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Principles of Economics Without the Prince of Denmark a

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Barbara J. Phipps , Robert J. Strom & William J. Baumol a

University of Kansas

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Ewing Marion Kauffman Foundation

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Berkley Center for Entrepreneurship & Innovation, Leonard N. Stern School of Business, New York University Available online: 18 Jan 2012

To cite this article: Barbara J. Phipps, Robert J. Strom & William J. Baumol (2012): Principles of Economics Without the Prince of Denmark, The Journal of Economic Education, 43:1, 58-71 To link to this article: http://dx.doi.org/10.1080/00220485.2012.636711

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THE JOURNAL OF ECONOMIC EDUCATION, 43(1), 58–71, 2012 C Taylor & Francis Group, LLC Copyright ISSN: 0022-0485 / 2152-4068 online DOI: 10.1080/00220485.2012.636711

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ECONOMIC INSTRUCTION

Principles of Economics Without the Prince of Denmark Barbara J. Phipps, Robert J. Strom, and William J. Baumol

In most introductory textbooks on principles of economics, discussion of the theory or practice of entrepreneurship is almost entirely absent. This omission is striking, given the important role in economic growth that economists assign to the entrepreneur. While there are plausible explanations for this omission, new research suggests the beginnings of a body of formal microtheory on innovative entrepreneurship. In this article, the authors first review treatment of the entrepreneur in the latest editions of three commonly used introductory economics textbooks, each of which includes a substantive discussion of entrepreneurship. Second, the authors present brief overviews of new microtheories of entrepreneurship (Parker 2009; Spulber 2009; and Baumol 2010), each of which has potential to serve as inspiration and to provide a framework for inclusion of entrepreneurship in introductory microtheory. Keywords economic education, entrepreneur, teaching of economics JEL codes A2, L26

If we can learn about government policy options that have even small effects on long-term growth rates, we can contribute much more to improvements in standards of living than has been provided by the entire history of macroeconomic analysis of countercyclical policy and fine-tuning. —R. J. Barro and X. Sala-i-Martin (2003, 6)

Barbara J. Phipps is Director of the Center for Economic Education at the University of Kansas and corresponding author (e-mail: [email protected]). Robert J. Strom is Director of Policy and Research at the Ewing Marion Kauffman Foundation (e-mail: [email protected]), and William J. Baumol is Academic Director of the Berkley Center for Entrepreneurship & Innovation, Leonard N. Stern School of Business, New York University (e-mail: [email protected]). The authors are grateful to Alyse Freilich for her very capable assistance in preparing and editing this manuscript, Marisa Porzig and Nadia Kardash for their assistance in analyzing textbooks, and Anne Noyes Saini for her invaluable, careful editing. This article is based on a paper that was presented at the National Conference on Teaching Economics at Stanford University on June 1–3, 2011.



PRINCIPLES SANS DANISH PRINCE

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Introductory textbooks on principles of economics typically begin presentation of the theory of distribution with a discussion of the three or four “factors of production”—land, labor, capital, and (sometimes) entrepreneurship. There commonly follows one or more chapters on the first three of these, but materials that address the theory or practice of entrepreneurship are absent or incomplete. Even textbook discussions of economic growth, a topic of profound importance, universally neglect the engines of growth: the inventors, who generate important novel ideas, and the entrepreneurs, who recognize the significance of these ideas, adapt them to consumer preferences, and then take the steps necessary to bring them to market. Discussions of economic growth are, without exception, located in the portion of the book devoted to macroeconomics, presenting growth issues in terms of broad categories, such as capital formation, technology development, health, and education. While this discussion is all to the good, offering valuable insights on important issues to the neophyte student, it is only part of the story. Material that is considered microeconomic, especially that regarding the vital role of the entrepreneur in innovation and economic growth, is regrettably omitted. To use the mot that was common over half a century ago (and to which Schumpeter (1911) himself resorted), we are witnessing a performance of Hamlet without the Prince of Denmark. To date there has been, we must acknowledge, a simple explanation for this omission. The obstacles to the development of formal theory or to the conduct of statistical analysis on entrepreneurship have left little concrete and straightforward evidence of the phenomenon to present to students in introductory courses. While there has long been a body of formal microtheory addressing the other three input classes, entrepreneurship has lacked any such work. A plausible reason for this deficiency is the focus of much of microtheory on optimization and stationary equilibrium. The innovative entrepreneur, as brought out by Schumpeter (1911) and Kirzner (1971), can tolerate neither stability of equilibrium (which his innovations upset) nor continued disequilibrium (which his alertness to arbitrage opportunities eliminates). In an optimized static equilibrium, there is no place for the entrepreneur, who will have departed to more malleable situations, his place having been taken over by the manager. Indeed, as Baumol stated in 1993, “The theoretical firm must choose among alternative values for a small number of rather well defined variables . . . management is taken to consider a set of values as described by the relevant functional relationships, equations and inequalities. Explicitly or implicitly, the firm is then taken to perform a mathematical calculation which yields optimal . . . values for all of its decision variables . . . the entrepreneur has been read out of the model” (12–13). Entrepreneurship also has resisted statistical analysis. The primary impediment to this type of work is the inherent heterogeneity of innovative entrepreneurship. We can measure labor expended in hours, land in acres, and capital in pecuniary terms, and we can add up the amount of wheat harvested or the number of cars manufactured. In speaking of the innovative entrepreneur, however, we are dealing with the inherently incommensurable. After all, at least one of any two identical inventions, by definition, cannot be an invention. This problem has impeded statistical investigation and handicapped mathematical theory. The foundation of statistical analysis of relationships is the availability of a sufficient number of homogeneous observations to ensure that any observed interrelationship in the behavior of two such sets has a very low probability of having been fortuitous. However, for the behavior of the innovative entrepreneur on the matters under discussion here, such internally comparable data sets have not been generally available. Economic history, it seems, has provided a strong source of evidence for the investigation of entrepreneurship, but economics texts generally are not inviting to more than sidebars of historical



