Freedom, Boldness, and Economic Creativity

William DiPietro

The improvement of mankind's material well-being in a scarcity world is an un- ending struggle. It is no small, easy task but rather an arduous, difficult, continu- ous endeavor. Over time, the betterment of man's condition requires, at a minimum, that economic growth outstrip population expansion. Although economic growth is so important, it is by no means automatic. Rapid economic growth is the out- come of a fine-tuned interaction between mankind and his environment. Maintain- ing sustained high levels of economic growth depends critically on the product of man's genius and imagination - technological progress or economic creativity. It is therefore of the utmost importance to identify the determinants of technological improvement, the conditions under which it flourishes, and the characteristics of human beings that foster its development. This paper looks across countries to assess the effect of two potential factors, freedom and boldness, on economic creativity.

The impor tance of en t repreneursh ip and innovat ion for cont inual e conomic p rospe r i ty is once again taking cen te r s tage. D e v e l o p i n g coun t r i es are con- c e rned that they will fal l fu r the r and fur ther beh ind b e c a u s e they lack the appropr ia te infras t ructure to at t ract en t repreneurs . The re is no th ing m o r e sa- cred to the economics profess ion than the model o f pure compet i t ion. Yet this s tandard mode l is under a t t ack for its lack o f any real ro le for i nnova t ion . M a k o w s k i and Os tory (2001) even sugges t that a mod i f i ed mode l that takes into account innova t ion rep lace the s tandard model .

O f course, for a look at the vital impor tance of the entrepreneur, there is no bet ter source than Schumpeter . In his view, entrepreneurs are the pr ime movers of the creative-destructive process that culminates in higher levels of output. Dixon (2000) provides a nice recently written overv iew of S c h u m p e t e r ' s work.

The decision to engage in entrepreneur ia l act ivi ty can be f r amed within the context o f an occupat ional choice model . Lucas (1978) and Jovanov ic (1994)

William DiPietro is a Professor of Economics at Daemen College in Amherst, New York. He has a Ph.D. in economics from the University of Pittsburgh and has published articles on a wide variety of economics topics. His current research interests include the areas of economic growth, economic development, international trade, and global income distribution. He may be reached at <wdipietr @ daemen.edu>.

Knowledge, Technology, & Policy, Winter 2003, Vol. 15, No. 4, pp. 37-45.

38 Knowledge, Technology, & Policy / Winter 2003

see individuals making the decision to become entrepreneurs on the basis of a comparison between wages and anticipated entrepreneurial rent.

Within an occupational choice model, entrepreneurial activity is expected to increase the smaller the rate of remuneration for non-entrepreneurial activi- ties, the greater the expected value of entrepreneurial activities, the lower the risk of entrepreneurial activities, and the greater the psychological disposition of individuals to bear risk.

For the year 2000, the World Economic Forum has, for the first time, pub- lished indexes on creativity and innovation on a country-by-country basis. This opens up the possibility of empirically investigating the determinants of entrepreneurial activity across countries. The purpose of this paper is to make a start in this direction by testing a very simple empirical model fundamen- tally grounded in occupational choice theory.

The article is broken down into four parts. The first part discusses the philo- sophical and theoretical background. Next, the paper delves into the data sources that will be used in the empirical section, The third part, the heart of the paper, shows the results of cross-country regressions on economic creativity and inno- vative indexes. Finally, there are concluding remarks in a fourth part.

The Importance of Creativity and Creativity's Potential Theoretical Determinants

Technological change is the locomotive of economic progress. Human be- ings are the very core, the heart and soul of the entire process. It is people who invent, who create, and who innovate. It is people who decide to devote time to inventing, to creating, or to innovating. Human beings function on the ba- sis of self-interest. They make their choices; they decide what to do and what not to do, on the basis of self-interest.

The entire world can be broken down into two major subsets - human beings and their environment Now, the two sides of a scissors require both sides in order for the scissors to cut paper. In like fashion, the promotion of innovative activity requires both the right type of human being and the right type of environment.

