What Local Governments Need to Learn to Nurture Local Prosperity

While nowadays virtually everyone claims to support entrepreneurship, this hasn’t always been so, even in the economics profession. As Israel Kirzner, among others, has demonstrated, entrepreneurship is the driving force behind economic development, using the Austrian School methodology widely associated with free markets. Yet the claim of supporting entrepreneurship, in my experience, is used to justify a range of interventions that do anything but enable it.

Even in cases where there are a wide range of government agencies charged with enhancing private commerce, the biggest obstacle faced by would-be private businesses is the government itself. Herein lies an important task for public policy: Can we create a framework to test if a given piece of legislation or other public sector action that purports to enhance entrepreneurship achieves its purpose?

Using some normative considerations and noting the workings of markets taken from the Austrian tradition, this post will lay out seven principles by which to test governmental claims to supporting entrepreneurship.

Historically, economics was about more than just numbers; it went to the heart of a notion of the good of society. Taking this view, how we live out the economic component of human liberty is tied to what and how much governments do to try to regulate commerce between individuals. Over the past few years, to test if a given piece of legislation violates the conditions for entrepreneurship, I have taken to probing if it violates any of the following first principles.

Entrepreneurship as Morally Valid

Before exploring the facts of entrepreneurship, establishing its moral validity is important. Utilitarianism or the “necessary evil” argument in defense of entrepreneurship is insufficient, yet evident in assumptions shared by policymakers and public officials alike, including several with whom I have spoken in North America and in my native South Africa. If the state is deemed more effective at any given point, for any given period, at promoting commerce, it is easy to justify ignoring entrepreneurship. Therefore, a first principle in this regard is an affirmation of entrepreneurship as inherently good both for the entrepreneur exercising his or her individual rights and for the rest of us.

The late philosopher Michael Novak identified some key traits that make entrepreneurs important members of our society. Most possess commercial virtues, serving the world through their inventiveness and creativity. Their traits include resourcefulness, industriousness, patience, and hopefulness about the future.

To create a new enterprise and sustain it requires drive, perseverance, and patience in the face of what are usually enormous challenges and risks that many among us are not willing to face. By placing his or her entire material wellbeing at risk, the entrepreneur forsakes ordinary economic security in pursuit of a goal that has no guarantee of success. This willingness to risk one’s time and capital drives economic growth in the long-term and improves the general welfare of entire societies. The virtues shown by individual entrepreneurs and the economic betterment they bring endow commerce with moral validity.

Voluntary Association

As Novak cautioned, “The commercial virtues are not sufficient to their own defense.” They rely on the character-forming power of voluntary institutions like family and church.

Some societies, to be sure, seek to bring economic development without freedom. But as venture capitalist Pitch Johnson observes, entrepreneurship and democracy are closely linked because they are two dimensions of personal freedom. Johnson goes on to state that these and the other freedoms that are widely agreed upon in many societies as ideals are related to and reinforce each other.

Furthermore, the entrepreneur’s creation of voluntarily constituted businesses as “communities of persons” naturally form part of the fabric of any given civil society, serving as a buffer between the individual and the state. Alexis de Tocqueville’s warning was clear: The morals and intelligence of a democratic people would be in as much danger as its commerce and industry if ever the government usurped the place of free associations.

In the developing world, there is a temptation at times to follow authoritarian capitalist models—economic development without freedom—that ignore this principle. Some have made impressive strides using models that focus primarily on economic growth. China has relied on arbitrage as an economic advantage, argues academic Weiying Zhang. However, as the gap between China and the developed world closes, future growth primarily will rely on entrepreneurial innovation, which is more institutionally demanding and sensitive.

The Principle of Profit

People before profit,” as Marxists are wont to say. Few would disagree with the words themselves; however, how does one determine the needs of thousands or even millions of current and/or potential customers, apart from the profit mechanism?

As Thomas E. Woods notes, without a profit motive, there is no certain way in which the morally legitimate desire to improve one’s condition and provide for one’s family can be pursued in a way that benefits oneself and society. With profit indicating greatest demand and need, human beings can channel their energies into the most important areas of economic life.

Professor William Hutt’s work at the University of Cape Town corroborates the proposition that rivalrous competition between profit-seeking entrepreneurs in an economy, where all prices and wage rates are competitively, and non-coercively, determined, ensures the full utilization of scarce resources in a manner that is continually and strictly in accord with consumer preferences. Profit allows us to be moral in serving needs, for it is the most precise measure by which we can accurately identify those needs of our neighbors whom we do not know and will never meet. Profit is a just and moral indicator, assuming that what it is indicating is a legal and morally valid commercial activity.

Often the legitimate role of profit has been underplayed in efforts to promote entrepreneurship, and this is especially the case with public sector promotion of it. Such de-emphasis undermines the crucial mechanism by which entrepreneurs respond to evolving needs, wants, and desires among people they do not and cannot know personally. Profit is a just mechanism for the ordering of social cooperation in the sphere of commercial development and a first principle in assessing legislative bills and other governmental acts affecting commercial life.