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discussion. Indeed, this reluctance is understandable. Historical accounts present us with complex events that are all subject to a multiplicity of influences, rather than clean evidence analogous to a controlled experiment. While these limitations explain a certain amount of the paucity of material regarding entrepreneurship in introductory economics textbooks, empirical research on entrepreneurship has emerged and burgeoned over the past decade. Among many other topics, economists have published empirical analyses of firm and industry dynamics, the institutional influences on entrepreneurship, the demographic characteristics of entrepreneurs, the significance of entrepreneurship for breakthrough or disruptive innovation, the contribution of entrepreneurs to job creation, and the important role of entrepreneurship in productivity growth. The growth in the economics literature relating to entrepreneurship can be seen in the Entrepreneurship and Economics Journal of the Entrepreneurship Research and Policy Network (ERPN) on the Social Science Research Network (SSRN). Since its inception in 2006, more than 5,100 papers on entrepreneurship and economics have been uploaded to the site and downloaded more than 612,000 times. This existing empirical work and the recent appearance of theoretical literature in this area could offer important insight to the introductory student. In this article, we examine textbooks that have moved toward introducing students to material on entrepreneurship and suggest how more material may be incorporated in introductory classes. We begin with a brief review of two previous articles on entrepreneurship in introductory textbooks.

THE TEXTBOOK ENTREPRENEUR: NOT QUITE INVISIBLE MAN In previous Journal of Economic Education articles, Kent (1989) and Kent and Rushing (1999) established the inadequate coverage of entrepreneurship in texts on principles. In reviewing 15 of the leading introductory texts in 1989 and another 14 texts in 1999, those authors noted references to 23 propositions on entrepreneurship within six major topical areas that they recommend introductory texts address: (1) entrepreneurship as a distinct factor of production, (2) entrepreneurship and market equilibrium, (3) profits and entrepreneurship, (4) entrepreneurship and innovation, (5) entrepreneurship in macroeconomics, and (6) entrepreneurship and economic growth. It should be noted that both studies consider only whether each proposition is mentioned and do not attempt to evaluate the quality of coverage. In the first of these studies, Kent (1989) finds that only one text1 addresses each of the six topical areas and that no text addresses all 23 of the propositions. In their follow-up study 10 years later, Kent and Rushing (1999) note that some of the newer textbooks contain profiles of well-known entrepreneurs, and that coverage “increased slightly” in the years between reviews (186). In both articles, however, the authors conclude that discussions of entrepreneurship were still largely implicit as a topic, rather than explicit, and that, overall, introductory economics textbooks lacked adequate coverage of entrepreneurship. In the years since the publication of Kent and Rushing (1999), introductory economics textbooks continue, for the most part, to lack comprehensive coverage of entrepreneurship and related topics. We reviewed recent editions of eight introductory texts2 and found only three that contain more than a brief mention of the entrepreneur as a factor of production: McConnell and Brue (2008), Baumol and Blinder (2009), and Samuelson and Nordhaus (2010).3 The newest editions of these three prominent introductory texts include enhanced discussion of the role of entrepreneurs


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and innovation in the economy and offer a more robust understanding of the importance of entrepreneurship to economic growth. In this article, we review the discussion of the entrepreneur in these three textbooks, with the hope that this comparison and discussion of the texts will serve as a starting point for more comprehensive coverage of the entrepreneur in the principles of economics course. For each of the three texts, we consider the overall arrangement of references to entrepreneurship and look at the discussion of the entrepreneur within the same six topical areas defined by Kent (1989), comparing both the content and the approaches of each text.


