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Concepts Behind a Global Innovation Index

November 2011

Introduction

This paper proposes that an index can be developed that applies standard measures and a rating against which the policies and laws of countries and regions can be assessed about the extent to which they enable entrepreneurship to happen or suppress entrepreneurship or make it more difficult.

Called the Global Innovation Index, this is in development and is intended as an indicator and tool for jurisdictions to review policies with the intent of encouraging entrepreneurship.

Since the late 1930s, economists have subscribed to a general thesis that economic development occurs through innovation and that innovation is the result of business activity by society's entrepreneurs. This thesis has become an important part of economists' and governments' understanding of economic development. The consequence is that if societies want economic development, they need to encourage their entrepreneurs.

Normally, entrepreneurs are thought of as being relatively rare individuals who, against all odds, create large business enterprises driving new, often attention-grabbing ways of doing business. This is true. Entrepreneurs often do create large enterprises.

This Index, however, takes the idea of entrepreneurship to its most basic level by asserting that the heartbeat of entrepreneurship in societies resides with self-employed individuals. Entrepreneurship, we assert, is in fact a common and normal attribute shared by all humans and therefore not at all rare.

Entrepreneurial capacity resides in every person. The question is not whether the entrepreneurial spirit exists, but whether a society's institutional structures and rules allow entrepreneurship to flourish. Entrepreneurship most commonly happens, we say, when an individual is self-employed.

The Index under development applies ratings against government policies as to whether they encourage or diminish the capacity to be self-employed and hence entrepreneurial.

This paper discusses the key concepts behind the Index.

The conceptual framework of entrepreneurship applied in this Index

The Index enables measures to be applied to government regulations, policies and practices assessing how those impact on individuals' capacities to find and express their entrepreneurial desires. The Index is specific looking at the details of government regulations, policies and practices. In this way the Index becomes a tool. It can measure the impact of government on entrepreneurship and identify specific changes to government regulations, policies and practices that can enhance and enable entrepreneurship or suppress it.

The Index doesn't nor does it attempt to measure other factors that impact on the entrepreneurial expression of individuals in societies. For example the Index does not attempt to measure cultural factors. That is, the culture of any given society heavily impacts on the willingness of individuals to be entrepreneurial. The assessment of this is beyond the intent and reach of this Index.

Instead by focusing on government laws and regulations the Index can, in a reasonably objective manner, create comparative ratings and assessments.

The Index focuses on two primary aspects of government laws and regulations in how they impact on the individual entrepreneurship capacity of self-employed people or people who desire to be self-employed. These are (a) the extent to which individuals are allowed to be self-employed as opposed to being forced to be employees and (b) the extent to which laws and practices around commercial contract transactions, enable self-employed individuals to have measures of equal rights under contract, as against large businesses and government.

The rationale behind each of these measures is explained below.

The conceptual structure of 'business' applied in this Index and its relationship to entrepreneurship, innovation and economic development

In a broad sense the idea of an individual being an 'entrepreneur' is tied to the idea of 'business'. An entrepreneur is someone who takes an idea, concept or invention and through business activity takes that 'thing' into a market. If an invention for example is not translated into a product that people buy and use it has not been transformed into an innovation. It is business activity that does the transformation. It is entrepreneurs that guide and give direction to the business activity.

To understand an entrepreneur and innovation it's helpful to have a structural understanding of what is a business. This index applies a three-step process to understanding that.

First, the Index starts with the basic idea that an individual can be a business, that is a 'business of one.' This is the self-employed individual.

The second phase is where the individual employs or engages other individuals to help them in their business but the business essentially remains the product of the originating individual.

The third stage is where the business takes on a size where the management of it is larger than what the originating individual can handle. The business by necessity becomes a management system that is bigger than the capacities and personalities of the originating individual, even if that individual retains a heavy influence.

Within public policy settings the focus on entrepreneurship and innovation probably and traditionally concentrates on the third stage. This Index however is interested in the first two stages. Stage two is probably easily recognised as 'small business' and stage one tagged as self-employment, independent contracting, consulting, micro-business and many other similar and related terms.

The assumption underpinning this Index is that entrepreneurship and innovation will always and most commonly be born through stages one and two. Stage three is where entrepreneurship and innovation is developed, consolidated and enhanced and yes, can also be reborn---although we contend with more difficulty than in stages one and two.

Our concentration on stages one and two is because the act of being self-employed, even if this involves employing others, of its essence requires the individual to be entrepreneurial. We assert this on the following basis. The self-employed person is entirely a risk taker. They are not protected from the market (as are employees). Their income from their business is exclusively dependent on the whims and fancies of the market/s within which they operate, that is their clients. If they don't satisfy the needs of their clients their income will quickly diminish or stop. They will then cease to be a business because a business does not exist without income. It follows that the consequence of being self-employed demands an obsessive client focus. It demands being entrepreneurial. We contend that the behavioural essence of entrepreneurship is this client focus.

