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Entrepreneurs and American Economic Growth

Entrepreneurs, Private Property Rights, and Economic Growth

    1. This is a course about Entrepreneurs and Economic Growth so I suppose the first question we should ask ourselves is: What is an Entrepreneur? The dictionary definition -- "One who assumes the risk and management of business" – is not very satisfactory. Anyone can assume the risk and management of a business – does that mean that anyone who does so is an entrepreneur?
    2. Clearly no. If we accepted the dictionary definition the subject would be quite uninteresting. Rather, what I am going to focus on are those individuals who meet Schumpeter’s definition of entrepreneur. Namely, as defined by Hughes (p.5), an individual "who changes the stream of the allocation of resources over time by introducing new departures into the flow of economic life…." An entrepreneur is an agent of creative destruction -- a person who changes the economic structure from within by developing new goods, new methods of production, and new forms of industrial organization. An entrepreneur is one of the Vital Few of the capitalist economy.
    1. A Schumpeteran entrepreneur only exists within Capitalism. Which brings me to the other side of the conjunction which is the title of this course: namely, Economic Growth. By economic growth I mean, in the words of North and Thomas, "a per capita long-run rise in [real] income." (p.1) The capitalist economic system is the only one in human history to have achieved long-run real per-capita income growth. And the Schumpeteran entrepreneur is the central figure in this accomplishment.
    2. Evidence
      1. Overhead: Per Capita Real GDP USA 1929-1996
      2. Overhead: Real Per Capita GNP USA Various Periods 1869-1989
      3. Overhead: Real Growth Rate GNP USA Various Periods
      4. Overhead: 20th Century Growth Rate Miscellaneous Countries
      5. Overhead: Per Capita GDP Various Countries, 1990
    1. The magnitude of the growth rates shown in the overheads is a rare phenomenon. For most of human history little or no growth has been the norm. For example, Herb Stein points out that if you assume per capita output in Rome in 1AD was about $400 a year (equal to that in Bangladesh today), then at an average rate of 1% growth per year, per capita income in 1990 would be about $16 billion per capita!
    2. Capitalism is a recent historical phenomenon – it is only about 250 years old. Schumpeter argues that Capitalism and Science developed together. Both are products of the rise of rationalism – that is, rational thought and rational behavior in which logic plays the key role.
    1. For example, because Capitalism exalts the monetary unit, its use of a unit of money produced double-entry bookkeeping. In the words of Schumpeter: "And thus defined and quantified for the economic sector, this type of logic or attitude or method then starts upon its conqueror’s career subjugating – rationalizing – man’s tools and philosophies, his medical practice, his picture of the cosmos, his outlook on life, everything in fact including his concepts of beauty and justice and his spiritual ambitions." (p.123-124)
    2. All this raises the interesting question – is it possible to have long-run growth in a pre-industrial, pre-mass manufacturing, economy? Almost certainly not. Short-run technical innovations – iron instead of wooden plow – but these would not generate much growth long-term.
    3. North and Thomas give the best explanation and description of the Rise of Capitalism. In the words of North and Thomas: READ PORTION PAGE 1
  1. The Rise of the Western World
    1. Private Property Rights and a Means of Enforcement are necessary for long run real per capita growth.
    2. Real per capita growth is

      1. Innovation (this can be good or bad – transistor vs. cotton gin)
      2. Economies to Scale (Steel vs. Iron Rails)
      3. Education (Investment in Human Capital)
      4. Capital Accumulation
    1. Private Property Rights that are Enforced are necessary for an Efficient Economic Organization. Growth will not occur without it. The structure of incentives must be such to bring the Private Rate of Return (Private Benefits – Private Costs) close to the Social Rate of Return (Private Rate of Return + Net Effect on everyone else).
    2. Example: The transistor. The patent on the transistor held by Bell Labs gave them property rights in the invention and the licensing fees brought Bell Labs and the inventors a large amount of money (private rate of return), but the net effect on everyone else was even larger so that everyone benefited from the invention.

    3. Examples of Poorly Defined property rights

      1. Navigation: Prize was necessary because there was no means of assigning intellectual property rights.
      2. Piracy: Ultimately solved by navies enforcing property rights.
      3. Spanish Mesta: Farmers did not have exclusive use of their lands. They did not have an incentive to grow a surplus.
    1. Why haven’t property rights evolved?

      1. Free-Rider problems – costly to enforce property rights
      2. Costs of Enforcement > Benefits – for example, it was probably cheaper for some period of time to bribe the pirates than to pay for a convoy.
      3. {Aside – Modern problems with books, articles, pictures, etc., anything that, in principle, is digitizable presents serious property rights problems.}
    1. Government is the best means to enforce private property rights. READ PORTION PAGE 6-7
    2. Problem: No guarantee that Government will protect those private property rights that promote efficiency!

