The incentives for entrepreneurs

Vast volumes have been written on the importance of entrepreneurship in building prosperity. Entrepreneurs innovate, identify new markets, implement new systems and process, connect labour, capital and technology in novel ways; in short, entrepreneurs make stuff more efficient than before. But measuring the contribution of ‘entrepreneursip’ to growth has been difficult, given the unquantifiable nature of entrepreneurial traits: motivation, creativity, risk-taking, to name a few. In a recent working paper, Sascha Becker and Hans Hvide claim to have found an answer to the question: Do Entrepreneurs Matter? They consider Norwegian companies between 1997 and 2008 and identify 500 firms where the founding entrepreneur died. This exogenous shock they show had strong negative consequences for these firms, regardless of firm size, age and location. Interestingly, more qualified entrepreneurs had a larger negative impact. (Read the review here.) Entrepreneurship clearly matters.

The more important (policy) question, though, is how to cultivate entrepreneurship. How important is formal education in creating entrepreneurs? (What type of education?) Does access to finance play a role? Rules and regulations? Inequality?

Koos Bekker at the World Economic Forum

William Baumol, in his famous 1990 paper, suggests an alternative framework for thinking about entrepreneurship. Instead of (attempting to) cultivate entrepreneurship, he assumes a given stock of entrepreneurs in all societies. (Just as one would assume that there is a given stock of land-handed people in all countries, instead of trying to ‘cultivate’ left-handed individuals.) The important question, Baumol suggests, is how to change the incentives for entrepreneurs so that they participate in what he calls “productive” activities. Here is his central hypothesis: “the exercise of entrepreneurship can sometimes be unproductive or even destructive, and whether it takes one of these directions or one that is more benign depends heavily on the structure of payoffs in the economy – the rules of the game.”

Baumol use historical examples to show how the incentives for entrepreneurs – in essence, the risk-taking individuals in society – determined whether they were involved in productive or unproductive activities. Where warfare was the most likely activity to yield wealth, ‘entrepreneurship’ was rewarded through war spoils, with destructive consequences for the economy. In other societies, incentives were directed to rent-seeking, i.e. spending resources on obtaining a larger share of existing wealth, instead of growing the wealth, also known as redistribution. The most successful entrepreneurs, in this context, were those that could extract as much wealth from the state.

These ideas are particularly relevant for South Africa. The rules of the game changed dramatically for white South Africans during the late 1980s and early 1990s. Gone were the days where the state could be relied on for support, where rent seeking could be a profitable exercise. Instead, as I’ve written before, it was Afrikaner entrepreneurs that came to the fore after 1994 – Jannie Mouton, Michiel le Roux, Christo Wiese, Koos Bekker. Much of this success has been built on export markets: between 1998 and 2013, Naspers shares increased by more than 1900%, largely due to investments in China, Russia and Brazil. The Financial Times recently dubbed Bekker the “exemplar of the post-apartheid Afrikaner”.

But how has the post-1994 “rules of the game” changed incentives for black South Africans? Have Black Economic Empowerment facilitated productive or unproductive activities by black entrepreneurs? Where are the highest financial rewards for black South African entrepreneurs: to sell to a market, or to sell to government? In the former, competition is rife and global; in the latter, competition is protected because only BEE-rated businesses compete. It seems the incentives are heavily biased in favour of (unproductive) government contracts.

Here is the key question for policy-makers: What can we do to modify and improve the rules of the game (the reward structure of the economy) so that entrepreneurs – black and white – change the type of activities they engage in (from unproductive to productive)? Allocating more entrepreneurial resources towards more productive activities is the key to building a prosperous future.