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Poverty, Entrepreneurship, and Development

Ha-Joon Chang

Many people believe that the lack of entrepreneurship is one of the main causes of poverty in developing countries. However, anyone who is from or has lived for a period in a developing country will know that developing countries are teeming with entrepreneurs. On the streets of poor countries, you will meet men, women, and children of all ages selling everything you can think of, and things that you did not even know could be bought—a place in the queue for the visa section of the American Embassy (sold to you by professional queuers), the right to set up a food stall on a particular corner (perhaps sold by the corrupt local police boss), or even a patch of land to beg from (sold to you by the local thugs).

In contrast, most citizens of rich countries have not even come near to becoming an entrepreneur. They mostly work for a company, doing highly specialized and narrowly specified jobs, implementing someone else’s entrepreneurial vision.

The upshot is that people are far more entreprenurial in the developing countries than in the developed countries. According to an OECD study, in most developing countries, 30-50 per cent of the non-agricultural workforce is self-employed (the ratio tends to be even higher in agriculture). In some of the poorest countries, the ratio of people working as one-person entrepreneurs can be way above that: 66.9 per cent in Ghana, 75.4 per cent in Bangladesh, and a staggering 88.7 per cent in Benin (see 1 under further reading). In contrast, only 12.8 per cent of the non-agricultural workforce in developed countries is self-employed. In some countries, the ratio does not even reach one in ten: 6.7 per cent in Norway, 7.5 per cent in the USA, and 8.6 per cent in France. So, even excluding the farmers (which would make the ratio even higher), the chance of an average developing country person being an entrepreneur is more than twice that for a developed country person (30 per cent versus 12.8 per cent). The difference is 10 times, if we compare Bangladesh with the USA (7.5 per cent versus 75.4 per cent). And in the most extreme case, the chance of someone from Benin being an entrepreneur is 13 times higher than the equivalent chance for a Norwegian (88.7 per cent versus 6.7 per cent).

Moreover, even those people who are running businesses in the richer countries need not be as entrepreneurial as their counterparts in the poorer countries. For developing country entrepreneurs, things go wrong all the time. There are power cuts that mess up the production schedule. Customs will not clear the spare parts needed to fix a machine, which has been delayed anyhow due to problems with the permit to buy USA dollars. Inputs are not delivered at the right time as the delivery truck broke down, yet again, due to pot holes on the road. And the petty local officials are bending, and even inventing, rules all the time in order to extract even more bribes. Coping with all these requires agile thinking and the ability to improvise.

So we are faced with an apparent puzzle. Compared to the richer countries, we have far more people in developing countries (in proportional terms) engaged in entrepreneurial activities. On top of that, their entrepreneurial skills are much more frequently and severely tested than those of their counterparts in the rich countries. But these more entrepreneurial countries are the poorer ones. Why?

Microfinance and entrepreneurship

The seemingly boundless entrepreneurial energy of people in poorer countries has of course not gone unnoticed. There is an increasingly influential view that the engine of development for poor countries should be the so-called ‘informal sector’, fuelled by microcredit. The recipe sounds perfect. Microcredit allows the poor to get out of poverty through their own efforts, by providing them with the financial means to realise their entrepreneurial potential. In the process they gain independence and self-respect, as they are not relying on hand-outs from the government and foreign aid agencies for their survival any more. Women are particularly ‘empowered’ by microcredit, as it gives them the ability to earn an income and thus improve their bargaining positions vis-à-vis their male partners. Not having to subsidise the poor, the government feels less pressure on its budget. The wealth created in the process, naturally, makes the overall economy, and not just the informal sector entrepreneurs, richer.

Unfortunately, there are growing criticisms of microfinance, even by some of its early ‘priests’. For example, in a recent paper with David Roodman, Jonathan Morduch, a long-time advocate of microfinance, confesses that ‘[s]trikingly, 30 years into the microfinance movement we have little solid evidence that it improves the lives of clients in measurable ways’ (see further reading).

The microfinance industry has always boasted that their operations remain profitable without government subsidies or contributions from international donors, except perhaps in the initial teething phase. However, it turns out that, without subsidies, microfinance institutions have to charge, and have been charging, near-usurious rates. It has been revealed that the Grameen Bank could initially charge reasonable interest rates only because of the (hushed up) subsidies that it was getting from the Bangladeshi government and international donors. If they are not subsidised, microfinance institutions have to typically charge interest rates of 40-50 per cent for their loans, with the rates as high as 80-100 per cent in countries like Mexico. When, in the late 1990s, it came under pressure to give up the subsidies, the Grameen Bank had to relaunch itself (in 2001) and start charging interest rates of 40-50 per cent.

With interest rates running up to 100 per cent, few businesses can make the necessary profits to repay the loans so most of the loans made by microfinance institutions (in some cases as high as 90 per cent) have been used for the purpose of consumption smoothing. More importantly, even the small portion of microcredit that goes into business activities is not pulling people out of poverty. At first, this sounds inexplicable. Those poor people who take out microcredit know what they are doing. Unlike their counterparts in rich countries, most of them have run businesses of one kind or another. Their business wits are sharpened to the limit by their desperation to survive and sheer desire to get out of poverty. They have to generate very high profits because they have to pay the ‘market rate’ of interest. So what is going wrong?

When a microfinance institution first starts its operation in a locality, the first group of clients may see their income rising—sometimes quite dramatically. For example, when in 1997 the Grameen Bank teamed up with Telenor, the Norwegian phone company, and gave out microloans to women to buy a mobile phone and rent it out to their villagers, these ‘telephone ladies’ made handsome profits—US$750-1,200 in a country whose annual average per capita income was around US$300. However, over time, the businesses financed by microcredit become crowded and their earnings fell. To go back to the Grameen Phone case, by 2005 there were so many telephone ladies that their income was estimated to be around only US$70 per year, even though the national average income had gone up to over US$450. This problem is known as the fallacy of composition—the fact that some people can succeed with a particular business does not mean that everyone can succeed with it.

