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? Why are all these people – highly motivated, in possession of relevant skills and strongly pressured by the market – making huge efforts with their business ventures, producing such meagre results?
When a microfinance institution first starts its operation in a locality, the first posse of its 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 – $750–$1,200 in a country whose annual average per capita income was around $300. However, over time, the businesses financed by microcredit become crowded and their earnings fall. 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 $70 per year, even though the national average income had gone up to over $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 – if one line of activity becomes unprofitable due to overcrowding, you simply open up another. 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 obviously have 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. So, you, a Croatian farmer who bought one more milk cow with a microcredit, stick to selling milk even as you watch the bottom falling out of your local milk market thanks to the 300 other farmers like you selling more milk, because turning yourself into an exporter of butter to Germany or cheese to Britain simply isn’t possible with the technologies, the organizational skills and the capital you have.
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. The point is that what really makes the rich countries rich is their ability to channel the individual entrepreneurial energy into collective entrepreneurship.
Very much influenced by capitalist folklore, with characters such as Thomas Edison and Bill Gates, and by the pioneering work of Joseph Schumpeter, the Austrian-born Harvard economics professor, our view of entrepreneurship is too much tinged by the individualistic perspective – entrepreneurship is what those heroic individuals with exceptional vision and determination do. By extension, we believe that any individual, if they try hard enough, can become successful in business. However, if it ever was true, this individualistic view of entrepreneurship is becoming increasingly obsolete. In the course of capitalist development, entrepreneurship has become an increasingly collective endeavour.
To begin with, even exceptional individuals like Edison and Gates have become what they have only because they were supported by a whole host of collective institutions (
Furthermore, in the rich countries, enterprises cooperate with each other a lot more than do their counterparts in poor countries, even if they operate in similar industries. For example, the dairy sectors in countries such as Denmark, the Netherlands and Germany have become what they are today only because their farmers organized themselves, with state help, into cooperatives and jointly invested in processing facilities (e.g., creaming machines) and overseas marketing. In contrast, the dairy sectors in the Balkan countries have failed to develop despite quite a large amount of microcredit channelled into them, because all 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 they do not have 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 and 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 and the process of innovation in products, processes and marketing – the key elements of Schumpeter’s entrepreneurship – has become increasingly ‘collectivist’ in its nature. Yet, despite this, 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 (
Thing 16
We are not smart enough to
leave things to the market
We should leave markets alone, because, essentially, market participants know what they are doing – that is, they are rational. Since individuals (and firms as collections of individuals who share the same interests) have their own best interests in mind and since they know their own circumstances best, attempts by outsiders, especially the government, to restrict the freedom of their actions can only produce inferior results. It is presumptuous of any government to prevent market agents from doing things they find profitable or to force them to do things they do not want to do, when it possesses inferior information.
People do not necessarily know what they are doing, because our ability to comprehend even matters that concern us directly is limited – or, in the jargon, we have ‘bounded rationality’. The world is very complex and our ability to deal with it is severely limited. Therefore, we need to, and usually do, deliberately restrict our freedom of choice in order to reduce the complexity of problems we have to face. Often, government regulation works, especially in complex areas like the modern financial market, not because the government has superior knowledge but because it restricts choices and thus the complexity of the problems at hand, thereby reducing the possibility that things may go wrong.
As expressed by Adam Smith in the idea of the invisible hand, free-market economists argue that the