Long ago Schumpeter recognized the importance for innovation of the en- trepreneur or the entrepreneurial spirit. The "right types" of people have this entrepreneurial spirit. Innovation and introducing new technology involve changes in existing practices and, to put it mildly, is disruptive and likely to be very risky. It is often seen as threatening and, in actuality, often really is threat- ening. It is therefore not uncommon for it to be resisted. It takes a certain type of individual to be willing to undertake innovation. An essential characteristic of such an individual, someone with an entrepreneurial spirit, is boldness. One needs people who are willing to take a chance for an unguaranteed future return, people who are willing to upset the present status quo in the face of criticism, and people who are willing to take a plunge into the unknown to remake the future.

There is an old movie, set during World War Two, in which an old million- aire businessman slums it in Washington, D.C. incognito and rents an apart-

DiPietro 39

ment from a young working woman. He proceeds to play matchmaker and to set her up with a young man who is destined to be off to war almost immedi- ately. The two young people fall in love, but she is reluctant to get married because of the young man's perilous future in harm's way. However, the old matchmaker is not to be deterred. His life's motto is "damn the torpedoes, full speed ahead." Of course, he ends up imbuing the same spirit to the young woman so that she marries the young man. This motto succinctly captures the essence of boldness of the entrepreneurial sprit.

The second half of the split, the environment, represents everything outside human beings. For economic creativity to flourish, the environment must be at least suitable, if not favorable for creativity. This means that it must provide an incentive, or at least not a penalty, for creativity. A positive environment allows people to obtain the fruits of their creative endeavors. It rewards people for successful innovations and inventions.

Freedom allows such an environment to sprout and to flourish. It accom- plishes this in a two-fold way. First, since it is diametrically opposed to the nature of freedom to restrict the behavior of individuals, it gives them the opportunity to engage in innovation. Second, the establishment of property rights allows individuals to recoup the potential rewards from their endeav- ors, or at least for individuals to have recourse to due process in the face of threatened seizure. This increases the anticipated value from innovative activ- ity.

More formally, let (x~, x 2 .... x ..... xN) represent the innovative opportunity set with N representing the available opportunities and x, representing the ex- pected value from the ith innovative activity. What an increase in freedom accomplishes is to increase the value of N, the available innovative opportu- nities, and, at the same time, to increase the value of the x,s.

Again, for innovation to flourish requires the presence of two complemen- tary factors. The first is a favorable environment. Here, the environment is interpreted in a broad sense to encompass the entire social, political, and eco- nomic milieu. The second is an adequate supply of entrepreneurs. Entrepre- neurs are the strong-willed individuals who shake up the status quo and bring about the possible occurrence of positive developments.

Without one or the other there will be little innovation. The right environ- ment is one thing, but one must still have the right type of individual to take advantage of the opportunities if any action is to take place. On the other hand, the lack of permitted opportunities results in little innovative activity even in the presence of a plenitude of entrepreneurs.

For any given opportunity set, the extent of innovation that takes place depends on the propensity of people in society to innovate. Since innovative activity is risky, with no certainty of return, one essential characteristic is their risk preference. Societies with individuals that are less risk-adverse, all other things being equal, will have greater innovative activity than those who are more risk-averse. In the parlance used here, societies with bolder individuals will be more innovative.

In sum, innovation is a very risky undertaking. It may succeed, but it is probably more likely to fail. At a minimum, innovation requires an environ-

40 Knowledge, Technology, & Policy [ Winter 2003

ment that at least allows people to take risks, plus the existence of people who are willing to take risks.

A key characteristic o f the environment is freedom, while an important characteristic of an entrepreneur is boldness. It is these two factors, freedom and boldness, that are selected to be used and analyzed as determinants of boldness in the empirical section.

Data Sources for Measures of Freedom, Creativity, and Boldness

In order to do cross-country analysis considering the effect of boldness and economic freedom on economic creativity, measures of economic creativity, boldness, and freedom on a country by country basis need to be found and gathered, and a data set needs to be assembled.

