Baumol's institutional theory of entrepreneurship

What is Baumol's theory of entrepreneurship?

William J. Baumol was an American economist at New York University. His theory of entrepreneurship starts with the assumption that every society is endowed with their share of entrepreneurs. However, the way in which entrepreneurs use their energies depends upon the institutions—the rules of the game—in place in a given society. It is also sometimes called a political theory because the regime in a given country or territory may have tremendous influence on incentives. He argues that entrepreneurs may engage in productive (i.e., innovation) or unproductive (rent-seeking and crime) forms of entrepreneurship depending on what a country’s institutions encourage.

Baumol argues that the notion of a “spirit of entrepreneurship” is useless for policymakers because there is really nothing they can do to improve it. He proposes that by altering the rules of the game, policymakers can actively invigorate productive entrepreneurship in their societies and reduce unproductive or destructive forms of entrepreneurship. Changes to the rules of the game can vary but include changes to tax rules, regulations, subsidies and support programs. The idea is to hone the rules over time until a maximum positive effect on entrepreneurial outcomes is detected.

Baumol uses several historical narratives to back up his theory. For instance, in Feudal Europe, entrepreneurship was largely destructive or redistributive. At the time, most of Europe was organized into small autonomous territories, such as a castle protecting a few thousand acres of farmland. Young men with ambition (princes) could put together an army and attempt to sack a nearby fiefdom. The result was some measure of death and destruction, and nothing was productive was accomplished. No new wealth was created--it only changed hands and at a high cost. He also uses the example of entrepreneurship being tied to calligraphy in ancient China and then of sexual slavery in ancient Rome as is shown in the example below. All the example have in common a set of pathways of acceptable conduct that are used to guide entrepreneurial energies.

"A clever (and handsome) member of the lower orders might deliberately arrange to be sold into slavery to a wealthy and powerful master. Then, with luck, skill, and drive, he would grow close to his owner, perhaps managing his financial affairs (and sometimes engaging in some homosexual activity with him). The master then gained cachet, after a suitable period, by granting freedom to the slave, setting him up with a fortune of his own."

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Baumol, W. J. (1996). Entrepreneurship: Productive, unproductive, and destructive. Journal of business venturing, 11(1), 3-22.921.