Theories of Entrepreneurship

1. Schumpeter’s Theory of Innovation:

Joseph Schumpeter propounded the well-known innovative theory of entrepreneurship. Schumpeter takes the case of a capitalist closed economy which is in stationary equilibrium. He believed that entrepreneurs disturb the stationary circular flow of the economy by introducing an innovation and takes the economy to a new level of development. The activities of the entrepreneurs represent a situation of disequilibrium as their activities break the routine circular flow.

Innovations of entrepreneurs are responsible for the rapid economic development of any country.

Talking about innovation, he referred to new combinations of the factors of production, Schumpeter had assigned the role of innovator to the entrepreneur, who is not a man of ordinary managerial ability, but one who introduces something entirely new.

Innovation could involve any of the following:

1. Innovation of new products.
2. Innovation in novel methods or processes of production.
3. The opening up of a new market.
4. Entrepreneurs might find new source of supply of raw materials
5. Innovation in management. This means reorganization of an industry.

Let us try to understand the meaning of different facets of the term innovation.

The introduction of new product means the product which the consumers have not seen and is of a new and better quality and utility. A new method of production refers to a novel process not yet been used in manufacturing and commercial production. This may increase the productivity and lower cost of production.

The discovery of a new market means a new market which may have existed before but was not entered by the enterprise for commercial purposes. A new source of raw material similarly refers to a source or a place which has not been commercially exploited by the enterprises before. Innovation in management refers to reorganization and reconciliation of the position of the enterprise in the industry by building a monopoly like control or dismantling existing monopoly of others in the industry.

Schumpeter was very explicit about the economic function of the entrepreneur, whom he considered as the prime mover in economic development and the entrepreneur’s task is to innovate or carry out new combinations.

Schumpeter had differentiated between invention and innovation. We should understand that invention refers to creation of new materials and innovation refers to application of new materials into practical use in industry. Similarly, there is a distinction between an innovator and an inventor. The inventor is the one who invents new materials and new methods. On the other hand, the innovator is the one who utilizes these inventions and discoveries in order to make new combinations.

Bringing about innovations is the main task of the entrepreneur and not the maintenance of the enterprise. Entrepreneurs dream and have a willingness to establish a private kingdom. They enjoy creating and getting things done. These “innovating entrepreneur” has played an important role in the rise of modem capitalism.

Criticisms:

Schumpeter’s theory has been subjected to the following criticisms:

1. Critics feel that the theory over emphasized on innovative functions of the entrepreneur. It ignored the organizing aspects of entrepreneurship.
2. Schumpeter had completely ignored the risk-taking function of the entrepreneur, which cannot be ignored. Whenever an entrepreneur develops a new combination of factors of production, there is enough risk involved.
3. The theory is more applicable in developed countries only. In developing countries there is a paucity of innovative entrepreneurs.
4. The theory does not provide the explanation as to why few countries have more entrepreneurship talent than others.

Despite of all the above criticisms Schumpeter’s theory is considered as a landmark in the expansion of entrepreneurship theories.

2. Max Weber’s Theory of Social Change (Emphasis on Impact of Religion):

Max Weber advocated a sociological explanation for the growth of entrepreneurship in his theory of social change. He felt that religion had a profound influence on the growth of entrepreneurship. The religious belief and ethical value associated with the society plays a vital role in determining the entrepreneurial culture.

Max Weber opined that the entrepreneurial energies of a society are exogenously generated and supplied by religious believes. Some religions profess the basic values to earn and acquire money whereas some religions put less emphasis on it. In order to understand the gist of Max Weber’s theory we need to understand few fundamental points of the theory.

In his theory spirit of capitalism is a fundamental concept. Capitalism refers to the economic system where market forces of demand and supply are allowed to play freely. As economic freedom and private enterprises are promoted in capitalism, the entrepreneurism is eulogized and entrepreneurial pursuits are encouraged. Spirit of capitalism promotes the entrepreneurs to engage in entrepreneurial pursuits and earn more and more profits.

The urge to acquire money and profits drives the individuals to become entrepreneurs. The spirit of capitalism will be widespread in the society that favours capitalism. Another associated concept was that of adventurous spirit which refers to the impulsive force that influences and promotes entrepreneurism. Weber felt that the belief systems of Hinduism didn’t encourage entrepreneurship.

