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Overview User: Adam Gore Activity: Entrepreneurship and Economic Growth Curriculum: Economics Date: 32 items printed. Tue, Sep 23 13:51:32 GM Page 1 of 14 Overview Entrepreneurship and Economic Growth INTRODUCTION Entrepreneurs are people who identify business opportunities. They gather together economic resources and assume the risks associated with taking advantage of these opportunities. Entrepreneurs can be found in both small new companies and in large wellestablished ones. Entrepreneurs usually need assistance -- financial, managerial, and technical. There are many sources for this assistance. Entrepreneurship promotes the growth of trade and industry for individual firms and countries . Economies that encourage entrepreneurs are also economies with higher levels of economic growth. Economic growth allows a higher standard of living and prosperity. Thus, government policies toward entrepreneurship are important to a country's economy. ENTREPRENEURS Entrepreneurs are an economic resource. An entrepreneur is someone who takes risks and organizes the factors of production in order to efficiently produce goods and services. They frequently create and develop new products or business opportunities. An example of creating a business opportunity is finding the perfect site for a new Italian restaurant and hiring an excellent chef. Entrepreneurs can start new companies or be employed within an established company. The Apple personal computer was developed in 1977 by Apple Computer, Inc., a new company . Though the Apple was popular, personal computers remained mostly an experimental device in the business world until the introduction of the IBM personal computer in 1981. IBM, an established company founded in 1911, broke many of its own traditions and allowed employees to work as entrepreneurs to develop its personal computer. The combination of IBM's position of prominence in the business world and its use of common hardware and software products made an unbeatable product. In a market economy (capitalism), most entrepreneurs are private individuals. In the United States 12% of people ages 18 to 64 were entrepreneurs in 2003. This is the largest percentage of entrepreneurs in any developed country. By comparison, only 6% of that age group were entrepreneurs in Great Britain, and slightly over 2% in Japan. Characteristics of an Entrepreneur Entrepreneurs have personal characteristics that help make them successful. They are visionaries, innovators, and risk-takers. They are motivated by personal success and profits. Tue, Sep 23 13:51:32 GM Page 2 of 14 Overview Entrepreneurs are visionaries. They anticipate consumer trends, invent products and processes, and dream up new ways of doing things. Michael Dell is a recent example of an entrepreneur with a vision. Back in the early 1980s, he had the idea that a lot of money could be made in customizing computers and selling them directly to consumers rather than in retail stores. He founded the Dell Computer Corporation in 1984 and today it is one of the top personal computer manufacturers. In 1992, Michael Dell became the youngest CEO of a company to earn a ranking on the Fortune 500 (a list of America's largest 500 businesses prepared by "Fortune" magazine). Entrepreneurs are innovators. They dream up new products and processes. For new products, they bridge the gap between the idea and the marketplace. It is in the market that new products are tested against consumer demands . New processes frequently allow existing products to be made more cheaply or efficiently. The software innovations of entrepreneurs like Steve Jobs (Apple Computer, Inc.) and Bill Gates (Microsoft Corp.) allowed computers to evolve from devices used only by electronics enthusiasts into ones that everyone can use. Computers can process and store data much faster and more efficiently than other previous devices. Microsoft Word, for instance, is a word-processing program that produces documents much easier and faster than the traditional typewriter. Entrepreneurs are risk-takers. The discovery and development of new business opportunities is risky. Failure can have a devastating effect on entrepreneurs . It is possible that they could end up bankrupt, losing both their invested money and time. Failure is highly likely. Only about half of all new businesses are still operating five years after their founding. Entrepreneurs are motivated by personal success and profits. Entrepreneurs can gain great personal satisfaction in seeing their ideas carried to a successful conclusion. Successful entrepreneurs can also make fortunes. For instance, of the top 10 people on the 2003 "World's Richest People" list of "Forbes" magazine, six are described as "self-made" -in other words, they made their own fortunes. The list includes such entrepreneurs as Bill Gates and Paul Allen (the founders of Microsoft Corp.), Karl and Theo Albrecht (the founders of Aldi discount stores [Germany]), and Larry Ellison (the founder of Oracle Corp.). The only four not described