Entrepreneurs and the Economy

An entrepreneur is a person who comes up with a new idea or invention and brings together a country's resources (land, labor and capital) to take the idea to the marketplace. Entrepreneurs manage and assume the risk of a business enterprise. They improve established products and services, or they create new ones. Entrepreneurs, like everyone else, respond to incentives. In a free market economy, one of the strongest incentives that drive entrepreneurs is to please customers and thereby earn a profit. To flourish, entrepreneurs need an economic environment that encourages private property and free markets.

What Is an Entrepreneur?

Everyone loves a hero—a person whose values we revere, whose accomplishments we respect. We admire and appreciate people who venture forth to try something new and end up benefitting a host of other people. These qualities describe the essence of entrepreneurship. An entrepreneur is one who asserts, "There is a better way, and I will find it." Being entrepreneurial means charging down a new path, staying alert to opportunity and taking risks to seize the opportunity. It means having energy, vision, optimism and daring to try something new. An entrepreneur is anyone with both an idea and the willingness to take the idea to the marketplace. Creativity and risk taking are two essential elements of entrepreneurship.

Entrepreneurs as Vital Resources

All of the economies around the world possess four major resources: land, labor, capital and entrepreneurship. Land represents natural resources—the soil, food crops, trees and lots we build on. Labor represents the farmers, accountants, cab drivers, dry cleaners, assembly-line workers and computer programmers who provide skills and expertise to build products or offer services in exchange for wages and salaries. Capital represents the buildings, equipment, hardware, tools and finances needed for production. Entrepreneurship represents ideas, innovation, talent, organizational skills and risk.

Entrepreneurs concoct the recipe, design the machine, develop the process and organize the workers who create and package the delicious chocolate bar on the grocery store shelf. In most cases, all we see is the final product, and thus we take entrepreneurs for granted. But entrepreneurs play the crucial role in the marketplace of making something that others will value. They are like the spark in an engine, igniting new ideas and discoveries that move the economy forward. They seek ways to improve current products, processes and services, and they create entirely new ones. They are willing to take risks to make things better.

Entrepreneurs can be found everywhere, doing just about everything—from starting a new restaurant to creating a new technology or invention. These people often put their money or their reputations on the line. Some wish to become rich and famous. Others wish to make themselves, their families or their communities better off. And some seek pure adventure—to challenge the limits of their capability. Regardless of motive, the entrepreneur's goal is to improve things. In 1926, Henry Ford, the inventor of the Model T, said, "It's strange how, just as soon as an article becomes successful, somebody starts to think that it would be more successful if only it were different." That somebody is an entrepreneur, someone who has a vision of what might be.

Entrepreneurs and Creative Destruction

In 1899, the director of the U.S. Patent Office said that everything that could be invented had already been invented. Boy, was he wrong! Practically everything we use today would have been unthinkable in 1899—airplanes, television, touch-tone telephones, microwave ovens and the Internet. Most of the modern conveniences we take for granted today did not exist 100 years ago.

The progress sparked by entrepreneurs' ideas does not simply happen. A tremendous amount of work and a great deal of risk go into every new idea that eventually makes its way into the marketplace. And even though entrepreneurs create wealth and opportunity with their ideas, they are not always appreciated for what they do in the economy. One reason for this is that entrepreneurs can be extremely disruptive.

When entrepreneurs take bold leaps and break contact with the familiar, they often leave behind a clutter of obsolete products and processes. This force is called creative destruction. For example, manual typewriters used to be in great demand, because they served a useful function. Now, one would be hard-pressed to find a manual typewriter, or even an electric one, at work in a business. The same fate awaits countless other products, processes and services. New technologies replace old ones, and entrepreneurs spark the change. A healthy economy is one that allows creative destruction to occur because, overall, more people benefit than lose. Each act of creation brought about by entrepreneurs more than offsets the losses associated with products or processes becoming obsolete.

Entrepreneurs in the Marketplace

A market system—one in which individuals, not the government, make decisions about how to use most of the economy's resources—provides entrepreneurs one of the best environments in which to flourish. In a free market, the potential to make a profit supplies a huge incentive for entrepreneurs to come up with new and better ideas.

