This post is one in a series by the Growthology team, where we will take a look at some of the topics discussed in State of the Field, a compilation of knowledge on entrepreneurship research written by the leading experts in the field.
What happens when the government places a bounty on cobras? People start to breed cobras to collect more bounty.
This was the case in colonial India. Once the bounty policy was enacted, cobra hunters became cobra breeders, realizing they could make a stable income from the bounties. In turn, when the government realized this and started to crack down on cobra breeders, thousands of cobras were released onto the streets, creating a more dangerous situation than before. This kind of narrow, targeted policy that caused perverse effects is called the cobra effect and has been documented multiple times throughout history.
This case exemplifies the impact that formal institutions, through regulation and law, can have on the allocation of entrepreneurship behavior – be it, productive, unproductive or destructive entrepreneurship (such as the cobras).
Formal institutions (protection of property rights, taxation, bankruptcy, financial institutions) undoubtedly have an impact on entrepreneurial behavior and allocation. However, there remain questions of which kinds of formal action (tax, law, and regulation) will positively affect the supply and allocation of entrepreneurship. What sort of institutional changes incentivize the quantity of entrepreneurial firms or quality? Will these changes encourage the growth of new firms or innovation and growth in existing firms? These questions are central to the State of the Field topic of Institutions and Environment and are explored in the recent paper, Public Policy to Promote Entrepreneurship: A Call to Arms.
The authors of the paper examine five different market failures or externalities that motivate entrepreneurship public policy: network externalities, knowledge externalities, failure externalities, demonstration externalities and sunk costs. Examining these factors in the western world, the authors find little evidence of entrepreneurship public policy correcting these market failures or improving the environment for productive entrepreneurship.
In many of the attempts to correct for market failures, policy makers have chosen a narrow policy measure (e.g. tax incentives for firms with more than a certain number of employees or government involvement in Venture Funding). Many of these narrow-focused attempts have backfired because policy makers fail to internalize the incentives they create – as with the case of the cobra effect in colonial India.
Likewise, the best forms of formal institutional change for entrepreneurship don’t focus narrowly on entrepreneurship, but on society at large.
“Indeed, if we accept that entrepreneurship is a deeply ingrained feature of many Western economies, we should not be surprised that successful policy measures will likely involve subtle and pervasive policy initiatives that have the unintended consequence of changing people’s minds about the costs and benefits of entrepreneurship.”
Examples of formal institutions that strongly impact the allocation and supply of entrepreneurship are everywhere: property rights, taxation, bankruptcy law, financial institutions, competition policy, and labor market regulations. Researchers from multiple disciplines – economics, strategic management, sociology and more have explored how changes in formal institutions matter on State of the Field.
Immigration reform, education and healthcare are some of the key issues that are the focus of researchers and policymakers. These are specific examples where a broader policy improvement leads to better outcomes for entrepreneurship in America. In fact, national legislature—Startup Act 3.0—has been proposed to address some of the aforementioned areas that benefit both society and indirectly improve the environment for productive entrepreneurship.
In order to develop formalized institutional change that accounts for the re-optimization of entrepreneurs, future policy must be informed with research stemming from multiple disciplines. Entrepreneurship is not one monolithic thing, and thus has something to learn from many different disciplines and approaches. Too often public policy is informed by just one or two disciplines, and creative paths to mold institutions to better outcomes for entrepreneurs are lost.
What do you want to know about institutions and environments and how they affect entrepreneurs? Let us know and check out all of the research topics including Institutions and Environment that make up Kauffman’s State of the Field! Check out the NEW website for updates!
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