Arrangement of References to Entrepreneurship McConnell and Brue (2008) include extensive discussion of the entrepreneur in their textbook, devoting slightly more than 4,000 words to the topic in relevant sections throughout the book. Those authors define entrepreneurship in the first chapter, “Limits, Alternatives, and Choices,” as one of the four factors of production (10). The entrepreneur reappears in four additional chapters. In chapter 2, “The Market System and the Circular Flow,” the authors explain how the characteristics of the market system, such as private property and freedom of enterprise, support entrepreneurship (30). They also discuss the role of the entrepreneur in the context of the fifth of their five fundamental questions, “How will the system promote progress?” Entrepreneurs, they explain, are partly responsible for capital accumulation and technological advance (36). In chapter 24, “Technology, R&D, and Efficiency,” the authors discuss the entrepreneur as one actor in the innovative process and introduce the concept of creative destruction, which they tie to the entrepreneur only implicitly (481). Profit as the return to entrepreneurship is presented in chapter 27, “Rent, Interest, and Profit” (526). Finally, the authors revisit creative destruction in the context of its effect on monopoly power in chapter 30, “Antitrust Policy and Regulation” (586). Baumol and Blinder (2009) address entrepreneurship directly in three chapters and implicitly in a fourth. They provide the longest coverage of the three textbooks, with about 4,200 words. In chapter 16, “The Market’s Prime Achievement: Innovation and Growth,” the authors briefly mention the entrepreneur as a source of free-market innovation that is indispensible for rapid economic growth (339). In chapter 19, “Pricing the Factors of Production,” they identify entrepreneurship as the factor of production to which profits are the return, and they discuss the ingredients of economic profits (412–14). Chapter 20, “Labor and Entrepreneurship: The Human Inputs,” contains their most extensive discussion of the entrepreneur. They devote more than one-third of the chapter to entrepreneurs, described as those “who contribute guidance to some critical market activities . . . [and] organize and establish new firms” (435). In this chapter, they look more closely at entrepreneurship and growth, product pricing and profits, and institutions and innovation (435–41). The authors address entrepreneurship implicitly in chapter 24, “Economic Growth: Theory & Policy,” where they present the three pillars of economic growth (capital formation, technology, and labor quality), and as they discuss the special problems of institutions in developing countries (531–32). Samuelson and Nordhaus’s (2010) textbook includes considerably less discussion of entrepreneurship than the other two textbooks, with about 2,800 words. However, they address most of the concepts either directly or indirectly, focusing more on innovation generally than on the entrepreneur’s role in the process. They first introduce entrepreneurship in a sidebar discussion of Schumpeter in chapter 11, “Economics of Uncertainty” (222). In this chapter, they also introduce the concept of innovation and explain Schumpeter’s notion of radical innovation, but reference to


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the entrepreneur is implicit. The authors revisit innovation in their discussion of profits as rewards for risk-bearing and innovation in chapter 15, “Capital, Interest, and Profit,” crediting “innovators or entrepreneurs” for bringing new products or processes to market (296). They provide a more lengthy discussion of entrepreneurship and innovation in the context of economic development in chapter 26, “The Challenge of Economic Development.” Entrepreneurship and innovation are presented as part of a discussion of technological change and innovation, one of the four elements of economic growth they identify (529). In chapter 28, “Open-Economy Macroeconomics,” they include the importance of “a secure environment for investment and entrepreneurship” in their analysis of growth in the open economy (579). And finally, the authors close the textbook in chapter 31, “Frontiers of Macroeconomics,” with a discussion of economic growth and human welfare that brings the entrepreneur implicitly into their discussion of the critical importance of “The Spirit of Enterprise” (649–50). The book ends with a quote from John Maynard Keynes: “It is Enterprise which builds and improves the world’s possessions. If Enterprise is afoot, wealth accumulates whatever happens to Thrift; and if Enterprise is asleep, wealth decays whatever Thrift may be doing” (650). In the following sections, we revisit the six topical areas of entrepreneurship outlined by Kent (1989), providing deeper comparison and contrasting of the three introductory texts.

Entrepreneurship as a Distinct Factor of Production While McConnell and Brue (2008) and Baumol and Blinder (2009) present entrepreneurship as a factor of production, Samuelson and Nordhaus’s (2010) textbook—like many other prominent texts—does not. McConnell and Brue (2008) introduce entrepreneurial ability as the fourth category of economic resources, “a special human resource, distinct from labor, called entrepreneurial ability” (10). They consider the primary functions of the entrepreneur to be the taking of initiative in basic, nonroutine policy decisions for the firm; making strategic business decisions for an enterprise; innovating by introducing new products or techniques; and bearing risks associated with all these functions. They further distinguish entrepreneurs from intrapreneurs, those involved in the pursuit of innovation who do not bear personal financial risk, including executives, scientists, and other salaried employees (470). Baumol and Blinder (2009) introduce the entrepreneur as a fifth factor of production, explaining, “It is useful to group the factors of production into five broad categories: land, labor, capital, exhaustible natural resources, and a rather mysterious input called entrepreneurship” (398). They also define entrepreneurs as those who combine the other factors of production and explain that, while labor contributes the physical and mental effort required for production, entrepreneurs organize the workers’ efforts and ensure that they are provided with the capital and raw materials they require. Samuelson and Nordhaus (2010), in contrast to the other authors, note only the three most standard categories of the factors of production: land, labor, and capital (9). These authors initially introduce students to entrepreneurship through a discussion of Schumpeter (1911) in their chapter on innovation and information, using his definition of the entrepreneur or innovator as “the person who introduces ‘new combinations’ in the form of new products or methods of organization” (Samuelson and Nordhaus 2010, 222).