      1. History shows that property rights developed when they did, and where they did, because it was in the fiscal interest of the government at the time.
      2. This raises the question: How do you get Government to behave rationally to promote growth?
      3. {Aside – Here is the rub. The incentives of the political class – politicians, bureaucrats, and their allies – are not necessarily compatible with economic growth. What may be rational for a politician – Gephardt opposing NAFTA, Republicans arguing that tariffs were taxes on foreigners during the 19th Century – may not be good for economic growth. Politicians respond to their incentives and these incentives may not be economically rational.}
    1. Overview of the Historical Argument of North and Thomas 900-1600AD – Private property rights evolved out of Feudal system and were established by a series of historical "accidents" (that is, they were not established deliberately).

      1. Population Increases – Revival of Trade and Markets
      2. Necessity of Government over larger geographic areas to protect trade and markets.
      3. Disintegration of Feudal System and Rise of Nation State
      4. Nation States need money to sustain professional military – Consequently, taxing schemes must be easy
      5. Some taxing schemes by chance guarantee forms of private property rights favorable to growth.
    1. Chronology

      1. 900AD – Europe a vast wilderness of isolated and self-sufficient manors
      2. 1000AD – Italian City States trading with Moslems – population increases in northern Europe, trade begins to revive, cities begin to revive
      3. 1066AD – Norman invasion of England – Normans impose strong central government and introduce their own court system – the Seigneurial (King’s) Court – so that a dual court system existed.
      4. 1100-1200AD
        1. Population growth continues; migration of peasants to wilderness areas weakens hold of Lords
        2. Trade increases, regional markets develop
      1. 1200-1300AD
        1. Very rapid population growth. Land becomes scarcer, balance of bargaining power shifts back to Lords
        2. Kings become more powerful – money economy allows Kings to hire permanent military. Military used to protect trade routes and markets.
        3. Commercial Law develops
        4. Private property in land emerges in England in part due to the dual court system. The Free-Men using the King’s courts gain the right to alienate (sell) land by substitution without the Lord’s permission.
        5. Italian Commercial Innovations: Bills of Exchange; Insurance; Deposit Banking
      1. 1300-1450 – Famine, Plague, and War – Population Crashes
        1. 1347-51 First Bubonic Plague
        2. Value of Labor increases, value of Land decreases, peasants
        3. strengthened vis a vis Lords
        4. Rent payments replace labor services because of labor shortages
        5. Consolidation of Nation States continues
        6. Labor shortage puts premium on military technology (capital substitution) – Pikemen, Longbow, gunpowder and cannons
        7. Military Technology + Labor Costs force governmental consolidation (returns to scale)
        8. Because of (c) to (e), Nation States need money which leads Kings to be creative with Taxes
          1. France – Inefficient Taxation – powerless taxed, nobles and clergy exempted – sales taxes, salt monopoly, tariffs within France, etc.
          2. Spain – The Mesta
          3. England – Tax on Wool but King’s ability to raise taxes limited by Magna Carta of 1215
      1. 1450-1600AD – The Age of Exploration
        1. Population increases again and reaches 1300AD level about 1600AD
        2. By about 1500 Feudalism effectively dead
        3. As population increases, real wages fall
      1. 1600-1700AD – England and Netherlands Achieve self-sustaining Real Per Capita Economic Growth
        1. England
            1. Dual Court System imposed in 1066 enables Free-Men to obtain more rights
            2. 1215 Magna Carta limits Monarch’s taxing power
            3. Henry VIII’s battle with the Catholic Church also gave Parliament more power
            4. Stuart Kings’ battles with Parliament weaken Monarchy further
            5. 1624 Statute of Monopolies ends Crown prerogative to grant monopolies thereby increasing economic efficiency
            6. 1688 Glorious Revolution makes Parliament Supreme. Balance of Power sets stage for Industrial Revolution
            7. Supremacy of Parliament plus the embedding of private property rights in the Common Law made Capitalism successful in England
        1. Netherlands
          1. Geography makes Netherlands a natural trade port
          2. Policy of rulers was to promote unity and trade
          3. Monopolies were discouraged and foreigners with skills were readily admitted to country in spite of the opposition of the guilds
          4. Adopted the Italian financial innovations – Deposit Banking, Bills of Credit, Endorsement, etc.
          5. Large volume of transactions led to standard practices – these put into commercial law
          6. Selling by sample and published prices – futures markets develop
      1. The Also-Rans: France and Spain
        1. France
          1. War to drive England from France in 15th Century makes King absolute
          2. King sells offices and tax exemptions and increases size of bureaucracy (needed to collect taxes from peasants)
          3. Tariffs between regions setup to collect more money
          4. Monopolies granted
        1. Spain
          1. After 1492 consolidation, Ferdinand & Isabella opt for short-run revenue gain and do not break the Mesta monopoly
          2. No agricultural surplus in produced in absence of true private property rights
          3. After Netherlands revolts and breaks free, loss of revenue forces Crown to tax merchants who are driven out of business as a result

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