Hinduism laid less emphasis on wealth accumulation, and material life. The Hinduism didn’t profess the spirit of capitalism and was thus an obstacle in the promotion of entrepreneurship. Weber was of the opinion that the Protestant ethic provided the mental attitude in a society that promotes spirit of capitalism and favours entrepreneurship.

The rate of industrial growth depends upon the values professed by the religion of the society. The Protestants had advanced at a faster rate in establishing capitalism in Europe owing to the value system professed by Protestant ethic. Protestant ethic granted them the rational economic attitude, accumulating assets, and permitted them to take pleasure in the material life.

Criticisms:

Max Weber had tried and made a commendable contribution in explaining the growth of entrepreneurship.

But, his theory has been challenged and criticized by many researchers and scholars on the following grounds:

1. The theory is based on unrealistic and invalid assumptions.
2. The theory has been found empirically invalid.
3. Max Weber has been criticized by many sociologists on his view on Hinduism and entrepreneurship. The rapid expansion of entrepreneurship in India in the post-independence period disproves that Hinduism is averse to the spirit of capitalism and to adventurous spirit.
4. The views on Protestant ethic were also not completely correct. Capitalism has flourished in regions where Protestant ethic is not present.

3. The Uncertainty-Bearing Theory of Knight:

Frank H. Knight (1957) in his book Risk, Uncertainty and Profit regards profit of the entrepreneur as the reward of bearing non-insurable risks and uncertainties. Entrepreneurship is genuinely associated with risk bearing. Knight had distinguished risk into insurable risks and non-insurable risks.

Let us try to understand the underling concept of risks.

There are certain risks that are measurable and the probability of such risk can be statistically estimated and hence such risks can be insured. Example of insurable risks include theft of commodities, fire in the enterprise, accidental death etc. On the other hand, there are certain risks which cannot be calculated.

The probability of their occurrence cannot be statistically ascertained. Such risks include risks associated to changes in prices, demand and supply. These risks are non-insurable. Prof. Knight opined that the profit is the reward for bearing the non-insurable risks and uncertainties.

Uncertainty-bearing is one of the most vital functions in a dynamic economy. The entrepreneur bears the uncertainty involved in the enterprise. The expectation of profit is the supply price of the entrepreneurial uncertainty bearing exercise. In a state of economy (competitive) where there is no risk, every entrepreneur will have a minimum supply price.

If the reward allocated to the entrepreneur is below it, the entrepreneurs will abstain from providing their entrepreneurial services. The existence of uncertainty tends to raise the minimum supply price. The entrepreneurs expect a level of profit for bearing the uncertainty.

The salient points of Knight’s theory include:

1. According to the theory, the entrepreneur earns pure profits for bearing the uncertainty.
2. The probability of uncertainty or non-insurable risks cannot be statistically estimated.
3. Entrepreneurs undertake risks of varying degrees according to their ability ad inclination. The theory suggests that the more risky the nature of enterprise, the higher level of profit earned by the entrepreneurs.
4. Profit is the reward of the entrepreneur for bearing uncertainties and risks. Hence, it should be a part of the normal cost.
5. The reward of the entrepreneur is uncertain. Entrepreneur guarantees interest to lender of capital, wages to workers and rent to the landlord.
6. The level of uncertainty in business can be reduced by applying the technique of consolidation. The total level of uncertainty can be reduced by pooling individual instances.

Criticisms:

F.H. Knight’s theory is one of the most sophisticated theories to explain supply of entrepreneurship based on profit. But, the theory suffers from certain drawbacks as pointed by the critics.

1. The role of an entrepreneur has not been elaborately provided by the theory. The entrepreneur’s activity has been restricted to uncertainty bearing. Modern business activities are different. Often, there is a dichotomy between ownership and management. These factors have not been taken into consideration.
2. The uncertainty-bearing theory discussed the concept of profit in a vague way. The exact estimation of profit for the entrepreneur has not been provided in the theory.
3. Profit as a residual income of the entrepreneur has been criticized.
4. Critics feel that uncertainty-bearing should not be treated like other factors of production like land, labour and capital. It is a psychological concept and should be treated in a different manner.