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Although textbooks vary on the number of factor categories, we believe it is most helpful to introduce the entrepreneur as a factor in the earliest discussion of resources, setting the stage for later references to his or her critical role as innovator.


Entrepreneurship and Market Equilibrium Entrepreneurs create new market equilibria through innovation and technological change. As part of this process, they alter existing supply and demand for related products through the process Schumpeter (1911) referred to as “creative destruction.” McConnell and Brue (2008) introduce creative destruction early in their textbook as part of their discussion of technological advance. They explain that the creation of new products or processes can destroy the market positions of firms wedded to older products or ways of doing businesses (36). They reintroduce this concept in their chapter on technology, research and development, and efficiency, calling it the “extreme” innovation, where “the creation of new products and new production methods destroys the monopoly market positions” of existing firms (481). This innovation expands output and brings down prices to a new equilibrium. McConnell and Brue (2008) point out that creative destruction can either (1) create monopoly power or (2) reduce or eliminate it, but these conclusions are not inevitable (483). Baumol and Blinder (2009) explain creative destruction by citing Schumpeter (1911), describing the process by which the alert innovative entrepreneur either creates or recognizes a new and better product, acquires it, and brings it to market, where it destroys the market position of older substitutes (Baumol and Blinder 2009, 436). Although Samuelson and Nordhaus (2010) do not use the term “creative destruction,” they introduce the idea in a textbox about Schumpeter (1911), explaining his theory about the entrepreneur’s role in introducing new products or production methods (Samuelson and Nordhaus 2010, 221). All three textbooks allude to the introduction of innovative products by entrepreneurial firms, but the dynamic process by which new firms are created is assumed, rather than stated explicitly in these texts. Profits and Entrepreneurship In 1989, Kent wrote, Students in the principles course need to have a broader and more complete understanding of the role of profit; they need to go beyond the view that profits are what is left over after all other bills have been paid. The microeconomic chapters in most college textbooks . . . tend to emphasize this limited view of profits. Their discussion, which tends to focus on break-even analysis, short-run shut-down points, and long-run economic profits as inducements to entry [into] or exit from an industry, is usually mechanical and lacking in real-world application to the entrepreneurial process. (158–59)

The three recent textbooks that we analyzed seem to be more explicit in explaining the role of profits in entrepreneurship than those in Kent’s (1989) review. In their chapter on rent, interest, and profit, McConnell and Brue (2008) assert that profit is the return to entrepreneurial ability. They distinguish between normal profit and residual profit, and focus on residual profits resulting from both uncertainty and monopoly (535). Baumol and Blinder (2009), while presenting economic profit as accruing as a result of monopoly power, risk-bearing, and innovation, overtly bring in the entrepreneur later in their discussion of returns to innovation (412–14). Like Baumol and Blinder

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(2009), Samuelson and Nordhaus (2010) focus explicitly on profit as a reward for entrepreneurial innovation.


Profit as a Reward for Risk Affirming that the innovations undertaken by entrepreneurs entail the possibility of losses, McConnell and Brue (2008) explain that some of the economic profit is compensation for dealing with the uncertainty of innovation (535–36). Economic profits result, they explain, because the entrepreneur takes on the uninsurable risks due to changes in the economic environment, the structure of the economy, and government policy. Baumol and Blinder (2009) discuss the returns to risk bearing more implicitly when they address the nonmonetary returns to entrepreneurship, which we discuss later (439).

Profit as a Reward for Innovation The authors of all three textbooks describe profit as the return to innovation. They discuss the complicated relationship between innovation and monopoly power, as innovation can be a source of monopoly power or can eliminate it. McConnell and Brue (2008) describe the time lags between innovation and diffusion that allow innovating firms to realize a substantial economic profit (477). They further conclude, “Innovation in general enhances economic efficiency, but in some cases it leads to entrenched monopoly power. Further innovation may eventually destroy that monopoly power, but the process of creative destruction is neither automatic nor inevitable” (483). Baumol and Blinder (2009), too, discuss the process by which a new innovation enjoys monopoly profits, which are then eroded by replicative competitors (436–37). In addition, they offer several nuances to Schumpeter’s (1911) theory. First, they point out that the financial returns to most innovators are very low and that failure is common. Second, they suggest that economic profits from innovation will not tend exactly toward zero, as a result of barriers to entry. Finally, they point out that firms may invest in R&D for many possible innovations. As some fail and others succeed, economic profit may be close to zero or, likely, even negative. In fact, even some very innovative industries often appear to have near-zero economic profit (Baumol and Blinder 2009, 437). In their chapter on labor and entrepreneurship, Baumol and Blinder (2009) cite Thomas Astebro’s research that concludes that only seven to nine percent of inventions reach the market and that the majority of these obtain negative returns (420). Similarly, Samuelson and Nordhaus (2010) explain, “Every successful innovation creates a temporary pool of monopoly. We can identify innovational profits (sometimes called Schumpeterian profits) as the temporarily excess return to innovators or entrepreneurs” (296). Referring to the role of replicative entrepreneurs, the authors explain that profits from innovation “are soon competed away by rivals and imitators. But just as one source of innovational profits disappears, another is being born” (222). Both Baumol and Blinder (2009) and Samuelson and Nordhaus (2010) acknowledge that, in addition to the prospect of financial rewards, entrepreneurs seem to be motivated by nonmonetary returns. Baumol and Blinder (2009) explain that entrepreneurship offers a psychological reward: the contemplation of the prospect of winning. Later, they expand on this idea, explaining that another currency is the psychological reward of independence and the excitement of participation


