ideas into business, simplify employment laws, taxes, social charges and licencing, and so on. Particularly for smaller firms which they impact most.

When Alexander the Great met the Cynic philosopher Diogenes, who eschewed worldly comforts and lived in a barrel, he asked: “Great Diogenes, what can I, with all my wealth and armies, do for you?” Diogenes looked up at him and waved him away, saying: “Just stand out of the sun.” If governments really want entrepreneurship and its benefits to grow, standing out of their sunlight seems sound advice.

Author

Written by Eamonn Butler

Eamonn Butler is Director of the Adam Smith Institute.

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