The Principle of Non-Distortion

Successfully obtaining profit is a process that can take place only when the entrepreneur is uniquely in tune with the wants and needs of the people he or she serves, and this takes place through the price mechanisms of the market. According to City Journal, Thomas Coleman, a hedge-fund veteran heading up an economic policy shop at the University of Chicago says markets function best when people and companies are able to trade “without systemic distortion of prices.” Interventions by the political authorities can distort accurate understandings of reality as it is, undermining the ability of the entrepreneur to read and make decisions that meet the commercial needs of others in the market.

One distortion prevalent today is the artificial expansion of credit. Critics observe that the supply of credit is not determined by demand, but by governments. Other actions such as the payment of subsidies send false signals to entrepreneurs, reflecting conditions which do not in fact exist, making it difficult over the long run to plan and nurture non-subsidized business. It is consumers who bear the higher costs imposed by state subsidies, thus undermining the effective making of business decisions and effective service to consumers.

Subsidies are, as we know, sometimes provided in the name of entrepreneurship to entrepreneurs, which inherently violates the very nature of real entrepreneurship. In its essence it is always a response to people, not to government’s (often upwards) redistribution to businesses. Corporate welfare in particular distorts the business climate for new enterprises and small- to medium-sized firms.

The Principle of Local Limitation

Government at the local level, while in principal the most sensitive to the freedoms of the people who make up a given community, is by no means exempt from the present critique. Previous work has pointed out that local government regularly infringes the rule of law even when its tasks are undertaken in the name of decentralization or federalism.

Under the general principle of subsidiarity, a term often employed by European scholars and invoked in EU legislation, any activity that can be performed by entities operating in a decentralized framework should be carried out in that way. Activities of the state as well as civil society are to be decentralized, at least ideally.

Beyond decentralization, the nature of laws passed by local authorities is crucial, too. As argued in a recent essay, city planning laws and regulations that are based on subjective decisionmaking by committees tend to infringe the rule of law, this in contrast to automatic rights based on compliance with pre-existing clearly defined rules, set as close to the people as possible.

For example, in the state of Texas, fewer—but more certain—rules regarding land-use planning make Texas more attractive to potential investors than the rules of other states when it comes to property prices. Indeed zoning laws have been cited for exacerbating inequality, thus excluding some from the market by creating artificial scarcity, while those within the market are able to continually improve their property.

Effective public policy on entrepreneurship requires not only that regulations be decentralized to the state or local level, but that the nature of those laws satisfy the principle of local limitation—that local government, in other words, be held within reasonable bounds. Fortunately, researchers are increasingly looking at assembling sub-regional indices at state and city levels, beyond only focusing on economic freedom at the nation-state level.

Free Exchange Across Borders

Protectionism is enjoying a certain vogue in the United States, and in fact entrepreneurs are sometimes just as quick to call for it as any other professional grouping in society. Globalization certainly is not a new phenomenon. I would say its aptness today is simply in expressing the rapidity at which international trade and interaction are now occurring.

According to Fred McMahon of Canada’s Fraser Institute, crony capitalism and state-controlled activities do not fare well when it comes to competition for world markets. The China example notwithstanding, McMahon, lead fellow on the institute’s annual Economic Freedom of the World Report, says that free trade put a lot of pressure on undemocratic and partly democratic governments the world over. He cites the spread of free trade as one of the reasons the globe has become a more democratic place.

On the other hand, some say globalization risks eroding culture and values, those features of a society that are beyond the merely material considerations inhering in entrepreneurship. In 1995, in his address to the members of the Pontifical Academy of the Social Sciences, Pope John Paul II—an uncompromising opponent of materialism—stated that globalization itself is not the problem. Rather, difficulties arise from the lack of a humane philosophical/ethical context in which the benefits of globalization can flow in the proper direction, which is to say, toward benefitting the ordinary people in a society. In John Paul’s view and that of others, a liberal market philosophy is an inadequate basis for globalization because it fails to provide a moral and cultural framework that recognizes human dignity and thus possesses no reference point outside itself.

The above-mentioned concept of subsidiarity affirms a good outside of the state and the market. It demands a space for the cultivation of character and communities, where decisions are made closest to those affected. This foundational principle for ordered liberty is respected within the principle of free exchange across borders.

The Principle of Uncertainty

City governments nowadays often open to the public the data they have collected over decades. This era of open data has given rise to new technology in areas like transport, turning raw data into useful information. Not all policymakers have welcomed this trend, however. “We should wait before opening up government data to the market until we know what outcomes we want in the market,” remarked one official in the Western Cape province of South Africa when I first proposed the measure, while serving in a local government.

Legislators, be they the most conscientious of public servants, nonetheless cannot predict, only enable. The principle of uncertainty is therefore another important benchmark by which to assess proposed legislation or other state action. The attempt to seek certainty is a very human one, but we cannot expect to do so by setting rules for innovation outcomes any more than we do people’s personal preferences on other kinds of day-to-day choices.

It may seem paradoxical, but policymakers’ acceptance of the uncertainty of outcomes does not promote uncertainty overall. If anything, it prevents distortion when governmental attempts at certainty come in the form of subsidies or protectionist legislation. One need only look at the data to see that, in fact, it is the uncertainty of outcomes within an institutional setting of ordered liberty that brings progress to a society.

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