Of course, this problem would not exist if new business lines could be constantly developed. So, for example, if phone renting becomes less profitable you could maintain your level of income by manufacturing mobile phones or writing the software for mobile phone games. You will have, of course, noticed the absurdity of these suggestions—the telephone ladies of Bangladesh simply do not have the wherewithal to move into phone manufacturing or software design. The problem is that there is only a limited range of (simple) businesses that the poor in developing countries can take on, given their limited skills, the narrow range of technologies available, and the limited amount of finance that they can mobilize through microfinance.

Collective nature of entrepreneurship

Our discussion so far shows that what makes the poor countries poor is not the lack of raw individual entrepreneurial energy, which they in fact have in abundance. It is their inability to channel the individual entrepreneurial energy into collective entrepreneurship.

Very much influenced by capitalist folklore, with characters like Thomas Edison and Bill Gates, and by the pioneering theoretical work of Joseph Schumpeter, our view of entrepreneurship is too much tinged by the individualistic perspective—entrepreneurship is what those heroic individuals with exceptional vision and determination do. However, if it ever was true, this view is becoming increasingly obsolete. In the course of capitalist development, entrepreneurship has become an increasingly collective endeavour.

To begin with, even those exceptional individuals like Edison and Gates became what they are only because they were supported by a whole host of collective institutions—the whole scientific infrastructure that enabled them to acquire their knowledge and also experiment with it; company law and other commercial laws that made it possible for them subsequently to build companies with large and complex organizations; educational systems that supplied highly trained scientists, engineers, managers, and workers that manned those companies; financial systems that enabled them to raise huge amounts of capital when they wanted to expand; patent and copyright laws that protected their inventions; easily accessible markets for their products, and so on.

Furthermore, in the richer countries, enterprises co-operate with each other a lot more than do their counterparts in poorer countries. For example, the dairy sectors in countries like Denmark, the Netherlands, and Germany have become what they are today only because their farmers organized themselves, with state help, into co-operatives and jointly invested in processing facilities and export marketing. In contrast, the dairy sectors in the Balkan countries have failed to develop, despite quite a large amount of microcredit channelled into them, mainly because their dairy farmers tried to make it on their own. For another example, many small firms in Italy and Germany jointly invest in R&D and export marketing, which are beyond their individual means, through industry associations (helped by government subsidies), whereas typical developing country firms do not invest in these areas because there is not such a collective mechanism.

Even at the firm level, entrepreneurship has become highly collective in the rich countries. Today, few companies are managed by charismatic visionaries like Edison or Gates, but by professional managers. Writing in the mid twentieth century, Schumpeter was already aware of this trend, although he was none too happy about it. He observed that the increasing scale of modern technologies was making it increasingly impossible for a large company to be established and run by a visionary individual entrepreneur. Schumpeter predicted that the displacement of heroic entrepreneurs with what he called ‘executive types’ would sap the dynamism from capitalism and eventually lead to its demise.

Schumpeter has been proven wrong in this regard. Over the last century, the heroic entrepreneur has increasingly become a rarity, but the world economy has grown much faster since the Second World War, compared to the period before it. In the case of Japan, the firms have even developed institutional mechanisms to exploit the creativity of even the lowliest production line workers. Many attribute the success of the Japanese firms, at least partly, to this characteristic.

If effective entrepreneurship ever was a purely individual thing it has stopped being so, at least for the last century. The collective ability to build and manage effective organizations and institutions is now far more important than the drives or even the talents of a nation’s individual members in determining its prosperity. Unless we reject the myth of heroic individual entrepreneurs and help them build institutions and organizations of collective entrepreneurship, we will never see the poor countries grow out of poverty on a sustainable basis.

References

Bateman, M. (2010) Why doesn’t microfinance work?, Zed Books: London.

OECD (2009). Is informal normal? Towards more and better jobs in developing countries, OECD: Paris.

Roodman, D., and J. Morduch (2009). ‘The impact of microcredit on the poor in Bangladesh: Revisiting the Evidence’, Center for Global Development Working Paper No. 174.

About the Author

Ha-Joon Chang teaches economics at the University of Cambridge, UK.  He directed the UNU-WIDER project on ‘Institutions for Economic Development: Theory, History and Contemporary Experiences’, and  edited the resulting book Institutional Change and Economic Development, published by Anthem Press. More information on Ha-Joon Chang here.

Further reading

This article is a condensed version of chapter 15 of his new book 23 Things They Don’t Tell You about Capitalism (Allen Lane).

Related UNU-WIDER reading:

‘Promoting Entrepreneurship in Developing Countries: Policy Challenges’, by Wim Naudé, 2010, UNU Policy Brief 04/2010.

‘Entrepreneurship, Developing Countries and Development Economics: New Approaches and Insights’, by Wim Naudé, Small Business Economics Journal, 2010, 34(1): 1-12.

‘A Model of Destructive Entrepreneurship’, by Sameeksha Desai, Zoltan Acs, and Utz Weitzel, WIDER Working Paper 2010/34.

‘Entrepreneurship, Economic Growth and Policy in Emerging Economies’, by Roy Thurik, UNU-WIDER Research Paper 2009/12. 

‘Firm Ownership, FOEs, and POEs’, by Alice Amsden, WIDER Research Paper 2009/46.

‘Entrepreneurial Ventures and the Developmental State: Lessons from the Advanced Economies’, by William Lazonick, WIDER Discussion Paper 2008/01.

WIDER Angle newsletter
October 2010
ISSN 1238-9544

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