as "self-made" are the heirs of an entrepreneur, Sam Walton, the founder of Wal-Mart. Although many on the list were hardly born poor, their substantial fortunes arose out of their own entrepreneurial efforts. In a market economy , profits are the reward for success. Assistance for Entrepreneurs Tue, Sep 23 13:51:32 GM Page 3 of 14 Overview In most cases, entrepreneurs cannot turn their ideas into products and bring them to the market by themselves. They need assistance. There are several sources of assistance available. Partners Entrepreneurs frequently need partners to provide financial resources and technical and managerial skills the entrepreneurs may be lacking . Partners can also provide psychological support, encouraging entrepreneurs to persevere against any difficulties. Thus, entrepreneurs frequently need to form partnerships that allow them to share the risks and the rewards of the new business venture. These partnerships can be either legal business partnerships (where each partner is liable for all the losses of the partnership) or corporations (where each shareholder is liable only for the amount of capital he or she contributes). Many entrepreneurs gather support from friends and relatives. If a sizable amount of money is needed, they may wish to involve venture capitalists. Venture capitalists look for opportunities to invest in new businesses, hoping to earn profits when the business succeeds. They can provide entrepreneurs with initial capital financing, management assistance, and business networking. In return, they expect to receive a share of the company's ownership and the eventual profits. A business plan is of particular importance for entrepreneurs who seek financing from venture capitalists. Venture capitalists usually require a carefully thought-out plan that describes the company's mission, product description, target market, competition, management team, and financial requirements. This is because venture capitalists are looking for clues to the entrepreneur's reputation, personality, background/experience, managerial capabilities, management commitment, ability to evaluate alternative business opportunities, and execute (reach) certain goals. Business Incubators Another source of assistance available to many entrepreneurs are business incubators. Business incubators provide start-ups with flexible accommodation and office leases, shared facilities, business networking, and often some capital financing. Business incubators are frequently run by public agencies and universities in order to promote the economic success of a particular regional area. Government Assistance Governments can encourage entrepreneurs directly by making it easier for them to Tue, Sep 23 13:51:32 GM Page 4 of 14 Overview obtain the investment financing that they need. In the United States, Congress has established the Small Business Administration (SBA). It guarantees loans that banks make to new companies approved by the SBA. It also provides training and sources of information . The Israeli and Irish governments have set up special funds to provide financing to new companies in certain industries, like the information and biotechnology industries. ENTREPRENEURSHIP Entrepreneurship is the process or act of being a successful entrepreneur . It includes having the abilities and skills to successfully accomplish the tasks that an entrepreneur must accomplish. Entrepreneurship involves the discovery and exploitation of new business opportunities. Thus, it involves making choices of which opportunities to pursue and which not to pursue. Entrepreneurship is different from managing a company. Managing a company involves allocating the right resources to pursue the opportunities chosen. While implementing their new product, process, or company, entrepreneurs frequently manage business firms, but the act of entrepreneurship is in recognizing or discovering the business opportunity to begin with. Entrepreneurship: A Source of Competitive Advantage Entrepreneurship is a source of competitive advantage. To stay ahead of the competition, firms must continuously discover and exploit new business opportunities. Thomas Edison, for instance, did not invent the electric light bulb itself -- many people had been experimenting with electric light since at least 1801. Sir Joseph Swan, a British scientist, had produced the basic design for a practical electric light bulb as early as 1860. However, Swan did not have a good electric power source. Edison's 1879 light bulb design was very similar to Swan's. However, Edison has received the major credit for the electric light bulb because of his development of the power lines and other equipment needed to establish electricity as a practical lighting system. His developments provided Consolidated Edison (New York City) a competitive advantage in the emerging electric utility industry. Another example of a successful entrepreneur is Andrew Carnegie. He was not knowledgeable about metals, but he foresaw the future importance of steel in America. Although the process of steel-making