The World Economic Forum's The Global Competitiveness Report 2000 provides a variety of measures of technological progress based on survey questions on a country by country basis for fifty-nine countries for 2000.

Their overall measure of creativity is the economic creativity index. The index considers both the extent that a country innovates on its own and the degree to which it is successful in transferring technology from outside its own borders. Higher values for the index indicate greater economic creativity. For 2000, the index ranges in value from a high of 2.02 for the United States to a low of -1 .55 for Bolivia.

The economic creativity index is constructed on the basis of four other indexes. These component indexes are the innovation index, the technology transfer index, the technology index, and the start-up index. In the main, the component indexes are grounded on the answers to survey questions from a survey questionnaire.

The innovation index, which attempts to measure innovation within a coun- try, ranges in value from 2.02 for the United States to -1.84 for Bolivia.

The technology transfer index is designed to measure the extent of the inflow of new technology into a country from the rest of the world. In 2000, it varied in value from a high of 1.95 (Singapore) to a low of -2.59 (Russia).

The technology index attempts to measure the availability of technology to a country regardless of whether it is internally generated or externally adopted. It is derived directly from the innovation index and the technology transfer index by simply taking the higher value of the two indexes. In 2000, it ranged in value from 2.02 for the United States to -2.59 for Bolivia.

In an attempt to capture the environmental suitability of a country for inno- vation, a measure of country freedom was sought out. One of the most thor- ough measures of economic freedom available on a cross-country basis is that produced by James Gwartney and Rober t Lawson. Gwartney and Lawson form indices of economic freedom for countries by weighing seventeen dif- ferent fundamental aspects of economic freedom. They use three different weighting schemes on these basic elements resulting in three different vari- ants of the freedom index. The first uses equal weights for each primary as- pect, the second employs weights based on a survey of k n o w l e d g e a b l e individuals, and the third utilizes the estimated regression coefficients of the

DiPietro 41

basic components on overall freedom. Within the paper, the three variants of the Gwartney and Lawson freedom indexes are labeled FRAVGA, FRAVGB, and FRAVGC, respectively. The Gwartney and Lawson freedom indices are available on a country-by-country basis for five periods. They are 1975, 1980, 1985, 1990, and 1993-1995. The variables used here, FRAVGA, FRAVGB, and FRAVGC, are simple averages for the five time periods. The use of aver- ages over several time periods, hopefully, provides a long-run profile of free- dom in countries. The freedom indexes range from a potential low of zero to a high of ten with higher values indicating greater freedom.

A favorable environment is just one side of the creativity story. Given a positive environment, whether or not a country is likely to experience sub- stantial innovation depends critically on the extent it propagates individuals with an aggressive, action-orientated, risk-taking, entrepreneurial spirit. The World Value Survey is a comprehensive survey on values and beliefs for forty- three societies for the period 1989-1993. One of the questions posed on the survey is "You will never achieve much unless you act boldly." The measure of boldness used here, labeled BOLD, is the percentage of respondents in a society that agree with this statement.

It should be pointed out at the outset that the variables collected are not from the same year. Anyone who deals with cross-sectional data is well aware that it is often difficult, if not impossible, to get measures on different vari- ables you desire for the same year. While the measured variables used here are not for the exact same year, they are very close. In any case, hopefully, it should be of little consequence, as one would expect both freedom and bold- ness to have some sustaining power in a country over time.

Cross-Country Regressions of Creativity on Freedom and Boldness

Tables A through D contain the results of cross-country regressions of the various creativity and innovative indexes on freedom and boldness measures. The first column contains the labels for each row. Running down the first column, the first row, EQ, is the equation number. The second row, C, is the constant. The third, fourth, and fifth row, FRAVGA, FRAVGB, and FAVGC, are the variants of the Gwartney and Lawson freedom index. The sixth row, BOLD, is the 1990-1993 World Value Survey measure of boldness. Finally, the last two rows, RSQ and N, give respectively the r-squared value and the number of available countries.

