Mark Sanders Utrecht School of Economics, Utrecht, Netherlands Max Planck Institute of Economics, Jena, Germany And Utz Weitzel Utrecht School of Economics, Utrecht, Netherlands Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 1 of 15 Institutions and the Allocation of Entrepreneurial Talent; A Model of Destructive Entrepreneurship

Motivation Inter-relations: -Institutions and Entrepreneurship Baumol (1990), Murphy et al. (1991), Acemoglu (1995) -Entrepreneurship and Development e.g. Naudé (2008) and all here present -Institutions and Development e.g. Hall and Jones (1999), Olson (1996), North (1990) -Entrepreneurs, Institutions and Development e.g. special issue SBEJ: Acs, Desai and Hessels (2008) Motivation Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 2 of 15

Motivation This paper develops a framework for analysis in which: Institutions drive the allocation of talent… … and the allocation of talent drives… …development (growth) and institutions. The interactions explain… …the emergence of development traps… …and helps formulate policy solutions. Motivation Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 3 of 15

The Basic Model Basic Structure as in Galor and Zeira (1993) and Acemoglu (1995) The agents in the model: Maximize log linear expected utility Live and consume for 2 periods Choose an occupation at start of period 1 Experience random events during period 1 Earn income, consume and save at the end of period 1 Consume savings and capital income in period 2 The Model Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 4 of 15

The Model n 0 to n 1 =N 1 n 1 to n 2 =N 2 n 2 to n=N 3 Wage Labor OC i t =1 Productive Ventures OC i t =2 Destructive Ventures OC i t =3 The Model Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 5 of 15 n0n0 n1n1 n2n2 n Basic Structure is an occupational choice model:

The Model Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 6 of 15 All agents solve: Where: ω i t is initial wealth random uniform over [ω l, ω h ] Y t i (.) is income earned from occupation OC t i

The Model Wage Labor OC i t =1 The Model Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 7 of 15 Expected earnings in period t and t+1: Expected utility:

The Model Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 8 of 15 Productive Ventures: Income without raid:

The Model Productive OC i t =2 The Model Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 9 of 15 Expected earnings in period t and t+1 when ξ is the probability of being raided: Expected utility:

The Model Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 10 of 15 Destructive Ventures: Expected assets seized per raid:

The Model Destructive OC i t =3 The Model Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 11 of 15 Expected earnings in period t and t+1: Expected utility:

Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 12 of k0k0 A B C D EF G H

The Dynamic Model Comparative Statics: Lower k 0 (Entry Barrier) 1.Allows for more people to engage in venture 2.Makes 2 more attractive relative to 1 3.Increases average size of ventures 4.Makes 3 more attractive to 1 5.Reduces probability for large ventures 6.Increases probability for small ventures 7.Makes 2 more attractive to 3 8.More 2, less 1, 3 ambiguous The Shocks Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 13 of 15

The Dynamic Model Comparative Statics: ω L or ω H (Initial Wealth) 1.Spread preserving increase in mean shifts box 2.Adding on right what is lost on left 3.No impact unless ω L >k 0 4.Only ω L will cause less raiding (A) 5.Reducing probability of being raided 6.More 2, less 1 and 3 7.Only ω H will have opposite effect. The Shocks Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 14 of 15

The Dynamic Model Comparative Statics: Wages w t (Economic Development) 1.Workers earn wage 2.Makes 1 more attractive directly 3.Raiders do not get wage 4.Does not affect 3 directly 5.Wage reduces return on capital 6.Raided ventures fall-back option is wage 7.Has ambiguous effect on 2 (depend on ξ) 8.More 1 or 2, less 3. The Shocks Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 15 of 15

The Dynamic Model Comparative Statics: Wages w t (Economic Development) 1.Workers earn wage 2.Makes 1 more attractive directly 3.Raiders do not get wage 4.Does not affect 3 directly 5.Wage reduces return on capital 6.Raided ventures fall-back option is wage 7.Has ambiguous effect on 2 (depend on ξ) 8.More 1 or 2, less 3. The Shocks Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 16 of 15

The Dynamic Model Comparative Statics: Lower λ (Institutions) 1.Reduce profitability of raiding 2.Makes 3 less attractive 3.Reduces probability of being raided 4.Makes 2 more attractive 5.No effect on 1 6.More 2, less 1 and 3 The Shocks Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 31, 2008slide 17 of 15

Policy Implications Discussion Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 30, 2008slide 18 of 15 Overlapping generations: Random initial wealth: more raiding Inheritance and endogenous wealth: vicious and virtuous cycles Endogenous growth and wages: high, no and cyclical growth

Concluding Remarks Entrepreneurship be a force for good and evil. Institutional design is paramount in allocating that resource. Destructive entrepreneurship feeds on productive assets. More inequality in the distribution of such assets increases the returns to destructive entrepreneurship. Credit constraints limit the options for talented entrepreneurs, so inequality increases the supply of destructive entrepreneurs. Effective redistribution and access to (micro-)credit may go a long way in breaking the vicious cycle in the short run. Concluding Remarks Mark Sanders UNU-WIDER/UNU-MERIT-workshop on Entrepreneurship, Technological Innovation, and Development Maastricht, NetherlandsOctober 30, 2008slide 19 of 15