Entrepreneurs and global wealth since 1850 – Part IV

November 13, 2013

Why, after the Industrial Revolution began in the West, did the Rest struggle to catch up?  Professor Geoffrey Jones argues that entrepreneurs are the missing gap in the analysis of what creates a prosperous modern economy.  Since 1850 those countries with the most friendly environments for entrepreneurs have innovated and prospered.

In this final installment we excerpt the author’s thinking on three more factors at the national level that affect entrepreneurship:  human capital, geography, and infrastructure.  We then close below the jump with his conclusion (verbatim) from the working paper that led to the book. 

(Here are links to Part IPart II, and Part III of this series.)

A popular explanation for wealth and poverty is egalitarian mass provision of secular education.  We agree that investing in human capital is important in its own right, but also agree with the author that it does not guarantee the spontaneous emergence of entrepreneurship.  Other vital pieces have to be in place as well:

Knowing that political and legal institutions or human capital matter is important – but a further set of critical questions relate to how firms and entrepreneurs interact with these aspects of an economy. It is firms and entrepreneurs which create wealth and innovation, rather than governmental institutions or schools. Here the economics literature is less well-developed. Institutions and human capital are treated as the first order causes of economic growth. The assumption is that if a society evolves or adopts the right institutions, or else has good human capital investment, firms and entrepreneurs will more or less appear spontaneously and create economic growth. The business history literature suggests that this is a considerable over-simplification… This brief survey of the historical evidence suggests that neither institutions nor human capital are fully discrete, and that historical case studies provide different answers to the question about what matters most. There are likely to have been other factors at work also. To have entrepreneurship, there must be entrepreneurial opportunities.

Regarding the role of geography and infrastructure, Professor Jones appears to ascribe the emergence of large integrated firms in the U.S. to the “Chandlerian” model and offers keen observations about two other interesting cases:

The growth and size of the American market provides a key component of the Chandlerian explanation for the emergence of large integrated firms in the United States.  It seems plausible that both in the case of Britain, the first industrializer, and Japan, the first successful non-Western catch-up, identification of entrepreneurial opportunities, and the building of managerial structures which permitted their exploitation, was facilitated by geographically compact domestic markets and unusually large capital cities.  The market opportunities for firms and entrepreneurs in most of Asia, Latin America and Africa were more constrained. They often faced great difficulties if they wanted to sell beyond their local markets because of poor transport and communications infrastructure. In India, market conditions have been identified as one explanation why India’s powerful and rich merchants in the seventeenth and eighteenth centuries left manufacturing in the hands of small artisans, pointing to fragmented markets, inadequate transport infrastructure, lawlessness and disregard for property rights.  These constraints were relaxed as the British colonial regime imposed political stability and promoted transport infrastructure, but a well-established argument in the literature on nineteenth century India has maintained that the small scale of the domestic market retarded the growth of a modern machinery industry…

The role of the state in catching up economic backwardness has been debated since the writings of Gershenkron decades ago.  However, the ways in which governments facilitated entrepreneurial perception and exploitation of opportunities has not been the primary emphasis of this research. Yet it is difficult to account for the rapid economic growth of the United States in the nineteenth century without mentioning government policy. The Federal government purchased, or annexed, much of the territory of the present day country, and then largely gave it away. State governments were active promoters of infrastructure investment. High levels of tariff protection widened the market opportunities for entrepreneurs and firms by shutting out cheaper imports from Europe.

Please find the summary/conclusion from Professor Jones’s white paper below:

This working paper has sought to integrate the role of entrepreneurship and firms into debates on why the Rest was slow to catch up with the West following the Industrial Revolution and the advent of modern economic growth.  It was been suggested that poor human capital development and deficient institutions are important, but not sufficient, explanations. The emphasis on national-level institutions seems particularly unhelpful given strong regional variations in business activities between countries.  The impact of institutions on the allocation of entrepreneurship between productive and redistributive activities takes the analysis to a deeper level, without entirely solving the problem, as the slow development of modern business in colonial India, and its skewed ownership, indicates. Entrepreneurs were also actors and not simply responders to institutions and resource endowments. They could train their own workers and they introduce investor protection into their own bylaws.

It is evident that once the process of modern economic growth had started catch-up was surprisingly difficult in much of the Rest, if less so neighboring regions of the original North Sea industrializers. The societal and cultural embeddedness of new technologies posed significant entrepreneurial challenges in the Rest. The best equipped to overcome these challenges were often entrepreneurs based in minority communities who held significant advantages in capital-raising and trust levels. They often also benefited from a greater willingness to engage with Western firms and colonial governments. Generally, as the first global economy got underway, MNEs proved important facilitators of globalization, but they were a disappointing diffuser of organizational skills and information to the Rest, and had limited importance in relieving the institutional, human capital or other constraints faced by many local entrepreneurs.  By the interwar years there is considerable evidence of productive modern entrepreneurship and business enterprise emerging across Asia, Latin America and even Africa.  Japan was a spectacular case of a more general process. This generation of entrepreneurs were sometimes facilitated by nationalistic governments and sentiments, and in China and elsewhere they were quite effective combining local and Western practices to produce hybrid forms of business enterprise. However many governmental policies after 1945 designed to facilitate catchup ended up crippling emergent business enterprises without putting an effective alternatives in place. They were too inward looking, and too inclined to incentivize inefficiency and corruption rather than innovation. Many policy regimes ended up favoring redistributive rather than productive entrepreneurship, although it was noteworthy that they also provided some shelter for local firms to develop without being crippled by competition from the West. Individual businesses had the agency either to invest in managerial and technological competences in this era, or alternatively focus on rent-seeking, but the rules of the game often made the first path the easier one.

The second global economy provided more opportunities for catch up from the Rest. Firms from emerging markets had the opportunity to access the global networks which, in part, replaced large integrated firms. There were new ways for firms in the Rest to access knowledge and capital, including returning diaspora, business schools and management consultancies. Smart state capitalism was a far greater source of international competitive advantage than the state intervention of the past, even if many government policies were not smart and continued to offer incentives for rent-seeking.

The rapid international growth of MNEs based in emerging markets was a striking departure from the past. However global capitalism also remained a system which rewarded winners, and facilitated clustering in favored locations. Innovation remained heavily clustered in the advanced countries, especially the United States. Western and Japanese firms have powerful incumbency advantages. Falling tariff and other barriers meant that a new generation of firms based in the Rest might even find it harder to reach scale than their predecessors who could grow in the much-derided era of import substitution.

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