Profits are essential signals to entrepreneurs that they are on the right track. They reward the entrepreneur for doing things that customers value and prefer. Profits are an important sign that people are reacting positively to what the entrepreneur has to offer. Likewise, an economic loss tells the entrepreneur that a product or idea may not provide enough value to the customer. In this light, the market can be a harsh critic and a sound judge.

The market system rewards those who create opportunities for employment and further innovation. When new products, processes and services are introduced by the entrepreneur, and when customers vote favorably with their dollars, even more opportunities arise. New products or service lines develop to further enhance the recently introduced products. The computer, for example, paved the way for the Internet, which, in turn, paved the way for search engines and software to explore the World Wide Web, which, in turn, created a new way for people to shop and obtain valuable information, and on and on. A wealthy economy is one teeming with superior contributions and the entrepreneurial opportunities created by them.

It is impossible to know in advance which entrepreneurial adventures will lead to more economic development. This is why the risk taking of entrepreneurs is so important. Entrepreneurs must listen to market signals of profit or loss to tell them whether they are on the right or wrong path to customer satisfaction. The market allows customers to be sound judges of the entrepreneur's contributions.

The free market demands that people be accountable for their actions. A good decision will be rewarded with higher profits, whereas a bad or poorly timed decision will result in loss. For each decision in the marketplace, something has to be given up, and people soon learn that nothing is free. Even the good things come with a cost. Entrepreneurs are those willing to risk the cost hoping to achieve a profit. The beauty of the free market is that entrepreneurs will only earn a profit if they do something that other people value.

Incentives for Entrepreneurship

Every country in the world has entrepreneurs, people who are creative and willing to take risks. But not all economies encourage their entrepreneurs to succeed in developing new products, ideas or services and getting them to consumers. An economic system must provide incentives that encourage entrepreneurs to risk trying something new. The most important incentives for entrepreneurs are private property rights and a competitive market system—the cornerstones of a prosperous, sound economy.

Private property. In a free enterprise system, one of the government's primary roles is to ensure that people can own and can make decisions regarding how they will use their property and ideas. Private property rights are essential to economic freedom and creativity. For example, in the United States, patent and copyright laws protect people from having their ideas and inventions stolen by others. This protection provides an incentive for entrepreneurs to create because they are allowed to benefit from their creativity.

In a system in which the government or some central planner owns the nation's resources and decides how they are allocated, entrepreneurs do not profit from their successes; thus, there is a much smaller incentive for them to be creative. In a free market economy, entrepreneurs can use their property and ideas in ways they think are best, and they can benefit directly from their successes in the form of higher profits or salaries.

Competitive markets. A free market economy also allows for competition among producers of goods or services. Competition provides another incentive for entrepreneurs to be creative. Entrepreneurs flourish in an environment that rewards them for their success and keeps them looking around the corner for competitors who may be gaining on them. When customers have a wide array of choices available to them, there is a greater burden on entrepreneurs to constantly find new and better ways of doing things.

Entrepreneurship and the Economy

Entrepreneurs are vital to economic growth and, consequently, to higher living standards. Thus, legislators and other leaders who create economic policies should strive to encourage the innovation and risk taking of entrepreneurs. Enforcing property rights through contract, patent and copyright laws; encouraging competition through free trade, deregulation and antitrust legislation; and promoting a healthy economic climate through Federal Reserve anti-inflation initiatives—these are all examples of policies that empower entrepreneurs to be creative and take risks.

The accomplishments of entrepreneurs in our modern world have been possible because of a climate of individual freedom that is so rare in human history. The society that does not honor entrepreneurial accomplishment will find fewer able people engaged in wealth creation. History has shown time and again that economies that appreciate the benefits created by entrepreneurs flourish, while those that devise laws and regulations aimed at seizing the entrepreneurs' rewards founder.

For additional copies of this publication, contact: Public Affairs Department, Federal Reserve Bank of Dallas, 2200 N. Pearl St., Dallas, Texas 75201-2272, or call (214)922-5254 or (800)333-4460, ext. 5254.