The economic theories of entrepreneurship

The economic theories carry illustrious and a long-established pedigree relating to the study of entrepreneurship. Furthermore, entrepreneurship can be broadly defined as the ability and the readiness to develop, organize and run the business along with handling the uncertainties in order to make the profits. In economics, entrepreneurship is closely related to the land, labour, natural resources and capital that can help to generate profit.

An entrepreneurial vision involves discovery and risk-taking that are critical for nations in order to succeed in the ever-changing and competitive global marketplace (McFarlane, 2016). Different schools of thoughts have been established on the theories of entrepreneurship from the psychological, sociological and cultural perspectives.

Economic theories help in examining and exploring economic factors that affect or enable entrepreneurial behaviour. Economic theories of entrepreneurship can be divided into three different time periods:

  1. classical,
  2. neo-classical and,
  3. Austrian market process.
Economic theories of entrepreneurship
Figure 1: Economic theories of entrepreneurship

The classical, neo-classical and the Austrian market processes are different approaches in explaining entrepreneurship. Classical theorists confined the role of an entrepreneur to producers and distributors of goods in the marketplace. Neo-classical theorists, on the other hand, described an entrepreneur as the people who, along with the production and the distribution of goods, undertake business risk, identify new opportunities, and simultaneously reduce costs for a business.

Finally, the Austrian market process theorists focused on human actions based on their knowledge regarding the economy. These theorists defined an entrepreneur as the one who is creative and imaginative in his work and one who sees a profitable opportunity.

Classical economic theories of entrepreneurship

Classical theories of entrepreneurship majorly focused on the virtues of free trade, competition and specialization. These theories defined the role of an entrepreneur in terms of production and distribution of goods in a competitive marketplace (Tiryaki, 2013). Some remarkable classical theories of entrepreneurship are as follows.

Richard Cantillon theory (1755)

Richard Cantillon provided one of the earliest contributions regarding the economic strand of thought about entrepreneurship. Richard described an entrepreneur as a speculator who conducts all exchanges, bears risks as a result of buying at certain prices and further selling them at uncertain prices. Centillion named it as the risk theory of profit where anyone who receives an uncertain income can be regarded as an entrepreneur.

Furthermore, the theory stated the importance of entrepreneurs as people who play a key role in the economy by relieving the paralysis engendered by uncertainty and along with it allowing the exchange and production of goods and services so that market equilibrium can be attained. Cantillon further stated that an entrepreneur is not an innovator. They cannot change the demand and supply trends. Rather, they are perceptive, intelligent and willing to take risks. Their main role in the process is to bring two sides of the market together (Parker, 2018).  

Innovation theory by Schumpeter

The innovation theory is considered to be one of the most important economic theories of entrepreneurship and was advanced by Schumpeter. The focus of the theory was that entrepreneurs do not operate with conventional technologies and do not believe in making small changes to the existing production method. Rather their main goal is to develop new technologies and products that can bring widespread changes and can help them to shift the paradigm altogether.

Thus, the Schumpeter view was completely different from that of Richard’s. Schumpeter stated that an entrepreneur is an innovator who is responsible for doing new things or the things that have already been done in a new way (Śledzik, 2013). This can be done in five different ways which are as follows:

Schumpeter's theory of entrepreneurship
Figure 2: Schumpeter’s theory of entrepreneurship

Schumpeter regarded entrepreneurial actions as a major factor causing business cycles and economic developments. According to his vision of creative destruction, when an entrepreneurial innovation hits the economy, it leads to the replacement of old products and processes which is eventually rapidly imitated by competitors (Braguinsky, Klepper and Ohyama, 2011).

Neoclassical economic theories of entrepreneurship 

The neo-classical theories emerged as a result of the criticism levelled against the classical theories. The neoclassical theory maintains the impact of diminishing marginal utility and entrepreneurial response to them as another major aspect which was missing in the classical works (Gimmnez Roche, 2017).

Marshallian theory

The study of entrepreneurs is far from being new. In the year 1755, Cantillon described entrepreneurs as agents who undertake risks for profits. Early theorist Adam Smith presented the concept of entrepreneurship which was not different from a company owner.

Alfred Marshal in his work combined both the concepts and presented entrepreneur as an individual who is both, a risktaker and an administrator. He identified entrepreneurs who are responsible for ensuring production function in a company, identify opportunities, reduce costs and increase profits. Marshall further in his theory classified entrepreneurs as:

  • Active entrepreneurs (those who find new ways, and
  • Passive entrepreneurs (those who tend to follow the existing road) (Fernandez, 2009).

Furthermore, the concept of Marshallian agglomeration economies tends to have a significant impact on entrepreneurial activities. Here ‘agglomeration’ refers to the tendency of increasing returns as a result of the accumulation of resources in a geographical location. Marshall mentioned that there are two main forms of agglomerations which are as follows:

  • Urbanization of economies that result from the accumulation of the population at one point.
  • Localization of economies resulting from the accumulation of a specific industry or sector.