4. Theory of Frank Young (Emphasis on Changes in Group Level Pattern):

A Micro-sociological interpretation of entrepreneurship as coined for the theory propounded by Frank Young emphasizes that the entrepreneurial initiatives are conditioned by group level pattern. Young rejected the psychogenic interpretations of entrepreneurship. He considered the solidarity groups responsible for building entrepreneurship.

We shall try to understand his theory by studying the various specific elements attached to this theory.

Frank Young opined that the entrepreneurial characteristics are observed in clusters, ethnic groups, occupational groups and groups with political orientation. Entrepreneurism at the individual level is the manifestation of the group level pattern. Young disapproves the notion of an entrepreneur working individually. The entrepreneur functions as a member of a group.

The entrepreneurial initiatives and actions are the outcome of the experiences and exposures of an individual entrepreneur as a member of a particular group, the family background of the entrepreneur and the manifestation of the general values of the group. The economic problems faced by the individual entrepreneurs are mitigated by the solidarity of entrepreneurial groups. The individual entrepreneurs enjoy the confidence of their association with the solidarity groups which help the individual entrepreneurs to overcome any sort of economic problems.

Frank Young deduced the group level pattern behaviour exhibited by the entrepreneurs on the basis of his test known as Thematic Appreciation Test (TAT) on groups of entrepreneurs.

The Young’s theory includes the idea of reactive subgroups. These reactive sub-groups play an important role in enterprise creation. The reactive groups crop up whenever a group experiences low status recognition, limited or no access to social networks and have better institutional resources as compared to other groups in the society at the same level.

5. Economic Theory of Entrepreneurship:

G.F. Papanek (1962) and J.R. Harris (1970) were of the view that economic incentive is the main factor that influences entrepreneurial activities. Economic gains spontaneously develop the willingness among the entrepreneurs to undertake diverse entrepreneurial initiatives. The relationship between an individual’s inner urge and the desired economic gains has a profound influence in the development of entrepreneurial competencies. Entrepreneurship development and economic growth takes place whenever certain economic conditions are favourable.

6. Mark Casson Theory (Economic Theory):

Mark Casson’s theory is an original synthesis of other approaches. Mark Casson in his book ‘The entrepreneur- An Economic Theory’, published in 1982, talks about the entrepreneur. According to Mark Casson the Entrepreneur might be a property developer, a small businessman or just someone who knows how to ‘turn a fast buck’. His book as expressed by Mark Casson endeavoured to provide a balanced view on the topic of entrepreneur.

Mark Casson felt that there was no established economic theory of the entrepreneur. Except for the discipline of Economics, all the social sciences had a definition of entrepreneur. He felt that there were two main reasons for the non-existence of an economic theory of the entrepreneur. These reasons were related to the limitations of the two main schools of economic thought prevalent at that point of time. First reason was that the neoclassical school of economics made extreme assumptions regarding the access to information.

The second reason was that the Austrian school of economics was committed to extreme level of subjectivism. This made the formulation of predictive theory of the entrepreneur impossible. The Mark Casson’s book the theoretical reconstruction proceeds on two fronts. The first is to recognize that individuals differ not only in their tastes but in their access to information.

Individuals with similar taste but with different information may take different decisions. The entrepreneur exhibits this phenomenon. The entrepreneur will decide in one way which would be very different from what everyone else would decide. The entrepreneur considers that the totality of the information available to him/her with respect to some decision is unique. The entrepreneur’s perception of the situation has a profound influence on the allocation of resources. The entrepreneur expects to earn profit from the difference in perception by ‘taking a position’ vis-a-vis other people.

Many of the predictions of the economic theory of entrepreneurship come from considering the tactical aspects of the strategy of the entrepreneur. The second area of reconstruction stems from recognition of the difficulty that is inherent in organizing a market. Mark Casson suggested that unlike neoclassical assumptions in reality transaction involves a significant resource cost. It is important for the entrepreneur’s success that the entrepreneur minimizes the transaction cost incurred in establishing any given volume of trade.