The subsequent columns, columns two through eight, contain equations (one equation per column). The end result is seven equations for every table. The equations are labeled with a number fol lowed by a letter. The number identifies the number of the equation and the letter that fol lows shows the table from which the equation comes. Thus, 2B refers to the second equation in Table B. Equations with the same number but from different tables such as 2B and 2C are readily comparable. They have the exact same independent variables, but different dependent variables.

Cells in the main body of the table give essential statistical output. The topmost value in the cell is the estimated value of the coefficient. Underneath,

42 Knowledge, Technology, & Policy / Winter 2003

in parentheses, is the individual t-statistic. Lastly, asterisks provide a short- hand way of quickly noting the level of significance of a variable in an equa- tion. Variables significant at the 1 percent level of significance or better have one asterisk. Variables significant at the 5 percent level of significance or bet- ter have two asterisks, and variables significant at the 10 per cent level o f significance or better have three asterisks.

Looking at Table A, for which the overall economic freedom index is used as the dependent variable, the results are quite impressive. In each of the seven equations of the Table A, whether they are used in isolation or jointly as explanatory variables, the three different variants of the freedom index and the single measure of boldness, with just one exception, are significant at the 1 percent level of significance or better. Together, freedom and boldness ac- count for over 61 percent of the variation in economic creativity (equations 5A, 6A, and 7A).

Table A

Cross-Country Regressions of the Economic Creativity Index on Freedom and Boldness

Eq~ C

FRAVGA

FRAVGB

FRAVGC

41A) 42A) - 1.409 -.679 (-2.272)** (-1.209) .280 (2.957)*

.194 (1.787)***

43A) -1.083 (-2.862)

.270 (3.841)*

B O L D

.183 .076 .275

(4A) - 424 (-1.240)

024 42.925)* 234

(5A) -1.548 (-3.297)* .235 (3.935)*

/3,745)*

.019 (3.675)* .631

f6A) -1,357 (-3.316)*

.276

.021 (4.010)* 615

47A) -.835 (-3.043)*

.176 (4.235)*

RSq N 41 41 41 30 22 22

Table B

Cross-Country Regressions of the Innovation Index on Freedom and Boldness

,017 (3.509)* .655

EQ (1B) (2B) C -1.768 -1.153

(-3.061)* (-1.765)*** FRAVGA .343

(3.143)* FRAVGB .227

(1.799)*** FRAVGC

B O L D

RSQ .202 .077 N 41 41

( 3 B )

- 1 803 (-4.506)*

.351 (4,506)*

.342 41

~ 4 B )

-.772 (-1.762)***

(5B) -3 079 (-6.593)* .498 (6.239)*

~6B) -3.512 (-6.264)*

.584 (5.793)*

.028 .029 .033 42.699)** (4.249)* (4.677)* .203 .769 .746 30 22 22 22

(7B) -2.349 (-6.300)*

.361 46.380)* .026 (3.902)* .776

DiPietro 43

Table C

Cross-Country Regressions of the Startup Index on Freedom and Boldness

zq C

FRAVGA

FRAVGB

FRAVGC

BOLD

RsQ N

(IC) -1.671 (-3.149)* .337 (3.367,)*

(2c) -1,254 (-2.105)**

.261 (2.268)**

(3C) -1.526 (-3.804)*

310 (4.163)*

.225 .I17 .308 41 41 41 30

(4C) - 1.062 (-2.558)**

,031 (3.158)* .263

Table D

(5C) - 1 944 (-3.577)* .266 (2.869)*

.O26 (3.326) .532 22

(6C) -2.129 (-3.346)*

.303 (2.645)**

.029 (3.5565* .510 22

(7c) -1.604 (-3 754)*

.204 (3.154)* .025 (3.197)* .560 22

C r o s s - C o u n t r y R e g r e s s i o n s o f t h e T e c h n o l o g y I n d e x o n F r e e d o m a n d B o l d n e s s

