Entrepreneurship, capital and capitalism

Ranil Dissanayake was trained as an economist and historian. He now specialises in aid effectiveness, having advised the Government of Malawi in this field for almost four years, before taking a similar post in Zanzibar.

He can also be found blogging at AidThoughts (http://aidthoughts.org/)

Recent debate on the role of entrepreneurship in the economic development of the world’s poorest countries has been largely misconceived. While many have focused on the need to support entrepreneurs or to expand their opportunities, the historical and structural aspects that form the context in which entrepreneurship contributes to economic dynamism have been largely ignored.

Specifically, three crucial aspects of the debate have been underplayed:

nthat entrepreneurship has long existed in a vibrant form throughout Africa and Asia, and in some cases for centuries;

nthat those countries that transitioned into major industrial economies elsewhere were distinguished by changing economic systems, structures and laws rather than entrepreneurship; and,

nentrepreneurship does not have the same benefits in all economic systems – it is under true capitalism that it has generated the returns we associate with it in the West.

To focus on entrepreneurs is to neglect the difficult but potentially far more dynamic aspects of economic development that developing countries lack. The question is not ‘does entrepreneurship support economic development’, but ‘under what circumstances does it do so?’

The entrepreneurial impulse

That entrepreneurship is in no short supply in the developing world is self-evident. If entrepreneurship is taken to be that characteristic that finds or creates economic opportunity and seeks to exploit it, it is difficult to think of a single place in Africa where it is not abundant. In rural Malawi today, if you express admiration for the pattern of a dress or design of a shirt, you will either be offered a roll of the same material or the item of clothing itself. This aim of transforming desires into profit is the essence of entrepreneurship, and the inventiveness with which it is achieved is staggering. At the port in Dar es Salaam, it is possible to charge a mobile phone at small stations where a car battery is used to power a range of phone chargers for a fee. Aggregated over the numbers of travellers embarking on ferries daily, this provides the basis of a sustainable company of sorts. The entrepreneurial impulse is powerful in Africa. It is, however, often unable to find expression or is limited to small enterprises.

This should be no surprise for scholars of the developing world. As far back as the 18th and 19th centuries, Chinese, Arab, Asian, and African merchants were taking opportunities provided by new trading relationships and routes to move their goods across the world in return for increased profits. While Europeans generated the lion’s share of the value-added in these relationships, they were responding to an acute entrepreneurial impulse. A range of historians have shown that vivid successes were being made even in the pre-colonial period in Africa, Asia, and the Arab world.

Addressing the constraints

Entrepreneurship is therefore abundant, and has historically been so. Its absence is not the constraint to industrialisation or dynamism in the economic path of the developing countries. The issue is that entrepreneurship struggles to find an appropriate outlet through which it can achieve the massive accumulation and growth that has characterised the European economies. It is addressing the constraints to this outlet that we should be devoting our energies. Again, a historical analysis can help us untangle what some of these issues were. In The Birth of the Modern World, the historian Chris Bayly looks at this very question: what was it about Europe and North America that transformed their entrepreneurship into massive trans-national economic entities, while other countries languished? He comes up with a range of characteristics, some of which are no longer relevant today. However, a number still are.

First among these was the importance of establishing transport links, both internally where an internal market exists, and externally where trading opportunities are available. This remains a massive drawback, particularly for Africa: the World Bank’s Doing Business report suggests transport costs in Africa are significantly higher than elsewhere. Entrepreneurship requires access to sufficient markets to be fully realised.

Bayly also cites the move to modern forms of intensive, investment-heavy agriculture which produced the domestic surplus required to power the urbanisation and industrialisation of European and North American economies, without requiring too great an import burden. Yet, food security in much of Africa remains fragile, largely because landholding patterns rule out the move to more intensive, commercial farming.

Additionally, the stability (geographical and political) of dominant groups created an incentive to invest – the possibility of accumulation of the returns to entrepreneurship provided a powerful accelerant to its realisation.

The Mystery of Capital

The other two central areas that Bayly cites are the importance of the emergence of modern financial institutions to provide credit, and new legal structures to stabilise the legal status of risk and returns to ownership. These factors form the central concern of Hernando De Soto, whose book, The Mystery of Capital, is probably the most important contribution made in the last 20 years to the question of Third World entrepreneurship. De Soto’s argument is essentially that entrepreneurship is limited by the availability of capital. What makes this argument so powerful is that he conceives capital in a far more complex way than it is commonly thought of.

De Soto shows that the value of assets held in the Third World is immense – several trillion dollars. Yet little of this can count as ‘capital’ since it is not bound by the central factor that creates capital: a functioning, efficient legal system that recognises and regularises the popular notions of property. Once assets are converted into legal property, they obtain a number of characteristics that convert them into capital.

 Their economic potential is fixed in the process of legally defining what they contain of value; they become part of a single network of information, which enables them to be traded, accumulated and acquired with ease; the owners are made accountable and legally liable for the asset, thus reducing risk associated with borrowing on them and so on. Combined with a strong borrowing and lending system, capital provides the fuel from which entrepreneurs can power their economic schemes.

For De Soto, therefore, our concern for entrepreneurs is misconceived. We should be far more exercised by the need to convert their assets into capital, subject currently to one major constraint. This constraint is the legal system. In far too many countries, there is currently either no recognition of what is socially accepted to be private capital or there are intolerable barriers of bureaucracy. To own legal property in Haiti, for example, takes up to 19 years.

The importance of stability

Yet, even if we resolve the outstanding issues concerning transport links, the need for commercialised agriculture, and the currently inadequate legal and financial systems, there may still be a fundamental constraint that entrepreneurs must overcome: the existence of stable capitalism. One of the issues that Bayly identified as crucial for Western development was that the stability of elite groups allowed them to reap the benefits of investment and entrepreneurship.

A similar argument is the root of Karl Marx’s analysis of why capitalism as a system allows entrepreneurs the freedom to power economic progress. Marx demonstrated that capitalism was more than markets or entrepreneurs. These have existed since time immemorial: it is difficult to think of any society in recorded history where each did not exist. What distinguishes capitalism from earlier systems are the specific relations between those who have the means to accumulate, and those who must work for a wage.

Essentially, under capitalism some entrepreneurs are able to accumulate capital, and can maintain this capital with some stability, in the sense that it is not arbitrarily seized from them; they then apply labour from a pool of property-less unemployed to their capital in order to generate profits. Because the capitalist does not use his own labour and takes the excess of revenue after wages are paid as his profit, his incentive is always to apply more capital to his property and to his labour force in order to increase the revenue generated from a constant labour force.

Incentives and potential

A smallholder, or a small self-employed entrepreneur, does not have the same incentives or potential. His horizons are limited on two dimensions: if he himself is his primary source of labour, his incentives as an entrepreneur, and as a labourer who values rest and recreation, are not in harmony; secondly, his limited asset holdings restrict the amount of capital he can access – the problem De Soto identified.

 As Lindsay Clinton noted in a recent article for The Wall Street Journal, a focus on entrepreneurs therefore gives no guarantee that the vast numbers of unemployed will see any benefits. We should instead be looking to allow a smaller pool of entrepreneurs to build the economic empires that can employ thousands, and form the basis of a competitive economy.

None of this is to suggest that entrepreneurship is unimportant. It is a necessary but insufficient condition for economic development, one that is already satisfied in almost all countries. Our focus should be on the supporting conditions that are necessary to give entrepreneurs the platform and capacity to catalyse economic growth and employment.

(Source: UNIDO: Making it Work)