Mark Casson has presented his book on Entrepreneur- An economic theory in fifteen chapters. Mark Casson had attempted to converge the two different approaches associated with the entrepreneurship theory. The functional approach was adopted by the economists and the indicative approach adopted by economic historians. The entrepreneur is defined as someone who specializes in taking judgmental decisions about the coordination of scarce resources.

7. Kunkel’s Theory (Emphasis on Entrepreneurial Supply):

John H. Kunkel had built up his theory on the edifice of entrepreneurship supply. He was of the opinion that the sociological and psychological factors influence the emergence of entrepreneurs.

Supply of entrepreneurs has a functional relationship with the social, political and economic structure.

In order to understand Kunkel’s theory, let us understand few concepts associated with his theory.

In an economy, the supply of entrepreneurship depends on the following structures existing in the economy:

(i) Demand Structure:

This refers to the demand situation prevailing in the economy. The entrepreneurs expect rewards for their contributions and their behaviour is influenced by the rewards. The demand structure of an economy can be enlarged by rewarding the entrepreneurs with material rewards for their entrepreneurial activities.

(ii) Limitation Structure:

This structure influences the entrepreneurs and other members of a society. The society in this structure restricts specific activities. The entrepreneurs and the other members come within the ambit of this structure.

(iii) Opportunity Structure:

This structure is regarded as one of the most significant structure that influences the supply of entrepreneurs in an economy. This structure includes the existing market structure, the available managerial and technical skills, information about production techniques, supply of labour and capital.

(iv) Labour Structure:

This structure relates to the availability of skilled labour willing to work. The labour structure in influenced by number of factors like the mobility of labour, available alternatives of employment, level of traditionalism and prevailing work culture.

In Kunkel’s theory, the conditioning procedure is a major determinant of the activities of the individuals. The behaviour of the individuals is highly subjected to the conditioning procedure surrounding the environment of the individuals. To influence and alter the individuals’ activities there is a need to change certain factors of situation that influences the conditioning.

Criticisms:

Kunkel’s theory despite of great recognition is criticized on the following grounds:

1. The theory is based on unrealistic postulates.
2. The different structures that influence supply of entrepreneurship are not that simple.
3. The theory of Kunkel tried not consider the ambiguous concepts like values, personality etc.

8. Hoselitz’s Theory (Emphasis on Marginal Groups):

Hoselitz’s theory emphasized that the cultural factors and the role of culturally marginal groups in entrepreneurial development. In his theory, Hoselitz had highlighted the importance of the culturally marginal groups in development of entrepreneurship and their contribution to economic development of the economy. The marginal groups are the minorities in the society and they yearn to elevate their conditions and in the process promote economic development.

In several countries the entrepreneurial aptitude are associated to persons of particular socio-economic classes. The importance and contribution of the culturally marginal groups like Lebanese in West Africa; Jews in Europe towards the economic development of those regions reflect the gist of the theory.

Hoselitz opined that the marginal men placed in an ambiguous position and therefore they are best suited to make creative adjustments in situations of change. They bring about genuine adaptations in their behaviours. They become entrepreneurs and promote economic development.

9. Cochoran’s Theory:

Thomas Cochran in his theory had tried to discuss the supply of entrepreneurship from the sociological point of view.

We can understand the crux of his theory by discussing some of the principle elements of his theory.

Cochran had suggested that the cultural values of a society, social expectations and role expectations play an important role in determining the supply of entrepreneurs. The basic problems associated with economic development include non-economic issues. The social factors are responsible in determining the entrepreneurial dynamism and the supply of entrepreneurs.

As far as the entrepreneur is concerned, Cochran opined that the entrepreneurs are not extraordinary persons or super normal persons and they are not abnormal individuals deviant from the society. Rather the entrepreneurs represented role models of the society. An entrepreneur represents a society’s model personality.

The entrepreneur plays an important social role. The role played by the entrepreneur is highly influenced by the model personality that crops up depending on the social conditioning. The role of an entrepreneur is defined by the defining group in corporate world which include the members of board of directors and other top officials.

Cochran was of the opinion that the intrinsic character and behaviour of the executive is highly dependent and conditioned by the type of childbearing and schooling. Thus all social and cultural factors play an important role in influencing the expectation levels, personality, behaviour of everyone in the society and entrepreneur’s role specially.

