Baumol's Institutional Theory of Entrepreneurship

William J. Baumol was an American economist at New York University. His theory of entrepreneurship starts with the assumption that every society is endowed with their share of entrepreneurs. However, the way in which entrepreneurs use their energies depends upon the institutions—the rules of the game—in place in a given society. It is also sometimes called a political theory because the regime in a given country or territory may have tremendous influence on incentives. He argues that entrepreneurs may engage in productive (i.e., innovation) or unproductive (rent-seeking and crime) forms of entrepreneurship depending on what a country’s institutions encourage.

Baumol argued that the notion of a "spirit of entrepreneurship" is largely useless for policymakers because it is difficult to measure and even more difficult to influence. Instead, Baumol proposed that policymakers should focus on altering the rules of the game to encourage productive entrepreneurship and discourage unproductive or destructive forms of entrepreneurship.

According to Baumol, the rules of the game refer to the formal and informal institutions that shape the incentives and constraints facing entrepreneurs in a given society. These institutions include tax rules, regulations, subsidies, support programs, and other policy interventions or norms that can either encourage or discourage entrepreneurial activity.

Baumol argued that policymakers should be actively engaged in shaping these institutions to encourage productive entrepreneurship. This might involve reducing barriers to entry for new businesses, streamlining regulatory processes, providing support and subsidies for entrepreneurs, and creating tax incentives for innovation and investment.

However, Baumol also recognized that there is no one-size-fits-all approach to fostering entrepreneurship. The optimal set of policies and interventions will vary depending on a country's unique economic, social, and cultural context. Therefore, he suggested that policymakers should be engaged in an ongoing process of experimentation and adaptation, continually refining the rules of the game to maximize the positive impact on entrepreneurial outcomes.

Baumol uses several historical narratives to back up his theory. For instance, in Feudal Europe, entrepreneurship was largely destructive or redistributive. At the time, most of Europe was organized into small autonomous territories, such as a castle protecting a few thousand acres of farmland. Young men with ambition (princes) could put together an army and attempt to sack a nearby fiefdom. The result was some measure of death and destruction, and nothing was productive was accomplished. No new wealth was created--it only changed hands and at a high cost. He also uses the example of entrepreneurship being tied to calligraphy in ancient China and then of sexual slavery in ancient Rome as is shown in the example below. All the example have in common a set of pathways of acceptable conduct that are used to guide entrepreneurial energies.

"A clever (and handsome) member of the lower orders might deliberately arrange to be sold into slavery to a wealthy and powerful master. Then, with luck, skill, and drive, he would grow close to his owner, perhaps managing his financial affairs (and sometimes engaging in some homosexual activity with him). The master then gained cachet, after a suitable period, by granting freedom to the slave, setting him up with a fortune of his own."

Sources:

Baumol, W. J. (1996). Entrepreneurship: Productive, unproductive, and destructive. Journal of business venturing, 11(1), 3-22.921.