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in the innovation process. The nonmonetary returns to the entrepreneur make him or her willing to undertake an activity that offers fewer financial rewards than those provided by employment by others (439–40). Furthermore, the authors suggest that entrepreneurs tend to be more optimistic than the norm (439), comparing colossal entrepreneurial success to winning the lottery. Samuelson and Nordhaus (2010) also recognize that not all entrepreneurial motivations are economic. They refer to Schumpeter’s (1911) assessment of the entrepreneur’s psychology, explaining that these individuals are “motivated by the will to conquer and the joy of creation,” in addition to the temporary monopoly profits (Samuelson and Nordhaus 2010, 222). Rewards, then, are both monetary and nonmonetary (i.e., personal satisfaction and other intangible psychic benefits, like participating in a competitive game).

Inappropriability Both Baumol and Blinder (2009, 421) and Samuelson and Nordhaus (2010, 222) note that, because of replication, firms tend not to capture the full social value of their innovations. The social return is many times greater than the appropriable private return to the innovator. Baumol and Blinder (2009) cite the work of Nordhaus, which estimates that innovators capture only about two percent of the total benefits of their innovation (Baumol and Blinder, ibid). The topic of returns to innovative entrepreneurship is also implicit in discussion of firm behaviors in both short run and the long run. It is entrepreneurial activity that competes away profits in the long run in a competitive industry, and allows longer-run monopoly profits when replication is impeded. Explicit tying of entrepreneurship to price and profit analysis in the introductory economics textbook could provide a starting point for further explicit microanalysis of the role of the entrepreneur. Entrepreneurship and Innovation According to Kent (1989), entrepreneurship and innovation, entrepreneurship in macroeconomics, and entrepreneurship and economic growth all relate to the role of the entrepreneur in economic growth. He found these three areas to be the least adequately covered among the texts he reviewed. The connection between entrepreneurship and innovation is presented in three contexts by the authors of the textbooks considered here—invention vs. innovation, innovation vs. replication, and radical vs. incremental innovation.

Invention vs. Innovation The authors of all three textbooks distinguish between invention and innovation, referring to the entrepreneur as the innovator, who may not actually be the inventor of a product or process. In their section on invention, innovation, and diffusion in their chapter on “Technology, R&D, and Efficiency,” McConnell and Brue (2008) distinguish between invention and innovation and go on to describe diffusion as the “spread of an innovation through imitation” (468). Baumol and Blinder (2009) consider the distinction between the concepts of invention and innovation to be critical. Innovation, they clarify, includes invention as an initial step, but it goes further, including the entire process from invention, through design development, to market introduction, and use in the economy (338). The authors also provide historical context, explaining

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that earlier economies were very successful at invention (e.g., medieval China and the former Soviet Union), but only the modern capitalist economy has succeeded substantially in using innovation to drive growth (440). They use the example of the steam engine to illustrate this distinction between invention and innovation. The authors explain that the steam engine was invented by the Chinese in the first century A.D., but it was not put to practical use until James Watt improved it and worked with his entrepreneur partner, Matthew Boulton, to make productive use of it (435–36). Samuelson and Nordhaus (2010) make the distinction between invention and innovation only in their glossary (664–65). The definition of innovation is followed by a note to contrast the term with invention, and vice versa.

Innovation vs. Replication Baumol and Blinder (2009) distinguish between innovative and replicative entrepreneurs. They define replicative entrepreneurs as those who create new businesses just like those around them, in contrast to a smaller population of entrepreneurs who innovate—that is, recognize the power of new inventions and make these inventions attractive to the market. Those authors state that the people who have been responsible for the remarkable economic growth in modern history are the innovative entrepreneurs (435).

Radical vs. Incremental Innovation In all three textbooks, the authors make the distinction between radical and incremental innovations. McConnell and Brue (2008), offering multiple examples of incremental innovation, explain that most innovation takes this form. They also offer an interesting discussion, in their chapter on technology, R&D, and efficiency, concerning the endogeneity of the innovator. They state that until recently, economists saw technological advance as “external to the economy—a random outside force to which the economy adjusted” (469). Now, however, economists view innovation as endogenous, arising from “intense rivalry among individuals and firms that motivates them to seek and exploit new profit opportunities or to expand existing opportunities” (469). They indicate that entrepreneurs are, in large part, responsible for this activity, but that other innovators, such as “intrapreneurs,” also play a role (470). Baumol and Blinder (2009) also discuss the importance of radical innovation. Indeed, they conclude, “So a high proportion of the revolutionary new ideas of the past two centuries have been, and are likely to continue to be, provided by independent innovators who operate small business enterprises” (340). Firm size, they explain, is often a factor in radical innovation. They suggest that innovation by large corporations is “inherently cautious and focuses on small, relatively limited improvements,” while small or new enterprises are largely responsible for breakthrough innovations (340). Similarly, Samuelson and Nordhaus (2010) emphasize the importance of radical innovation: “Our economy has been revolutionized by the discoveries of great inventors . . . and it is individual entrepreneurs and small firms that have produced many of the greatest technological breakthroughs” (296). In his 1989 article, Kent writes that principles students should learn that “the entrepreneur is the one who innovates and commercializes the innovations. So long as the profit incentive


