Entrepreneurship: Productive, Unproductive and Destructive

Reading on Entrepreneurship: Productive, Unproductive and Destructive
By William J Baumol 1990

Using historical analysis, Baumol suggests that entrepreneurial activities can be productive, unproductive and even destructive depends on what kind of activities took place and how did it allocate in society. He argues that policy maker can influence the allocation of entrepreneurship more effectively than it can influence its supply.

Expanding on Schumpeterian model of “Innovation” which Baumol would refer as productive entrepreneurship, he regards activities such as rent-seeking as one kind of unproductive entrepreneurship.

In Schumpeterian model, innovation which leads to entrepreneurship covers five cases: 1) introduction of a new good, or of a new quality of a good; 2) the introduction of a new method of production; 3) The opening of new market; 4) the conquest of new resource of raw materials or half manufactured goods; 5) the carrying out of the new organization for any industry, such as in monopoly position or the breaking through a monopoly position.

Baumol thinks Schumpeterian model has its limitation. For example, it does not explicitly encompass innovative acts of technology transfer that take advantage of opportunities to introduce already available technology. He suggests expanding Schumpeterian model to include such items as innovations in rent-seeking procedures, which is an unproductive entrepreneurship.

Here, we need to examine the definition of entrepreneurship. If entrepreneurs are defined to be persons who are ingenious and creative in finding ways that add to their own wealth, power, and prestige, then it is to be expected that not all of them will be good for society as a whole. Baumol argues that the exercise of entrepreneurship can sometimes be unproductive even destructive, depending on structure of payoffs in the economy- the rules of game.

He therefore provides two propositions:

1. the rules of the game that determine the relative payoffs to different entrepreneurial activities do change dramatically from time to time
2. Entrepreneurial behaviour changes direction from one economy to another in a manner that corresponds to the variation in the rule of game.

Historical evidences:

-Where the rule of games did not encourage enterprising, later the rule of games changed, there were some innovation activities for military purpose which often reduced the overall social welfare as one of destructive entrepreneurial activities:

Ancient Rome

For Romans, people in honourable position had three primary and acceptable sources of income: landholding, usury and political payments. It was however, freedmen, not honourable Romans, who were in operation of commerce and industry. The attitude towards promoting technology and productivity was not favourable. Economic effort was neither the way nor the purpose, the labour, not even labour of the entrepreneur, was not respected.

Medieval China

In China, people were more motivated to past imperial exams so that they could land a position of higher rank in bureaucracy where they could reap wealth by power therein. The others who failed would engage commerce and trading. Enterprise was not only socially encouraged and well regarded, even facing many obstacles from officials. The overall rule of games in China then was against innovation. At the same time, the state had power to confiscate all property within its power. That had become a substantial impediment to economic expansion.

The Earlier middle Ages

Military activities were the main avenues for wealth accumulation and prestige in society. The innovations were therefore mostly related on military conquest and protection, which differs vastly from the introduction of costing saving industrial process or a valued new goods and services. These types of activities would not increase but often reduce the overall social welfare.

The later Middle Ages

The revival of the towns and protection from arbitrary taxation and confiscation was well under way. Small activities such as architect and water-driven mill technology began to yield some return. It was however seen as more for release one from physical labour for spiritual devotion than any economic gains.

Fourteenth Century

The long period of war between French and England had titled to favour more than before inventions designed for military purposes. This military enterprise developed at expense of the general public.

Early rent seeking. Unproductive entrepreneurship, by using legal system for rent seeking purposes, gradually replaced military power as a prime source of wealth and power.

If entrepreneurship is the imaginative pursuit of position, with limited concern about the means used to achieve the purpose, then we can expect changes in the structure of rewards to modify the nature of the entrepreneur’s activities sometimes drastically.

The rules of game can then be a critical influence helping to determine whether entrepreneurship will be allocated predominantly to activities that are productive or unproductive and even destructive.

Baumol arrives his third proposition:- The allocation of entrepreneurship between productive and unproductive activities can have a profound effect on the innovativeness of the economy and he degree of dissemination of its technological discoveries.

As discussed above that in ancient Rome and its empire the rule did not favour productive entrepreneurship. Even though there were many invention and technology know-how, under such rules of game which encouraged the pursuit of wealth but discouraged its pursuit through the exercise of productive entrepreneurship, they did not transfer into economic development.

Similarly in ancient China, where constituted one of earliest potential revolutions in industry such as the invention of paper, compass, waterwheels, and water clocks and gunpowder, none of these led to flowing of industry. What China lacked was not mechanical skill or scientific aptitude, nor a sufficient accumulation of wealth, but scope for individual enterprise, there was no individual freedom and no security for private enterprise, no legal foundation for the rights other than those of the state, on alternative investment other than landed property, no guarantee against being penalized by arbitrary exactions from officials or against intervention by the state. Therefore free enterprise was of no ground to grow.

Since the first Industrial Revolution in 18th century, the rules of games had changed dramatically. Entrepreneurship has since reaped great rewards. However, the unproductive entrepreneurship takes many new forms, often via activities such as litigation and takeover, and tax evasion and so on.

The corporate executives devote much time and effects to litigate and countersuit, huge reward by the courts can bring prosperity to the victor and threaten the loser with insolvency. It is tempting for company to hire the top lawyers rather than engineers.

Taxes can be served to redirect entrepreneurial effort. Instead of focusing on productive activities, the corporate management engage speculative financial transaction. Baumol suggests that policy makers should carefully examine the possible direction on how the reallocation of entrepreneurial effort will serve the goal of society. For example the restriction of monopolies