Abstract
We examine how economic institutions, measured by the Economic Freedom of the World (EFW) index, affect the relationship between capital—human, social, and financial—and opportunity-motivated entrepreneurship (OME). To do this, we develop a multi-level model that connects theories of human and social capital at the micro-level to institutional theories at the macro-level. Using data from the Global Entrepreneurship Monitor (GEM), we then test the predictions of our model and find evidence that economic institutions play a crucial role in the relationship between these three distinct types of capital and OME. Our results are somewhat counter-intuitive—as the quality of the institutional environment improves, human and financial capitals become less important determinants of entrepreneurship while the relationship between social capital and entrepreneurship substantially strengthens.
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Notes
Our study differs in important ways—both theoretically and empirically. First, we focus on level 2 formal institutions in Williamson’s (2000) four level hierarchy. Within this theoretical framework, formal institutions are often proxied with economic freedom. In our case, we use the Economic Freedom of the World (EFW) index, which is a complex composite indicator that captures formal institutions related to five areas (1) size of the government, (2) rule of law, (3) freedom to trade internationally, (4) sound monetary policy, and (5) credit, business, and market regulations. Importantly, the majority of the 43 distinct items used to create the EFW index are based on objective indicators such marginal tax rates, rate of inflation, and tariffs (Gwartney et al. 2016). In contrast, De Clercq et al. (2013) focus on a specific set of institutions and rely on people’s subjective valuation to gauge the supportiveness of the educational and financial systems. In addition, our study focuses on opportunity entrepreneurship because of its potential for economic growth and job creation, spans over a longer period of time, and covers a more extensive number of countries. In additional robustness tests, we also show how our findings different with respect to necessity-driven ventures and nascent entrepreneurship. Finally, our multi-level theoretical framework makes different predictions than those in De Clercq et al. (2013). For example, our model suggests that as the quality of the institutional environment improves, financial capital will become a weaker determinant of opportunity entrepreneurship. Similarly, based on the second-best institutions model (Rodrik 2008), we argue that the importance of social capital will also diminish in economies with better institutions. Our findings also differ in important ways. For example, we find that as the quality of the institutional environment improves (i.e., EFW goes up), human and financial capital become less important determinants of entrepreneurship while the relationship between social capital and entrepreneurship improves. Because we use similar empirical models, our findings suggest that measurement of both institutions and entrepreneurship may be critical and call for further research.
Hurst and Lusardi (2004) argue that liquidity constraints are not really present as the majority of the relationship between assets and entrepreneurial entry is found only for those with wealth beyond the 95th percentile in the wealth distribution. However, Fairlie and Krashinsky (2012) bifurcate samples into opportunity and necessity entrepreneurs and find that, when this selection bias is considered, liquidity constraints are found to be present.
Social capital gained popularity after Coleman (1988) laid its theoretical foundation by drawing parallels with other types of capital such as financial and human capital. Since then, a large body of literature has emerged in different disciplines to explain how social capital functions as both social norms (Fukuyama 2001; Putnam et al. 1994) and networks (Nahapiet and Ghoshal 1998; Tsai and Ghoshal 1998), which have important implications for business and value creation.
We appreciate one reviewer’s comments that point out this very plausible explanation.
Abbreviations
- OME:
-
Opportunity-motivated entrepreneurship
- GEM:
-
Global Entrepreneurship Monitor
- TEA:
-
Total early-stage entrepreneurial activity
- Institutions:
-
Economic freedom (Fraser Institute)
- Human capital:
-
College education
- Financial capital:
-
Household income
- Social capital:
-
Ties with other entrepreneurs
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Appendix
Appendix
1.1 Necessity-Motivated Entrepreneurship
The interaction between country-level economic freedom and individual-level financial capital on necessity-motivated entrepreneurship (NME). Note. Financial capital = 1 if an individual’s household income is in the highest tercile and 0 otherwise. Economic freedom is measured by the Fraser Institute’s Economic Freedom of the World index. The 95% confidence intervals are reported
The interaction between country-level economic freedom and individual-level human capital on necessity-motivated entrepreneurship (NME). Note. Human capital = 1 if an individual has a college education or higher and 0 otherwise. Economic freedom is measured by the Fraser Institute’s Economic Freedom of the World index. The 95% confidence intervals are reported
The interaction between country-level economic freedom and individual-level social capital on necessity-motivated entrepreneurship (NME). Note. Social capital = 1 if an individual knows someone who has created a business in the past 2 years and 0 otherwise. Economic freedom is measured by the Fraser Institute’s Economic Freedom of the World index. The 95% confidence intervals are reported
1.2 Nascent Entrepreneurship
The interaction between country-level economic freedom and individual-level financial capital on nascent entrepreneurship. Note. Financial capital = 1 if an individual’s household income is in the highest tercile and 0 otherwise. Economic freedom is measured by the Fraser Institute’s Economic Freedom of the World index. The 95% confidence intervals are reported
The interaction between country-level economic freedom and individual-level human capital on nascent entrepreneurship. Note. Human capital = 1 if an individual has a college education or higher and 0 otherwise. Economic freedom is measured by the Fraser Institute’s Economic Freedom of the World index. The 95% confidence intervals are reported
The interaction between country-level economic freedom and individual-level social capital on nascent entrepreneurship. Note. Social capital = 1 if an individual knows someone who has created a business in the past 2 years and 0 otherwise. Economic freedom is measured by the Fraser Institute’s Economic Freedom of the World index. The 95% confidence intervals are reported
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Boudreaux, C.J., Nikolaev, B. Capital is not enough: opportunity entrepreneurship and formal institutions. Small Bus Econ 53, 709–738 (2019). https://doi.org/10.1007/s11187-018-0068-7
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DOI: https://doi.org/10.1007/s11187-018-0068-7