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is sufficient, innovation will take place and the economy will benefit from a steady stream of new ideas and new applications of existing ones” (160). We contend that this is an insufficient explanation of innovative activity, because, as we noted in the previous section, other motivations of the entrepreneur also must be recognized. The innovative spirit seems to thrive even in the context of overall low profits and many failures. We conclude that the three textbooks we have analyzed present a thorough, albeit nontechnical, discussion of innovation and the role of the entrepreneur.


Entrepreneurship in Macroeconomics (Economic Instability) According to Kent (1989), the traditional approach to macroeconomics that breaks unemployment into frictional, structural, and cyclical components and views monetary and fiscal policy as the ways of ending unemployment and creating new job opportunities is too narrow. He states, “Although a sufficiently high level of aggregate demand may be a necessary condition for generating job opportunities, it is not a sufficient condition. There must be an entrepreneurial response” (160). He cites a 1983 Small Business Administration report that indicates that small/entrepreneurial firms create a disproportionately large number of the new jobs in the economy and concludes that “Principles students need to know that there is more to investment than merely stimulating the economy by expansionary fiscal and monetary measures and that the type of fiscal and monetary policies pursued may be an important determinant of whether entrepreneurial activity does or does not result” (Kent 1989, 161). Consequently, Kent looks at whether textbooks present the ideas that entrepreneurs create jobs and that entrepreneurship is a policy option for unemployment. In the analyses in Kent (1989) and Kent and Rushing (1999), the role of the entrepreneur in macroeconomics was one of the least frequently addressed topics in the textbooks they reviewed. We reached the same conclusion in our review. None of the books we reviewed mentioned this proposition. Although Kent (1989) presents argument and some empirical evidence that entrepreneurship may be a solution to economic instability, the lack of discussion of these ideas in principles texts is possibly due to the difficulty of untangling economic recovery from a recession from longer-term economic growth. The recent increase in empirical studies of entrepreneurs and business formation, however, may uncover new evidence to address the role of the entrepreneur in stimulating the economy. Entrepreneurship and Economic Growth All three textbooks address the relationship between entrepreneurship and economic growth. McConnell and Brue (2008) include this discussion in their explanation of the market system in chapter 2 of their textbook. They note that the market system provides profit as an incentive for technological advance, which in turn creates growth, and that this technological advance and this capital accumulation are what contribute to higher standards of living. The authors also include entrepreneurs in their discussion of capital formation as an important ingredient of economic growth and observe that successful open economies use “the institutions of the market” to provide a secure environment for investment and entrepreneurship (37). McConnell and Brue’s (2008) explanation of recent theory that entrepreneurs are endogenous, rather than exogenous, to markets also puts such innovators at the center of the technological advance that produces economic growth (469).


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Baumol and Blinder (2009) begin their discussion of entrepreneurship with the premise that entrepreneurs use their new firms “to introduce innovations that play such a critical part in the economic growth important to living standards . . . .. Thus, the entrepreneur may be thought of as the secret behind the market’s greatest achievement—unprecedented rates of economic growth” (435). The authors distinguish the innovative entrepreneurs as those associated unreservedly with the growth of the economy, stating, “To prevent termination of the monopoly rewards, the entrepreneur can never desist from further innovation and cannot rest on his laurels” (344). Baumol and Blinder (2009) attribute the success of the innovation process in the modern freemarket economy and its “fundamental contribution to rates of economic growth that have never previously been experienced in human history” to the new institutions that grew up along with the capitalist economy (440). Offering a range of historical examples, the authors illustrate the ways in which governments made unproductive entrepreneurship more difficult to carry out and innovative entrepreneurship safer, easier, and more profitable. These institutions—the government’s rules and the pressures that stem from other influential sources—direct those enterprising individuals to seek profit-making opportunities that are productive, rather than unproductive. Examples mentioned include the patent system, sanctity of property, enforceability of contracts by courts, and bankruptcy protection. They conclude with a warning, “In order to keep this process going, we must be careful to prevent the adoption of rules that undercut these activities and remove the incentive for entrepreneurs to keep up their productivity-enhancing efforts” (441). The authors also take up the issue of institutions and innovation in their chapter on economic growth. They indicate that one of the problems in poor, less-developed countries is the lack of a well-functioning government to develop and protect market institutions, such as property rights, rule of law, and limited bureaucracy (533). Samuelson and Nordhaus (2010) discuss the role of the entrepreneur in creating economic growth more directly. They assert that improvements in knowledge are primarily responsible for growth in output and wealth, and they note that institutions to promote the creation and spread of knowledge provide incentives for people to do it. Many of these institutions, however, were developed late in human history. Citing Baumol and historian Joel Mokyr, Samuelson and Nordhaus (2010) suggest that innovation depends critically on the development of incentives and institutions. They point in particular to the role of private ownership, the patent system, and a rule-based system of adjudicating disputes as devices for fostering innovation (506). Samuelson and Nordhaus (2010) further state, “Governments often promote rapid technological change best when they set a sound economic and legal framework with strong intellectual property rights and then allow great economic freedom within that framework. Free markets in labor, capital, products, and ideas have proved to be the most fertile soil for innovation and technological change . . . . Governments can foster rapid technological change both by encouraging new ideas and by ensuring that technologies are effectively used” [italics in original] (649). Samuelson and Nordhaus (2010) also address the role of entrepreneurship and innovation in economic development. In chapter 26, “The Challenge of Economic Development,” they describe the four wheels that drive economic growth: human resources, natural resources, capital, and technology. While these factors drive growth in both rich and poor countries, the mix and strategies differ. Those authors include entrepreneurship and innovation in their discussion of technology. Within developing countries, they explain, implementation of technological change is impeded by the lack of adequate capital and a skilled workforce (including scientists, engineers, and entrepreneurs). One of the key tasks of economic development, therefore, is to promote an


