Impact of Entrepreneurship on the Economy - Entrepreneurship is synonymous to Economic Growth

“Entrepreneurs throughout modern economic history…have been disproportionately responsible for

truly radical innovations – the airplane, the railroad, the automobile, electric service, the telegraph and
telephone, the computer, air conditioning, and so on – that not only fundamentally transformed
consumers’ lives, but also became platforms for many other industries that, in combination, have
fundamentally changed entire economies.” ~ Robert Litan and Carl Schramm, 2012

Entrepreneurship is central to achieving overall economic growth as:

1. It improves Productivity

Over most of economic history, it had been widely assumed that economic growth stems from
enhancements to one or both of the two principal components of an economy – capital and labor. But in
1957, American economist Robert Solow demonstrated that most of economic growth cannot be
attributed to increases in capital and labor, but only to gains in productivity – more output per unit of
input – driven by innovation. As businesses and workers become more efficient, costs fall, profits and
incomes rise, demand expands, and economic growth and job creation accelerate.

If that’s true, then what drives productivity growth?

The first of these is “efficiency,” or the manner in which the factors of production are assembled. An
efficient economy will generate a greater level of output for a given level of inputs (capital, labor,
technology) compared with a less efficient economy.

A key aspect of this efficiency is “reallocative efficiency” – the ability for resources (capital and labor) to
flow freely to where is most beneficial. In an economy where reallocative efficiency is high, more
productive companies stay in business and grow, while less productive firms contract or possibly close
doors.

The formation of new businesses – what we loosely refer to as “entrepreneurship” – is a particularly

important component of this process of reallocative efficiency. Why? Because new businesses enter the
market to challenge established firms, products, and method of production and distribution; they bring
something new or improved and, in the process of doing so, their emergence promotes a more
competitive environment.
2. It spurs Innovation

The second and more significant force driving productivity growth is innovation – the advance of new
technologies, the creation of something new or improved, or doing something in a superior way.
Innovation enhances the productive capacity of an economy while holding inputs (capital and labor)
constant. Growth in productivity raises the material well-being for a society, improves standards of living,
and is the primary source of long-term economic prosperity.

Joseph Schumpeter wrote in 1942 about the “creative destruction” inherent in a capitalist economy –
innovation is a constant, disruptive force, and a necessary one, for economic advance. Schumpeter also
wrote about the central role of entrepreneurs in driving this change: “… the function of entrepreneurs is
to reform or revolutionize the pattern of production by exploiting an invention or, more generally, an
untried technological possibility for producing a new commodity or producing an old one in a new way,
by opening up a new source of supply of materials or a new outlet for products, by reorganizing an
industry and so on.”

In other words, economies rely on constant improvement and fierce competition – they do not grow
without innovation, especially transformative or “disruptive” innovation. And these types of innovations
depend heavily on the contributions of entrepreneurs.

3. It creates Job Opportunities

During the industrial era, economies of scale prevailed – bigger was better, and the largest businesses
employed most people. By the 1980s, the notion that small businesses were the engine of job creation
had been set in stone – it was politically popular, consistent with the American cultural vision, and was
empirically verifiable. This was called the "small business effect" (Birch, 2009)

But a small group of economists began to challenge this thinking in the mid-1990s, and by the mid-
2000s, aided by a breakthrough in data availability at the U.S. Census Bureau, turned this concept upside
down. They found that it’s not small businesses that drive new job creation, but rather new and young
businesses. (Davis & Haltiwanger, 1992)

These researchers found that after adjusting for firm age, the “small business effect” of net job creation
disappeared. In fact, outside of new and young firms, small businesses as a whole are net job destroyers
– some create jobs, while others destroy them, but overall the second effect is larger.
Put differently, small businesses as a whole are disguised as net job creators simply because young
businesses tend to be small. Untangling the size-age relationship has been a critical development for
policy development – traditional small businesses have fundamentally different characteristics and
objectives from growth-oriented companies in their formative years. (Why Is Entrepreneurship
Important? - Center for American Entrepreneurship, 2019)

Now all of these points contribute to the first idea which is Entrepreneurship is synonymous to Economic
Growth