Institutions, Entrepreneurship, and Regional Differences in Economic Growth Joshua C. Hall Assistant Professor of Economics Department of Economics & Management Beloit College Russell S. Sobel James Clark Coffman Distinguished Chair in Entrepreneurial Studies Department of Economics West Virginia University ABSTRACT This paper takes an institutional approach to explaining differences in the levels of entrepreneurship and economic growth across U.S. states. The institutional approach to growth argues that political and economic institutions influence the productivity of resource use. We hypothesize that institutions influence economic growth primarily through their effect on entrepreneurship and discovery. In this paper, we test the hypothesis that institutional quality is a determinant of regional differences in entrepreneurship and economic growth using data from the Economic Freedom of North America index to measure institutional quality. Keywords: innovation, economic freedom, entrepreneurship JEL Code: M130, 0180, R110
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Institutions, Entrepreneurship, and Regional Differences in Economic Growth
Joshua C. HallAssistant Professor of Economics
Department of Economics & ManagementBeloit College
Russell S. SobelJames Clark Coffman Distinguished Chair in Entrepreneurial Studies
Department of EconomicsWest Virginia University
ABSTRACT
This paper takes an institutional approach to explaining differences in the levels of
entrepreneurship and economic growth across U.S. states. The institutional approach to growth argues
that political and economic institutions influence the productivity of resource use. We hypothesize that
institutions influence economic growth primarily through their effect on entrepreneurship and
discovery. In this paper, we test the hypothesis that institutional quality is a determinant of regional
differences in entrepreneurship and economic growth using data from the Economic Freedom of North
Note:: *indicates significance at the 10 % level, **at the 5 % level, and *** at 1% levelIn Column 1, Absolute t-statistics in parentheses, in 2 & 3, posterior std. deviations.OLS corrected for heteroskedasticity using White's correction.
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In the first two columns, failing to correct for the spatially dependent error structure biased
downward the estimates of the impact of economic freedom, median age, and the square of the
homestead exemption, which is now larger and statistically significant. The negative sign on the
homestead exemption variable is the result of the credit access effect, while the positive and significant
sign on the homestead exemption squared is the result of the wealth insurance effect. Thus, the
homestead exemption actually reduces the rate of entrepreneurship until the wealth insurance effect
begins to dominate. The larger coefficient on the EFNA term suggests that a one unit increase in a
state’s EFNA index would increase that state’s score on the KIEA by 5.879 percentage points, other
things equal. That is around 85 percent of a standard deviation increase in the change in a state’s KIEA
score. More importantly, correcting for spatial dependence only strengthens the positive relationship
between economic freedom and entrepreneurship at the state level. These results presented in table 2
confirm the previous research by Kreft and Sobel (2005) and Campbell and Rodgers (2007) showing that
economic freedom has a positive and significant impact on measures of entrepreneurial activity, but
using this new measure of state entrepreneurial activity.
Conclusion
The evidence presented here suggests that differences in institutional quality help to explain
differences in entrepreneurship across states. Combined with other research showing that
entrepreneurship leads to higher levels of economic growth, we argue that entrepreneurship is the
mechanism through which institutions are translated into economic growth. This finding helps explain
the evidence that low-income regions converge towards high-income regions in a slow and
discontinuous manner. The effect of institutions on entrepreneurial innovation make it the case that
although capital and labor tend to move to where they are most valued, the higher levels of innovation
in regions with good institutions disrupts the convergence and pushes areas with good institutions
Institutions, Entrepreneurship, and Regional Differences in Economic Growth
June 58
ahead again. The persistence of differences in institutional quality thus helps to explain the persistence
of income and wealth differences across states.
While borrowing from the literature on endogenous growth, this paper differs in its
policy implications. Endogenous growth theory takes knowledge production and hence, research and
development spending, as the key to generating increasing returns. We argue that the results presented
here shows that it is good institutions that allow research and development to be translated into
economic growth. Good institutions simply better channel productive resources to their highest valued
use. Thus, state policymakers interested in improving economic growth in a state should focus on
improving that state’s economic freedom, rather than trying to pursue policies to increase the quantity
of economic inputs (subsidies for education, technology, venture capital, etc.). While institutions are
persistent and thus effecting institutional change is difficult, recognition that institutions matter is an
important first step in the process of promoting entrepreneurial activity—the root source of economic
growth and prosperity.
HALL, SOBEL
59 American Journal of Entrepreneurship
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