12.3 How Differences in Political, Economic, and Legal Systems Shape Economic Development

Countries around the globe differ drastically in their levels of economic development, which is influenced by the political, economic, and legal systems of a country. To understand the relationship between economic development and the political economy of a country, we need to explore and understand the two main drivers of economic growth: innovation and entrepreneurship.

As underlying factors of economic growth and development, innovation and entrepreneurship form a dynamic environment that enables progress and prosperity. Countries that have adopted innovation and entrepreneurship have experienced enormous economic growth, while those resisting or unable to change have stagnated (Cao, 2018).

Innovation

Innovation is a useful new or improved idea that offers a solution to a problem (Boyles, 2022). It has long been recognized as a catalyst for progress, and these days, with rapid technological advancements, globalization, a constantly changing business environment, and the need to solve emerging problems, innovation is becoming more pronounced than ever. Innovation, whether in the form of creating a new product, service, process, or business model and/or improving existing ones, serves as a driving force for entrepreneurship (AIContentify Team, 2024).

Innovation can be grouped into two categories: sustaining and disruptive.

• Sustaining innovation is a continuous improvement of the product over a long period of time. The purpose of sustaining innovation is to gain more profit, either by entering an existing market or creating a new market (Twin, 2023).
• Disruptive innovation refers to a concept, a process, a product or service, or a business model that creates a new value field (Cote, 2022).

Entrepreneurship

Entrepreneurship is a way of thinking, the ability and capacity to initiate a transformation and a holistic approach to turning innovation into a successful business (Villacci, 2023). Entrepreneurs, therefore, translate ideas into products and services and foster creativity and innovation. The interplay between innovation and entrepreneurship enhances productivity levels across all sectors of the economy. Innovation in processes, business models, technology, and organizational structures increases efficiency. This efficient way of operating translates into increased productivity, greater profitability, and overall economic growth (Jobanputra, 2023).

Therefore, high economic growth and development are experienced in countries that encourage entrepreneurship and foster innovation. In today’s world, countries considered economically developed, such as Switzerland, Singapore, the USA, Germany, Canada, and other developed countries, share similar political economies and legal institutions.

Democratic Political Systems

Entrepreneurship requires freedom, which is possible in a democratic society. Limiting human freedom suppresses human development and, therefore, limits progress. A study done by Farè, Audretsch, and Dejardin (2023) using data from 23 countries between 1972 and 2010 suggests that there is direct link between democracy and entrepreneurship (Fare, 2023). Almost all countries have a constitution which protects and limits individual freedom at the same time, however in a democratic society where people have the freedom of expression and the right to participate in political decision-making process, they can have an impact on those limitations of freedom (Johnson, 2005).

Market Economies

Economic freedom is key to entrepreneurial activity and is achieved through a market economy. In a command economic system, the state owns all enterprises. It controls all economic activities, and individuals are not compensated or recognized for their contributions, leading to a situation where people are less motivated to use their creativity and talent in their work. A market economy offers the rights to private property and freedom of enterprise:

• Rights to private property refers to the official right to ownership of tangible and intangible property that can be used, controlled, and transferred or passed on as an inheritance. The right to own and control one’s property motivates individuals to change, improve, and create – resulting in progress and economic prosperity (Garrett, 2005).
• Freedom of enterprise refers to freedom of economic activities without government intervention or regulations. Free enterprise gives individuals the freedom to start any business or enter a contract in a manner that is most beneficial to them, and they have the freedom to form any type of company or firm wherever they like, providing they have the skills, the means and the entrepreneurial spirit of risk-taking (Banton, 2024).

Strong Legal Institutions

Innovation requires strong property protection laws and legal institutions that can implement those laws. With no protection of intellectual property, it would not be possible for the entrepreneur to fully realize the financial gain of the property that rightfully belongs to them (Goudreault, 2019).

References

AIContentify Team. (2024, June 10). The role of innovation in entrepreneurship. AIContentify. https://aicontentfy.com/en/blog/role-of-innovation-in-entrepreneurship

Banton, C. (2024, May 22). Free enterprise: Definition, how it works, origins, and example. Investopedia. https://www.investopedia.com/terms/f/free_enterprise.asp

Boyles, M. (2022, March 8). Innovation in business: What it is & why it’s important. Harvard Business School Online. https://online.hbs.edu/blog/post/importance-of-innovation-in-business

Cao, J.L. (2018, December). Entrepreneurship, innovation, & economic growth: An empirical study of developed & developing countries. [Master’s Thesis]. University of Ottawa. https://ruor.uottawa.ca/server/api/core/bitstreams/2447da68-5f40-4979-a42d-0e96b6b38266/content

Cote, C. (2022, February 3). Sustaining vs. disruptive innovation: What’s the difference? Harvard Business School Online. https://online.hbs.edu/blog/post/sustaining-vs-disruptive-innovation

Farè, L., Audretsch, D.B. & Dejardin, M. (2023). Does democracy foster entrepreneurship? Small Business Economics, 61: 1461–1495. https://doi.org/10.1007/s11187-023-00737-7

Frieden, (2020, June). The political economy of economic policy. Finance & Development. https://www.imf.org/en/Publications/fandd/issues/2020/06/political-economy-of-economic-policy-jeff-frieden

Garrett, T.A. (2005, April 1). Entrepreneurs thrive in America – Federal, state policies make a difference for those facing risk. Federal Reserve Bank of St. Louis. https://www.stlouisfed.org/publications/bridges/spring-2005/entrepreneurs-thrive-in-americafederal-state-policies-make-a-difference-for-those-facing-risk

Goudreault, D. (2019, August 28). Innovation needs protection. BCF. https://www.bcf.ca/en/thought-leadership/2019/innovation-needs-protection

Jobanputra, K. (2023, July 31). Entrepreneurship: The engine of growth driving our economy. Forbes. https://www.forbes.com/sites/forbesbusinesscouncil/2023/07/31/entrepreneurship-the-engine-of-growth-driving-our-economy/?sh=7cd74c855af9

Johnson, P. (2005, January 30). Entrepreneurship and democracy. Hoover Digest. https://www.hoover.org/research/entrepreneurship-and-democracy

Twin, A. (2023, June 28). Disruptive innovation: Meaning and examples. Investopedia. https://www.investopedia.com/terms/d/disruptive-innovation.asp

Villacci, J. (2023, November 10). What is the definition of entrepreneurship? Babson Thought & Action. https://entrepreneurship.babson.edu/entrepreneurship-definition/

WIPO. (n.d.). What is intellectual property? World Intellectual Property Organization. https://www.wipo.int/about-ip/en/