had been known for centuries, it was comparatively more expensive than that for other metals -- iron was cheaper to produce, for instance. Mass production of steel was only made possible when Sir Henry Bessemer developed his new steel-making process in England in 1855. In the 1870s, Carnegie was the first in Tue, Sep 23 13:51:32 GM Page 5 of 14 Overview America to build steel plants that used the Bessemer process. This gave his Carnegie Steel Company an advantage in the emerging U.S. steel industry. If an established firm is entrepreneurial , it is often built into the culture and is therefore hard for competitors to copy. Established companies can encourage entrepreneurship by giving their employees stock options or otherwise rewarding employees that act in an entrepreneurial manner. Stock options give employees an incentive to ensure that the firm does well. Entrepreneurship Has Taken Different Forms over Time In the history of humankind, entrepreneurship has taken a number of forms and meanings. In the pre-capitalist world, entrepreneurship often took the form of land expeditions and sea explorations that encouraged trade, growth, and prosperity. Early America In early colonial America, entrepreneurs developed trade with the West Indies, Africa, and Europe. This involved exporting fish, meat, lumber, iron, rum, and other goods. This encouraged the emerging fishing and shipping industries of the colonial Northeast American economy . After the Revolutionary War, new merchant ventures expanded the new republic's foreign markets across the Atlantic Ocean. New ones were begun in Asia across the Pacific Ocean. Meanwhile, land expeditions expanded America's domestic markets westward across the North American continent. In the early period of industrialization, entrepreneurship in the form of industrial innovations spurred new industries, such as the automated production of textiles, the economical mass manufacturing of iron and steel, and the development of railroads. Modern America Entrepreneurship promotes the growth of trade and industry. It is estimated that a great deal of America's economic growth is due to technological innovation initiated by entrepreneurs. In the 20th century, entrepreneurship has yielded new products and processes which fostered the growth of new businesses and industries. For instance, entrepreneurship has resulted in innovations based on integrated circuits and lasers (CD-ROMS and fiber -optics) that have led to computers and an "information revolution." These new ways of gathering, storing, manipulating, and transmitting information have given rise to yet another host of industries and developments. Thus, in recent years, entrepreneurship Tue, Sep 23 13:51:32 GM Page 6 of 14 Overview has created new computer software and hardware, the Internet, and new business organizations. This information technology continues to be the source of economic growth. Example: Information technology is used by Wal-Mart to track every purchase, every shipment of supplies, and every cost of business, everywhere around the world. With this information technology, Wal-Mart can quickly respond to any business situation. If Wal -Mart finds a cheaper supplier of toothbrushes, it can immediately switch suppliers and pass the savings on to its customers . It is estimated that Wal-Mart price reductions saved consumers $80 billion in 2003. Wal-Mart has grown into one of the largest corporations in the United States. Government Policies to Encourage Entrepreneurship Since entrepreneurship can be such an important part of a market economy, governments frequently encourage entrepreneurs. Governments and government officials can be instrumental in creating an "entrepreneur-friendly" environment. New Business Opportunity Creation The government can create new business opportunities in foreign and domestic markets. In foreign markets, they can negotiate international agreements to lower tariffs and other barriers to trade. In domestic markets, they can create new business opportunities through deregulation and the opening of commodity and resource markets to competition. For example, in the United States, some states have moved to deregulate energy markets, such as electricity, allowing newly formed companies to compete with formerly monopolistic utilities. Legal Protections The government can pass laws that protect private property and encourage new business activity. For example, intellectual property can be protected through patent and copyright laws. These laws allow inventors and innovators to reap the benefits of their developments. Patents are especially important to companies that need to spend a great deal of money to bring a product to market. For instance, a successful drug can cost billions of dollars to discover, test, and market. Favorable Tax Policies Another measure that governments can take is to lower taxes on business profits. For Tue, Sep 23 13:51:32 GM Page 7 of 14 Overview example, capital gains taxes are assessed on profits from securities, property, or other assets considered investments in