The level of dynamics associated with entrepreneurial depends on social factors. These factors result in major changes. The model of Cochran was built on American experience of entrepreneurial dynamism. In the nineteenth century, American economy had experienced major changes as a result of the dynamism exhibited by the entrepreneurs.

Thomas Cochran held the view that the factors having a profound influence on the performance of the entrepreneurs include- First, the attitude of a person towards his/her own occupation. Second, the role expectations conceived and expected by the sanctioning group. And third, the operational requirements of the concerned job.

Criticisms:

Cochran’s theory despite having earned high appreciations has been criticized on the following counts:

1. The theory doesn’t provide a satisfactory explanation of the supply of entrepreneurs in an economy.
2. The theory concentrates only on the social factors and their impact.
3. The theory ignores the influence of important elements like risk, profit and innovation.
4. The multiple roles associated with the entrepreneur have not been focused in the theory.

10. E. E. Hagen’s Theory (Emphasis on Withdrawal of Status Respect):

Hagen in his theory had accredited the withdrawal of status respect of a group as the starting point for entrepreneurship development process. Before we discuss the concept of withdrawal of status respect let us try to consider the various crucial facets of the theory.

The theory is based on a general model of the society. His theory viewed the entrepreneur as a trouble shooter who contributes to economic development. The creativity of the entrepreneur brings about social transformation and economic development. Economic growth is associated with the social and political changes. He didn’t encourage the entrepreneurs to imitate other’s technology.

Hagen had ascribed the genesis of entrepreneurship to withdrawal of status respect of a group. The social group that experiences the withdrawal of status respect engulfs itself into aggressive entrepreneurism. In such a situation the status loosing group and the members of status loosing group endeavour to regain their status by undertaking rigorous entrepreneurial drive.

Hagen had suggested the events that could create as well as indicate withdrawal of status respect of a social group. First, dislodgment of a traditional elite group from its prior status, Second, defamation of valued symbols through some change in the attitude of the superior group. Third, Unpredictability of status symbols in the changed allocation of economic power. Fourth, when social group doesn’t enjoy the expected status when it migrates to a new society.

There four possible reactions to the withdrawal of status respect which relates to four different personality types:

(i) The retreatist – An individual who works in the society but is indifferent to the work and position.

(ii) The ritualist – An individual who works in the manner accepted and approved by the society but has no hopes of improving his/her position.

(iii) The reformist – An individual who fights against the injustice and tries to rebels against the established society in order to form a new society.

(iv) The innovator – An individual who endeavours to bring about new changes and utilizes all opportunities. This personality reflects the personality of an entrepreneur.

Criticisms:

1. The theory lacks general application. It is not always true that all the social groups have behaved in the manner as advocated in the theory.
2. The theory ignores the various other factors accountable for development of entrepreneurship.

11. Leibenstein’s Theory (Emphasis on X-Efficiency):

The concept of X-efficiency was introduced by Harvey Leibenstein a noted economist in1966 in his article titled “Allocative efficiency vs. X-efficiency”. This is also referred to as X-inefficiency. In general X-inefficiency refers to the difference between the optimal efficient behaviour of business in theory and the observed behaviour is practice which occurs owing to different factors.

X-efficiency refers to the effectiveness with which a given set of inputs are used to produce outputs. If a particular firm is producing the maximum output it can, given the resources it employs with the best available technology, it is said to be technical-efficient. X-inefficiency occurs when technical-efficiency is not achieved. Whenever an input is not used effectively the difference between the actual output and the maximum output attributable to that input is a measure of the degree of X-efficiency.

Harvey Leibenstein had mentioned that for allocative efficiency the whole economy was considered whereas in case of X-efficiency just specific companies and industries are to be considered.

X-efficiency arises either because the firm’s resources are used in the wrong way or because they are wasted, that is, not used at all.

The entrepreneur has been entrusted two roles; first the role of a gap filler and second an input completer. The production function usually has certain deficiencies. These deficiencies and gap arise because all the factors of production function cannot be marketed. The entrepreneur has been entrusted the job to fill the gaps in the market. The second role of the entrepreneur is input completion. The entrepreneur has to mobilize all the available inputs in order to improve the efficiency of existing production methods.