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“entrepreneurial spirit.” Institutions must be established that help to create incentives to take risks to open new businesses, adopt new technologies, and develop new ways of doing business (529). They cite the most fundamental of these institutions as complete, clear property rights, low, predictable taxes, and prevention of corruption. In addition, they indicate that governments can support entrepreneurship through targeted investments, such as workforce and management training and extension services for agriculture (529). Samuelson and Nordhaus (2010) summarize chapter 26 with this thought: “Technological change is often associated with investment and new machinery. It offers much hope to the developing nations because they can adopt the more productive technologies of advanced nations. This requires entrepreneurship. One task of development is to spur internal growth of the scarce entrepreneurial spirit” (540). Summary The three recent principles textbooks that we reviewed address five of Kent’s (1989) six “essential elements of entrepreneurship in economic education” (155). Furthermore, there are more pages devoted to discussion of these elements and a more robust infusion of the elements throughout these textbooks, in comparison to those reviewed by Kent and Rushing (1999). There are, however, many other well-known books that continue to make little, if any, mention of the role of entrepreneurs in a growing market economy. We hope to have shown here how those texts that include entrepreneurship in a substantial way have done so. Moreover, we hope to inspire those who teach introductory economics to include discussion of the role and importance of entrepreneurs in economic growth. RECENT RESEARCH ILLUMINATING THE ENTREPRENEUR IN ECONOMIC THEORY In this section, we provide an overview of three recently published books that put the entrepreneur at center stage—two theoretical and one empirical—and which may further inspire textbook authors and teachers of economics to give additional, more in-depth treatment to the entrepreneur in introductory textbooks and courses. The discussion of these books is not intended to serve as a guide or roadmap to authors of texts on principles, regarding either what should be included on the subject of entrepreneurship or where such material should be placed. Rather, it is intended to highlight the fact that there is a recent body of literature that may be incorporated into texts and courses on principles in the future. The first book, The Theory of the Firm: Microeconomics with Endogenous Entrepreneurs, Firms, Markets, and Organizations (Spulber 2008), offers a ground-breaking theoretical framework for understanding the central role played by entrepreneurs in establishing firms. Spulber’s book introduces the firm as a “transaction institution whose objectives are separate from those of its owners” (4). He addresses three fundamental questions regarding his theory of the firm in an effort to incorporate the pivotal role of the entrepreneur. First, why do firms exist? Second, how are firms established? And third, what do firms contribute to the economy? With regard to the first question, Spulber (2008) hypothesizes that “firms exist only when they improve the efficiency of economic transactions . . . as compared to the alternative of