capital. Reducing these should encourage capital investment. Tax incentives can encourage companies to purchase new capital equipment to replace older capital equipment with more modern equipment. Ireland was among the first countries in Europe to cut business taxes in order to create a business-friendly environment. Since the 1980s, Ireland has become a popular site for investment by American businesses and investors. The United States has also recently reduced federal taxes. Encouragement of Capital Investment Investment is the primary source of efficiency and productivity gains for businesses. Capital investment is the acquisition of physical and human assets that expand and enhance the productive capacity of business enterprises. Capital investment generally translates to higher profits, incomes, and living standards. For example, America's long economic expansion in the 1990s was mostly due to productivity gains propelled by capital investment in new technologies like the Internet. Email and instant messaging increased the speed of communications between companies and their customers, suppliers, and employees. Web-based inventory and customer-profile tracking cut product inventory and marketing costs. Recognizing the contribution of capital investment to efficiency and productivity, governments around the world have a number of policies in place to foster capital investment. These include encouraging entrepreneurs directly, investing in infrastructure, and investing in human capital through student scholarships and low-interest student loans. Direct Assistance to Entrepreneurs Governments can encourage entrepreneurs directly by making it easier for them to obtain the investment financing that they need. For instance, in the United States, the federal government has set up the Small Business Administration (SBA), which guarantees loans and provides training and sources of information. Many state governments and local communities provide similar assistance and may also offer tax incentives for businesses that locate in their area. Certain regional areas may establish business incubators or industrial parks to encourage businesses to locate in their area. Business incubators, in particular, are aimed specifically at new companies. Infrastructure Spending Tue, Sep 23 13:51:32 GM Page 8 of 14 Overview Spending on the country's infrastructure -- for example, improving the transportation system through better roads, railroads, seaports, and airports -- makes it easier for companies to expand their business and productive capacity. This encourages capital investment in established and new businesses. Encourage Education and Training Student scholarships and low-interest student loans lower the cost of education and training. This encourages spending that improves a country's human capital. Some countries, such as Brazil and Mexico, even have programs that pay poor families if their children stay in school. A lot of human capital improvement takes place today within corporations. The government can also give incentives, such as grants, that lower the cost of this training. This is especially important in those industries where workers need to be retrained because they will otherwise lose their jobs . ECONOMIC GROWTH Economies that encourage entrepreneurs are also economies with higher levels of economic growth. Economic growth is an increase in an economy's production of goods and services. Thus, entrepreneurship greatly affects a nation's economic growth by promoting the growth of business, trade, and industry. Economic growth is desired and encouraged by governments and people because it allows a higher standard of living and prosperity. Gross National Product {GNP) and Gross Domestic Product {GDP) Economic growth is usually determined by comparing either of two measures over time: Gross National Product (GNP) or Gross Domestic Product (GDP). GNP is the total market value of all goods and services produced by a nation's economy during a specific period of time (usually a year), including foreign investments. GDP is basically the same as GNP, but it eliminates profits on foreign investments from the calculation. "Gross" in this case means an overall total -- like gross income is total income before taxes. "National" and "domestic" both mean that the measure is about an economy or nation. "National" here indicates all of the nation's production, while "domestic" indicates that the production counted derives solely from that nation's own resources. "Product" here means everything that is made or created. Both GNP and GDP are expressed in terms of money. These types of measurement can only be accumulated if everything produced in an economy is converted into money because the money price is the final price that a thing is sold for and is a common measure of its worth. Nominal and Real GNP and GDP Tue, Sep 23 13:51:32 GM Page 9 of 14 Overview Unfortunately, money does not maintain a constant value. It is normal for money to gradually lose value and be able to purchase less. This is called inflation. Thus, it can be difficult