Economic freedom and veto players jointly affect entrepreneurship
| Date | 06 November 2017 |
| Pages | 340-358 |
| Published date | 06 November 2017 |
| DOI | https://doi.org/10.1108/JEPP-D-17-00007 |
| Author | Jacob Lihn,Christian Bjørnskov |
| Subject Matter | Strategy,Entrepreneurship,Business climate/policy |
Economic freedom and veto players
jointly affect entrepreneurship
Jacob Lihn
QVARTZ, Copenhagen, Denmark, and
Christian Bjørnskov
Aarhus University, Aarhus, Denmark
Abstract
Purpose –The purpose of this paper is to explore how the strength of political veto players affects the
long-run credibility of economic institutions and how they jointly affect entrepreneurial activity.
Design/methodology/approach –The authors employ an annual panel covering 30 OECD countries
from 1993 to 2011.
Findings –An error correction model identifies a positive and significant short-run effect on
self-employment from large government spending at low levels of veto player strength. A static model
conversely indicates that smaller government spending is positively associated with entrepreneurship at
lower levels of veto player strength in the long run.
Originality/value –The authors are the first to explore the interaction of economic and political institutions
in the development of entrepreneurship.
Keywords Entrepreneurship, Economic freedom, Veto institutions
Paper type Research paper
1. Introduction
Commentators, politicians, and pundits have in recent y ears begun to highlight the importance
of entrepreneurs as prime movers of development. Politicians seek to promote entrepreneurship
because they see entrepreneurs as the most important actors creating the foundation for future
growth and welfare. It is easy to see the importance of single entrepreneurs: what would the
modern world look like without Alexander Graham Bell, Henry Ford or Bill Gates, i.e. without
the telephone, the first affordable automobile –Ford’sModelT–and personal computer
technology that does not require experts to operate it?
In economics, the interest in entrepreneurship research has also increased since the mid-
1980s. Both theoretical studies such as the pioneering work in Baumol (1990), Aghion and
Howitt (1992), and Kirzner (1997), as well as recent empirical studies, have verified the
relationship between entrepreneurial activity and long-run development (Reynolds et al.,
1999; Audretsch and Thurik, 2000; Wennekers et al., 2005; Bjørnskov and Foss, 2013).
Such growth effects of entrepreneurship make policy-makers eager to promote
entrepreneurial activity. The theoretical and empirical findings have therefore created
further interest in studying the antecedents of entrepreneurship, and in particular
institutions and policies affecting entrepreneurship.
However, while Baumol (1990) famously theorized that institutional differences
effectively affect the allocat ion of entrepreneurship, most st udies in institutional
economics have instead investigated how institutions affect cross-country differences in
economic growth or foreign direct investments. Comparatively, few studies have focused on
the potentially growth-relevant connections between institutions and entrepreneurs,
although a large literature documents the overall effects of institutions on long-run growth
and productivity (Henisz, 2000; Klein and Luu, 2003; Rodrik et al., 2004; Justesen and
Kurrild-Klitgaard, 2013).
Journal of Entrepreneurship and
Public Policy
Vol. 6 No. 3, 2017
pp. 340-358
© Emerald PublishingLimited
2045-2101
DOI 10.1108/JEPP-D-17-00007
Received 15 June 2017
Revised 3 July 2017
Accepted 9 July 2017
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/2045-2101.htm
JEL Classification —M13, O31, O50
340
JEPP
6,3
Bjørnskov and Foss (20 16) survey the specifi c literature on insti tutions and
entrepreneurship and identify a number of lacunae in existing studies. They note that a
series of previous papers have credibly established the existence of a general association
between economic institutions and various measures of entrepreneurship (e.g. Kreft and
Sobel, 2005; Bjørnskov and Foss, 2008; Chowdhury et al., 2015). However, one of the
problems that have so far been ignored in the entrepreneurship literature is response
heterogeneity, i.e. if similar institutions only produce similar outcomes when other
conditions or institutions are also similar. We believe that this is a particularly important
problem because the parallel literature on long-run development and institutions has
recently shown that veto player institutions in particular affect the credibility and stability
of economic institutions and thereby improve their economic effectiveness (Tsebelis, 2002;
Justesen and Kurrild-Klitgaard, 2013; Justesen, 2014).
We therefore take a step further than the existing literature by applying these insights to
the study of entrepreneurship, and explore the joint effects of economic freedom and
political veto institutions on entrepreneurial activity. We do so in an annual panel of
30 OECD countries observed between 1993 and 2011 for which comparable data exist.
We separate short- and long-run consequences by estimating both an error correction model
(ECM) and a static panel. While the static model that identifies what we interpret as long-run
equilibrium effects shows the well-known association with government size and exhibits
larger effectiveness with weak veto player institutions, the short-run effects appear to run in
the opposite direction.
The rest of the paper is structured as follows. Section 2 outlines an intuitive theoretical
framework in which we integrate entrepreneurship and institutional mechanisms and derive
a set of testable hypotheses. Section 3 presents the data and estimation strategies
while Section 4 presents the empirical findings. We conclude the paper in Section 5 in which
we discuss how to reconcile the findings with previous insights.
2. Institutions and entrepreneurship
During the last few decades, an increasing theoretical interest in the effect of institutions on
entrepreneurship has emerged (Bjørnskov and Foss, 2016). Most studies apply a version of
North’s (1991, p. 97) definition of institutions as “humanly devised constraints that structure
political, economic and social interaction.”According to North (1991), institutions can be
formal (laws, bureaucracy, regulations, etc.) or informal (social norms, values, beliefs, etc.).
This distinction implies that formal institutions may be easier to quantify than the “softer”
informal institutions, as they are in principle directly quantifiable via regulative measures
(Voigt, 2013). The institutions set the rules of the game in society and influence the behavior
of individuals and organizations and can thereby affect entrepreneurship in multiple ways.
As Baumol (1990) emphasized, institutional differences may either affect the supply of
potential entrepreneurs or their incentives.
Bjørnskov and Foss (2016) provide a survey of the existing literature on the links
between entrepreneurship and the institutional environment, which we build on in the
following. Within the tradition from Baumol (1990), the institutional setting mainly affects
the allocation of entrepreneurship, which can be productive (wealth creating), unproductive
(purely redistributive), and destructive (rent seeking), depending on institutional
characteristics. The omnipresenc e of entrepreneurship implies that the effe cts of
institutional differences must be major determinants of the different directions in which
entrepreneurial activity is channeled such that, as argued by Boettke and Coyne (2003),
economic development as a consequence of particularly productive entrepreneurship is
incentivized by supporting institutions. As such, the institutional environment deters or
reinforces risk-taking behavior and influences the coordination of human transactions
(North, 1991). The profit-seeking activities of entrepreneurs are thereby influenced by the
341
Economic
freedom and
veto players
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