Menger’s theory

It is generally argued that the development of the neoclassical analysis began with Menger in the year the 1870s. Menger in his book defined entrepreneurial activity as a special kind of labour service and an activity that is valuable while economizing men. Despite this, they cannot be bought or sold and do not carry any market price. However, there is a necessary prerequisite for the provision of such services which is the ownership of the capital (Kirzner, 2011). Menger moving forward stated the specific functions that are involved in the entrepreneurial activity:

  • Collection of information regarding economic situations.
  • Economic calculations in order to make the production process efficient.
  • Assigning of goods to a particular production process.
  • Supervising the execution of the production plan and making sure that it is carried out in an economical way.

Thus it does not seem to be unfair to compare Menger’s entrepreneurial activities with being similar to Marshallian theory.

Austrian market process theories of entrepreneurship 

The Austrian market process theories were proposed in order to provide answers to questions that remained unanswered in the neo-classical school of thought regarding entrepreneurship. These theories mainly focus on human actions based on their knowledge regarding the economy.

Kirzner’s Alert Entrepreneurship

Kirzner in his work provided an Austrian approach to the concept of the entrepreneurship. The main focus of Kirzner was to answer whether a market economy works, and if so, then what leads to an equilibrium situation. Kirzner further accepted that a market is not always perfectly clear, and there do not exist perfectly informed representative agents. For the entrepreneurs to bring any change they need incentives and these incentives come in the form of knowledge and information (Tiryaki, 2013).

Furthermore, he stated that an entrepreneur is the one who sees a profitable opportunity. For them, it is majorly profit opportunities that stimulate entrepreneurship. However, this view differs from Schumpeter’s theory as it implies that profit arises due to arbitrage and not due to innovation. The pure entrepreneurial function consists of buying products for cheap and selling them at higher prices. In simple terms, it means discovering the fact that the market has undervalued something and now its real value has to be realized (Langlois, 2002).

Shackle’s theory

According to Shackle’s theory, entrepreneurs are creative and imaginative in their work. It states that entrepreneurs imagine opportunities and have the creative ability to make choices. Furthermore, according to this theory, uncertainty and imperfect information play an important role because it is the presence of both these aspects that gives rise to opportunities for individuals. This act of imagination helps entrepreneurs in the identification of potential of market opportunities. This, when compared with the resources available, can lead to effective decision making.

Shackle presented entrepreneurs’ education levels, personal background, experiences and attitudes as the major factors that tend to affect their imagination and creativity (Smith and Chimucheka, 2014).

Entrepreneurs add value to the economy

The various theories presented by classical, neo-classical and Austrian market process theorists encapsulate the relationship between an entrepreneur and economic growth of a country. Through Innovation, an entrepreneur can have a significant impact on the market, thus leading to the economic growth of a nation. All these theories still carry strong implications for the modern-day entrepreneurs as well, since the role of an entrepreneur still remains the same, i.e. the one who equilibrates supply and demand in an economy by bearing risks and uncertainties. Furthermore, by the introduction of innovation in products and techniques, an entrepreneur brings in new opportunities in the market.

References  

  • Braguinsky, S., Klepper, S. and Ohyama, A. (2011) ‘Schumpeterian Entrepreneurship’, SSRN Electronic Journal, pp. 1–35. doi: 10.2139/ssrn.1347063.
  • Fernandez, R. (2009) ‘Marshallian agglomeration economics and entrepreneurship: the spanish case’, Innovation, pp. 1–30.
  • Gimmnez Roche, G. A. (2017) ‘Neoclassical Entrepreneurship Theory: Limits and Insights for a Heterodox Approach’, SSRN Electronic Journal, (January). doi: 10.2139/ssrn.2908067.
  • Kirzner, I. M. (2011) ‘The entrepreneurial role in Menger’s system’, Atlantic Economic Journal, 6(3), pp. 31–45. doi: 10.1007/BF02313307.
  • Langlois, R. N. (2002) ‘Kirznerian entrepreneurship and the nature of the firm’, Journal des Economistes et des Etudes Humaines, 12(1), pp. 1–8. doi: 10.2202/1145-6396.1050.
  • McFarlane, J. (2016) ‘Economic Theories of Entrepreneurship’, Enterprise: Concepts and Issues. doi: 10.23912/978-1-910158-75-3-2880.
  • Parker, S. C. (2018) ‘Entrepreneurship and economic theory’, Oxford Review of Economic Policy, 34(4), pp. 540–564. doi: 10.1093/oxrep/gry013.
  • Śledzik, K. (2013) ‘Schumpeter’s View on Innovation and Entrepreneurship’, SSRN Electronic Journal, (April 2013). doi: 10.2139/ssrn.2257783.
  • Smith, W. and Chimucheka, T. (2014) ‘Entrepreneurship, economic growth and entrepreneurship theories’, Mediterranean Journal of Social Sciences, 5(14), pp. 160–168. doi: 10.5901/mjss.2014.v5n14p160.
  • Tiryaki, A. (2013) ‘Theories of Entrepreneurship: A Critical Overview’, (i).
Ashni Walia
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