Economic Freedom and Entrepreneurship: A Panel Study of the United States

Abstract

ABSTRACTINTRODUCTIONThis paper investigates the empirical relationship between economic freedom and entrepreneurship. Entrepreneurship involves taking actions to seize previously ungrasped profit opportunities. It requires entrepreneurs to see the situation differently than others and have the freedom to act on their vision. Absent either the vision or the freedom to act entrepreneurship can't occur. So almost by definition we should expect freedom and entrepreneurship to be strongly related. We exploit this close relationship to investigate the questions of which freedoms are important for what forms of entrepreneurship and to prompt a discussion of which measures of entrepreneurship are likely to be effective proxies of the fundamentally un-measurable concept of entrepreneurship.We use the Economic Freedom of North America (EFNA) index (Ashby et al, 2011) which defines economic freedom as a lack of government interference in markets through taxation, spending, and regulation (the EFNA index focuses on labor market regulations and restrictions) to investigate how it effects five different measures of entrepreneurship. The index measures these freedoms at the state and local level. States that score high on the index have relatively low taxes, freeing individuals' savings to invest in new businesses; less government spending, releasing resources into the market to be used by entrepreneurs to serve customers; and fewer regulations limiting the transactions that entrepreneurs and workers can engage in.Our five measures of entrepreneurship are business birth rates, patents, venture capital, sole-proprietorships, and the Kauffman Index of Entrepreneurial Activity (KIEA). All five of these measures have served as proxies for entrepreneurship in the literature but none fully captures all entrepreneurial actions. The KIEA index investigates the proportion of the population involved in either running a young firm (less than 42 months old), or setting up a new firm. The KIEA measure as well as business birth rates involve seeing a profit opportunity and creating a new business to exploit it. But it leaves out entrepreneurial actions taken by existing firms. Patents involve seeing a profit opportunity by designing a new product. Inventions may be patented by new or existing firms but this hardly encompasses all entrepreneurial actions. Venture capital might be needed to fund new entrepreneurial actions but as we'll discuss below there are problems with using this as a measure of entrepreneurship. Finally the sole proprietorship rate is a common measure of entrepreneurship in the literature but it suffers from some problems as well.We find some support for the view that economic freedom can be important for entrepreneurship but it depends on which aspect of entrepreneurship we look at. Business birth rates are both positively correlated with economic freedom but the relationship between economic freedom and Kauffman Economic Activity index and patents are mixed while the relationship between economic freedom venture capital and sole-proprietorships is insignificant.The following section reviews the related literature. Section 3 describes the data. The fourth section contains our main results, robustness checks and analysis. The final section concludes.LITERATURE REVIEWThere is an extensive literature investigating entrepreneurship, institutional quality, economic growth, and the relationships between them. This paper contributes the first panel study of economic freedom of the fifty U.S. states that uses all five major measures of entrepreneurship.Bjomskov and Foss (2008) offer the following primary conceptions of entrepreneurship in economics: innovations that create new products in new ways (Schumpeter 1911), alertness and discovery that drives the market's process of equilibration (Kirzner 1973), and judgment in making decisions while facing uncertainty (Knight 1921). Baumol (1990) distinguishes between productive entrepreneurship that creates wealth for society and unproductive and destructive entrepreneurship such as rent seeking. …

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