(3D) (5D) (7D) z q C

' FRAVGA

FRAVGB

FRAVGC

BOLD

RS 9 N

(1D) -.614 (-1.087) .223 (2.091)**

.101 41

(2D) -1.07 (-.173)

.126 (1.060)

.028 41

- 64O (-1.475)

229 (2.842)*

.172 41

(4D) .212 (623)

.017 (2,036)*** 129

30

-.361 (-.855) 203 .(2.820) *"

.011 (1.810)** .396 22

(6D) -.581 (-1.210)

.248 (2.868)*

.013 ~2.118)** ,402 22

- 061 (-.179)

.147 (2.838) *~ .010 (1.632) .399 22

Table E

Cross-Country Regressions of the Technology Transfer Index on Freedom and Boldness

zQ IC

FRAVGA

FRAVGB

FRAVGC

(1E) -.412 (-.711) .107 (.975)

(2E) -.209 (-.342)

,069

(.578)

(3E) -.351 (-.761)

.096 (1.110)

BOLD

.024 ,009 .031 41 41

~Q N 41

(4E) 824

(1.731)***

-.016 (-1.3875 .064 30

(5E5 1.753 (3 463)* - 051 (-.588)

-.027 (-3.6365" .428 22

(6E) 1.848 (3 202)*

-.070 (-.678)

-.027 /-3.727)* .431 22

(7E) 1.658 (4.034)*

-.032 (-.518) -,027 (-3.577)* .425 22

44 Knowledge, Technology, & Policy / Winter 2003

Looking at the component parts of the economic creativity index, the four remaining tables allow one to diagnose the channel whereby f reedom and boldness exert their influence on overall economic creativity. The most im- portant conduit would appear to be innovation (Table B), followed by start- ups (table C) and technology (Table D). Freedom and boldness together explain over 74 percent of the variation in the innovation index (equations 5B, 6B, and 7B), over 50 percent of the variation in the start-up index (equations 5C, 6C, and 7C), and over 39 percent of the variation in the technology index (equations 5D, 6D, and 7D).

The least important channel is the transfer of technology (Table E). Here, f reedom ends up being an insignificant variable, and boldness is found to even have a negative effect on technology transfer. The former implies that the entrepreneurial friendly environment of freedom is unimportant with re- gard to the ease a country adopts already existing technology from other coun- tries. The latter implies that boldness positive effect on overall economic creativity comes in spite of its negative effect on the transfer of technology from other countries. In other words, it indicates that boldness overcomes the negative influ- ence it has here by its positive influence elsewhere. Even more importantly, the negative effect of boldness on the technology transfer index suggests that the entrepreneurial spirit, as embodied in the form of boldness, has little taste for the implementing and copying of existing technologies, but is much more attuned to adopting and tinkering with something completely new.

Conclusion

Sustained increases in output per capita that improve the material lot of mankind come about through the activity of innovative entrepreneurs. Cre- ative activity can be encouraged or discouraged. Creative activity will be en- couraged to the extent a society creates conditions that make the pursuit of innovative activity in the self-interest of its central participants - human be- ings. It will be discouraged to the extent it does not.

Looking at a cross-section of countries using regression analysis, this ar- ticle finds that freer societies, and societies that place a higher value on bold- ness, tend to have higher overall levels of economic creativity. This is just as one might expect. In order to engage in creative activity people must, first, externally be given the opportunity and, second, internally be endowed with the willingness to overcome obstacles and seize the opportunity. Freedom gives people the opportunity to engage in creative activity. It is generally associated with property rights that allow them to capture the fruits of their labor. Boldness gives people the necessary courage to undertake risky innovative ventures.

The policy implications forthcoming from the results are clear. In order to promote economic creativity, societies need to cultivate freedom and social- ize individuals to act boldly in business undertakings.

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