Leibenstein advocated two types of entrepreneurship. First type is the ‘Routine entrepreneurship’ which involves the important functions of management of business. Second type is that of the ‘New entrepreneurship’ which involves innovative entrepreneurship.

Criticisms:

The Leibenstein’s theory has been often compared with the neoclassical views.

The theory has many novel contributions but has been criticized on following counts:

1. The exact influence which the X-efficiency has on output of an organisation cannot be determined.
2. The theory is less predictable as compared to normal theories.

12. M. Kirzrier’s View on Entrepreneurship:

Israel Meir Kirzner, an American economist has made remarkable contributions towards entrepreneurship. He has contributed many books. His ideas and theory on entrepreneurship can be understood by the going through his book ‘Competition and entrepreneurship’ published in 1973. There are six chapters. The second chapter is devoted to discuss the topics like nature of entrepreneurship, the different facets of entrepreneurs, entrepreneurial profits.

We shall try to understand the basics features enshrined in his ideas.

The basis of Kirzner’s idea of entrepreneurship is spontaneous learning. The simplest situation in which spontaneous learning can occur is a Crusoe situation. Further, Kirzner calls the state of mind that enables spontaneous learning to occur alertness.

Kirzner introduces the notion of the pure entrepreneur by saying that there are two distinct ways in which this notion enters the analysis of the market process: First, by means of contrast with Robbinsian economizers, and Second, through the alertness.

According to Kirzner, the pure entrepreneur is “a market participant whose decisions are entirely incapable of being subsumed under the category of Robbinsian economizing.” And the pure entrepreneur is “a decision-maker whose entire role arises out of his alertness to hitherto unnoticed opportunities.”

Kirzner’s notion of entrepreneurship as equilibrating combines three ideas. The first is that subconscious learning is equilibrating to the isolated actor. The second is that subconscious learning about arbitrage opportunities is equilibrating in markets. The third is that subconscious learning would lead to a general equilibrium if there were no changes in the non-entrepreneurial determinants of demand and supply.

13. Baumol’s View on Entrepreneurship:

William J. Baumol a noted economist had made significant contributions towards the theory of entrepreneurship. He has many articles like ‘Entrepreneurship in Economic Theory’, ‘Entrepreneurship: Productive, Unproductive, and Destructive’ to his credit that reflects his notion on entrepreneurship.

Baumol (1968) discussed role of entrepreneur. He felt that the role of the entrepreneur is vital to economic growth. Baumol’s approach to entrepreneurship within the economy shows that the entrepreneur is basically nonexistent in the models of economics. He stated that the entrepreneur has been read out of the model because the economic models are based on well-defined variables like output and price. There is no scope for analyzing the issues related to like inventiveness, cleverness, ambition of the entrepreneur in the models. He opined that theories won’t be able to portray the function of entrepreneurial activity.

Again in an article Baumol laid out a simple hypothesis. He stated that the total supply of entrepreneurs varies across the societies. Moreover, the productive contribution of the society’s entrepreneurial activities also varies due to allocation of their activities into productive and unproductive activities.

14. Peter Drucker’s View on Entrepreneurship:

Peter Ferinand Drucker was an Austrian born American multifaceted management consultant, author, professor who described himself as a social ecologist. Drucker’s book Innovation and Entrepreneurship published in 1985 is a great contribution. Peter Drucker regards the definition of J. B. Say on entrepreneur. J.B. Say was of the opinion that the “entrepreneur shifts economic resources out of an area of lower and into area of higher productivity and greater yield.”

Peter Drucker viewed the entrepreneur as a unique agent of change. Drucker writes that “the entrepreneur always searches for change, responds to it, and exploits it as an opportunity.”

In his book “Innovation and Entrepreneurship”, Peter Drucker offers guidelines on how entrepreneurs can become innovative. Drucker opined that successful innovation practices are result of systematic hard work. Drucker introduces systematic innovation as a framework for exploiting innovative opportunities.

He also considered that the entrepreneurial society is the outcome of innovative entrepreneurship combined with government facilitation.

Drucker takes the instance of the United States of America as a successful entrepreneurial economy. He has separately dealt with three branches- existing business, public service institutions, and new ventures.