to compare GNP and GDP from year to year because they are calculated in money terms and the value of the money can change. GNP and GDP figures that have not been adjusted for inflation are called "nominal." Without adjustment, they cannot accurately be compared with other figures in other time periods. For example, if the inflation rate is 3%, this means that money has lost 3% of its value and prices are 3% higher to purchase the same goods and services. Economists thus reduce the nominal numbers for GNP and GDP by 3% in order to compensate for the inflation. The adjusted numbers are called "real" numbers and can be used to compare to figures from other time periods. Assume that the nominal GDP this year is 5% greater than it was the previous year, but there was an inflation rate of 2%. Therefore, the nominal GDP must be reduced by 2% for a real GDP of 3%. It is always necessary to convert the nominal numbers to real numbers in order to accurately compare different time periods and determine whether or not the economy is growing. If real GNP and GDP are rising, an economy is said to be enjoying healthy growth or expansion. Prolonged economic growth and prosperity is called a "boom." Most of the 1990s were boom years. If real GNP and GDP are falling, the economy is said to be in recession. A recession is a reduction in the size of a nation's economy. One definition is that a recession is when real GDP declines for two consecutive quarters. In both 1992 and 2002, the United States had recessions. If the recession continues for several years and results in much unemployment, it is called a depression. The Great Depression of 1929-1939, which spread worldwide, was the longest and most severe depression experienced by the modern Western world. It was the last depression that the United States experienced. Technological Innovation and Government Policies Affect Economic Growth Economic growth comes mostly from technological innovation -- that is, innovations in products and processes used to make products. Product innovations allow the country's enterprises to expand their product offerings to consumers, while process innovations allow enterprises to produce these products more efficiently, on a timely basis, and at lower costs. Government policies can also encourage economic growth, both directly and indirectly. Government policies like tax incentives directly affect growth by allowing businesses and Tue, Sep 23 13:51:32 GM Page 10 of 14 Overview individuals to retain more of their money for spending and investment. Government policies that encourage lower interest rates also indirectly affect growth because lower interest rates stimulate capital investment. By encouraging investment, government policies can spur productivity. Example: In the 3rd quarter of 2003, the economy of the United States grew by 8.2% because of tax rebates, lower interest rates, and higher productivity growth. That summer, Congress granted a tax rebate to many Americans with children. This increased the amount of money that they had available to spend. At the same time, many Americans took advantage of lower interest rates to refinance their mortgages -- that is, they took out new home mortgages at the current low rates and used these to pay off their old, higher-rate mortgages. Getting a new loan at a lower interest rate means a lower monthly payment, thus they have more cash to spend. Businesses benefited from surging productivity due to the better use of technology. Ways to Measure Economic Growth Other Than GNP and GDP Economic growth should reduce poverty. First, economic growth spurs business opportunities and entrepreneurship. These create job opportunities and lower unemployment, a major source of poverty. Second, economic growth allows governments increased tax revenues without raising taxes. In other words, more people and companies are paying more taxes because sales and incomes are higher. This increases the amount of money the government takes in without increasing the tax rate. Higher revenues, in turn, allow governments to pursue social programs that lower poverty. However, some countries find it difficult to experience true economic growth. It is possible for a country's economy to be growing while its people are actually getting poorer. Thus, economists attempt to determine how economically comfortable a nation's people are as a way to measure economic growth. Economists are limited, however, to what can be accurately measured through money. Since many aspects of life cannot be directly translated into money, these evaluations by economists may not always match how economically comfortable people feel. Standard of Living Unfortunately, there is no precise measure of people's economic health, but the term "standard of living" is usually used to compare the quality of life in different countries. It is often defined as the goods and services either considered necessary and desirable or Tue, Sep 23 13:51:32 GM Page 11 of 14 Overview actually enjoyed by a person or group of people. Other things being equal, the higher a