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direct exchange between consumers” (3). As to how firms are established, Spulber states that “consumers, acting as entrepreneurs, choose to establish firms when doing so improves economic efficiency” (3). Finally, with respect to the contribution of firms to the economy, Spulber contends that “firms are institutions that coordinate transactions by acting as intermediaries” (4). In doing so, firms create and operate markets, employ and allocate resources, and carry out production. In answering his three questions, Spulber departs from neoclassical general equilibrium theory that takes both firms and markets as exogenous and does not consider the role of the entrepreneur in establishing the firm. In contrast, Simon Parker’s (2009) book, The Economics of Entrepreneurship, brings together theoretical insights and recent empirical findings to demonstrate how economics can contribute to a better understanding of entrepreneurship. Parker’s view is that “the economics of entrepreneurship analyses [sic] how economic incentives affect entrepreneurial behavior, and how that behavior in turn affects the broader economy” (4). The book treats four aspects of the economics of entrepreneurship. The first section deals with entrepreneurial choice—who chooses to become an entrepreneur and why—discussing theoretical choice models and empirical work on entrepreneurship among particular groups within the population. Parker next addresses the financing of the entrepreneurial venture, including debt and equity, as well as informal financing. A third section examines the impact of entrepreneurship on broader measures of the economy, including wealth creation, innovation, job creation, and economic growth, among others. Finally, Parker addresses a wide-ranging view of economic policies and the impact of those policies on entrepreneurship. These policy measures include regulatory, tax, finance, innovation, and labor market policies. William Baumol’s (2010) book, The Microtheory of Innovative Entrepreneurship, follows closely on Spulber’s (2008) book by integrating the entrepreneur into mainstream microtheory and into standard theoretical models of the firm. Baumol (2010) deals with the determinants of the supply of entrepreneurs whose activities are innovative and productive—that is, entrepreneurs whose innovation does not entail unproductive activities, such as the introduction of more effective ways to market illegal narcotics. These unproductive activities, which have typified entrepreneurship throughout much of human history, clearly are enterprising and can be innovative but surely contribute little to alleviation of world poverty. The book constructs a formal, but simple, Schumpeterian model that analyzes the profits of those entrepreneurs who are productive and innovative, as well as the prices of their products. In short, the book seeks to provide for the productive, innovative entrepreneur the counterpart analytical framework to that generally offered by the textbooks for the other “factors of production”—i.e., land, labor, and capital. This encouraging research begins to create a place for entrepreneurship in the economics literature that can be brought to introductory economics textbooks. It may not entirely fill the gap in textbooks and it is, of course, more complex and analytically advanced than what is needed to meet the needs of the introductory-level, undergraduate economics student. Yet, we believe that it provides materials that will make the requisite textbook content possible. Taken together, the three books offer a variety of perspectives that are relevant to the more complete infusion of entrepreneurship in the introductory course. Indeed, these three books offer new ideas on a subject that, from the viewpoint of the general welfare, is unparalleled in importance. Surely there is no excuse for continued neglect of a topic as vital as the microanalysis of economic growth. Growth and the benefits that it alone can promise are surely among the most important economic issues for the general welfare. With severe poverty far from eradicated, we


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surely cannot justify neglect of any opportunity to address this problem. That is, we cannot ignore analysis of the determinants of economic growth that alone can provide the wherewithal for amelioration of these circumstances. Surely this topic merits some priority in our introductory texts and courses.


NOTES 1. Dolan, E. G. 1986. Economics. 4th ed. Chicago: Dryden Press. 2. We reviewed books from the lists in Kent (1989) and Kent and Rushing (1999) that were available in current editions, as well as newer books selected from the amazon.com list of bestsellers. Texts reviewed included Baumol and Blinder, 11th ed. (2009); Frank and Bernanke, 4th ed. (2008); Hall and Lieberman, 2nd ed. (2007); Krugman and Wells, 2nd ed. (2009); Mankiw, 5th ed. (2009); McConnell and Brue, 17th ed. (2008); Parkin, 8th ed. (2007); and Samuelson and Nordhaus, 19th ed. (2010). Our selection of the three books to analyze more thoroughly is based on a word count of sections addressing entrepreneurship, along with our judgment as to the completeness of coverage. 3. Professor Baumol, as the author of one of the textbooks analyzed in this article, had no role in writing any remarks on the three textbooks reviewed in this article.

REFERENCES Barro, R. J., and X. Sala-i-Martin. 2003. Economic growth. 2nd ed. Cambridge, MA: MIT Press. Baumol, W. J. 1993. Entrepreneurship, management, and the structure of payoffs. Cambridge, MA: MIT Press. ———. 2010. The microtheory of innovative entrepreneurship. Princeton, NJ: Princeton University Press. Baumol, W. J., and A. S. Blinder. 2009. Economics: Principles and policy. 11th ed. Mason, OH: Cengage Learning. Dolan, E. G. 1986. Economics. 4th ed. Chicago: Dryden Press. Kent, C. A. 1989. The treatment of entrepreneurship in principles of economics textbooks. Journal of Economic Education 20:153–64. Kent, C. A., and F. W. Rushing. 1999. Coverage of entrepreneurship in principles of economics textbooks: An update. Journal of Economic Education 30:184–88. Kirzner, I. 1971. Competition and entrepreneurship. Chicago: University of Chicago Press. McConnell, C. R., and S. L. Brue. 2008. Economics: Principles, problems, and policies. 17th ed. Columbus, OH: McGraw-Hill. Parker, S. C. 2009. The economics of entrepreneurship. Cambridge, UK: Cambridge University Press. Samuelson, P. A., and W. D. Nordhaus. 2010. Economics. 19th ed. Columbus, OH: McGraw-Hill. Schumpeter, J. A. 1911. The theory of economic development. Trans. R. Opie. Cambridge, MA: Harvard University Press, 1936. Spulber, D. 2008. The theory of the firm: Microeconomics with endogenous entrepreneurs, firms, markets, and organizations. Cambridge.