country's economic growth, the higher its standard of living. Ways to measure the standard of living include per capita GDP, the cost of living, the consumption of certain goods (such as protein), the distribution of income, and the quality and availability of services (such as the water supply). Because there is no precise way of measuring a nation's standard of living, it can never be a perfect tool. Furthermore, different nations spend their income purchasing different goods and services. Americans spend more money on automobiles than the people of any other nation, while Germans spend more on vacations. Both nations believe that they have a high standard of living. Inflation, a steady increase in prices, has a negative impact on a country's standard of living. Thus, other things being equal, countries that experience higher inflation rates end up with a higher cost of living and a lower standard of living. Per Capita GDP "Per capita" is Latin for "by heads" -- thus, it means "per person." Per capita GDP is determined by dividing the GDP of a particular region or country by the number of people living there. If the per capita GDP is declining, it is possible for a country's economy to be growing while its people are actually getting poorer. If the GDP is growing at a rate of 2% per year, while the number of people in the country is growing at the rate of 3% per year, the per capita GDP is decreasing. Thus, the typical person in the country is getting poorer even though the economy is growing. During the last 30 years, this has happened in many poor countries. Their economies were growing, but their population was growing even faster. Thus, their people were getting poorer -- their per capita GDP was falling. Cost of Living Cost of living is another way to assess how economically comfortable a nation's people are. In the United States, the cost of living is computed using the Consumer Price Index (CPI). This is the total amount of money needed to purchase about 300 consumer goods and services that would be purchased by a "typical" urban consumer. By comparing the CPI over time, you can measure the change in the cost of living. Other things being equal, countries with a higher cost of living have a lower standard of living. Distribution of Income Tue, Sep 23 13:51:32 GM Page 12 of 14 Overview If a nation has a growing per capita GDP, it usually means that most people in that nation are getting richer, but that is not always true. This would be true if everyone shared equally in the increase, but that never actually happens. Some people earn a greater part of the national income than others earn. This is called "distribution of income." In some poor countries, there is a very great difference in the distribution of income among the people. For example, a few thousand wealthy people may earn a very large part of the nation's income, while millions live in poverty. Uneven Economic Growth Economic growth and standards of living are uneven around the world. Some countries have been growing for a longer time and have become "developed," other countries have been growing for a shorter time and have yet to become developed ("developing"), while a third group has yet to grow, remaining "underdeveloped." The United States and most European countries belong in the first category, a number of Southeast Asian countries belong in the second category , while most Latin American, African , and South Asian countries belong in the second or third category . The sources of slow economic growth and poverty are many: lack of natural resources, poor health and nutrition, war, lack of political and economic freedoms , extensive government intervention in the economy , heavy taxation, and lack of physical infrastructure. Civil wars, for instance, increase economic and political uncertainty, which has the effect of discouraging entrepreneurship and capital investment. Poor health and nutrition is responsible for a number of diseases that negatively affect the quantity and quality of human resources. This further discourages entrepreneurship and capital investment, making it difficult for the country to grow, compete, and catch up with countries growing at a faster rate. Lack of political and economic freedoms further impairs entrepreneurship and economic growth. According to an annual survey of 150 countries conducted by "The Wall Street Journal" and the Heritage Foundation, economic and political freedom is closely correlated with economic growth. Countries that are "more free" have been consistently growing faster than "less free" countries . That is, the economic growth of market economies has generally been better than that of command economies. SUMMARY Entrepreneurship is at the core of the capitalist system. It is the spark of new business enterprises and industries, and a source of competitive advantage, especially in global Tue, Sep 23 13:51:32 GM Page 13 of 14 Overview industries. Entrepreneurship together with capital investment contributes to economic growth and the reduction of poverty. Tue, Sep 23 13:51:32 GM Page 14 of 14