It is this profound characteristic of self-employed people that warrants attention and to which this Index looks. There is global significance, we believe for economic growth potential in all economies, because of the sheer scale of entrepreneurship that can be brought to economies by self-employed people.

Self-employment in all societies is significant and large in numbers. Research indicates for example that in the major developed economies (non-agricultural) self-employment falls into a band of between 15 to 25 per cent of workforces. That is, it can be argued, that up to a quarter of any given community's workforce is potentially behaving within an entrepreneurial framework. If this is accepted, even partly and with qualifications, it follows that encouragement of self-employment should aid economic development and should be important as a government policy objective. It's on this basis and this assumption that this Index operates.

Measurement One: Why the difference between employment and self-employment is an entrepreneurial indicator

The first major theme the Index studies is the extent to which laws, rules and regulations make it difficult or prevent individuals from becoming self-employed. If it is complex to become or remain self-employed the realisation of entrepreneurial capacity in a society is constrained. The reasons behind this contention are as follows.

Work in societies is mostly structured and organised through employment. Employment is a highly specific legal and managerial status. In both its legalities and managerial application employment involves a 'boss', an employer, organising employees to perform functions at the employer's direction. In businesses that operate using employment, and that is most particularly with large businesses, entrepreneurial activity is restricted by design to the activities of the employer. The entrepreneur in the business is the employer. The employee's primary function is to be an enabler of the entrepreneurial employers wishes, not to be entrepreneurs themselves. This does not mean that employees cannot be entrepreneurs in some way but it's only possible if the employer approves. Any discretion the employee may be able to exercise to be entrepreneurial is only allowable within the parameters set by the employer.

With self-employment it's completely different. Self-employment is an escape from being employed. Self-employment by its nature forces the individual into risk taking. There is no income security umbrella of the firm because they are the firm. They are subject to the vagaries of the market/s within which they operate. To not innovate as a self-employed person is to cause your business to decline and ultimately to put yourself out of business.

But the entrepreneurial activities of the self-employed person are mostly small and unspectacular, and in some ways 'ordinary'. Quite often it is said that a small business person can be running a business but not be entrepreneurial. This Index does not accept that proposition. Rather the Index asserts that the fact of being self-employed is to be entrepreneurial. This can be demonstrated by an example.

Take a basic business, say someone who runs a street fruit-selling stall in a financial district in a major city. The potential client base is drawn from the thousands of office staff who walk past the stall daily and who may buy an apple for lunch or a small bag of fruit at most. If the person operating the stall is an employee of the stall owner their income will most likely be set on a fixed hourly or weekly basis. Their income is not tied to the financial success or otherwise of the stall. The employee's behaviour is dictated by the price signals they receive, namely a set wage. Consequently it's more likely that they will mostly stand by the stall waiting for customers to approach, hand over the fruit and take the money. They may have a 'personality', be engaging with customers and do a good job. But their price signal motivations won't be essentially entrepreneurial.

Take the owner of the fruit stall on the other hand, a self-employed person. Their income is entirely dependent on the volume of and price of fruit they sell less the costs they have in running the stall. To the casual observer there may be little apparent difference in being served by the owner as opposed to the employee. But the owner, has no choice but to be constantly entrepreneurial and in thousands of small ways. This includes ensuring the fruit on offer is of high quality, observing what people buy and don't buy, changing the mixture of produce accordingly, creating specials based on fruit in season, paying attention to the positioning of the stall on the street so it attracts the eye of passing potential customers and so on. The list of questions and issues the business owner must deal with are seemingly endless and require constant consideration and fine-tuning. One issue addressed one way one day may need to be addressed differently the following day.

To some, these activities of the fruit stall owner may not seem to be entrepreneurial at all and rather just the normal things that are done in running a business. But this is a misconceived view. The essence of being a business, requires and demands a constant switching of the brain into an entrepreneurial mode focused on clients. The 'fear' of the market (clients) cause the human entrepreneurial DNA to kick in. If our fruit stall owner allows the quality of the fruit to drop, customers will stop buying. The 'art' of buying suitable fruit is an entrepreneurial exercise. And it's through this process that innovation may happen. Innovation is not guaranteed but entrepreneurship activity is.

This is how economic development through entrepreneurship and innovation mostly happens. It's the process of creative destruction that happens in markets. One person does something better and another person responds by doing something better still. And it mostly happens at the 'small end of town.' It's the millions of little things happening all day, every day that few people even recognise, and even fewer would think are of interest or importance. But the cumulative effective of millions of people doing this in millions of different ways is the big driver of economic development. It is vastly more significant in its impact because of the cumulative effect as compared to the small numbers of big innovations that attract big attention.

Can employees innovate? Yes. But as mentioned only within the authority granted to them by their employer. The fruit stall owner may have an employee that is paid a bonus based on sales turnover. This should cause the employee to be more client (entrepreneurial) focused. This is smart management on the part of the fruit stall owner, but it's still the inducing of entrepreneurial behaviour within the authority limits granted by the employer, who is self-employed.

This discussion above sets the scene within which the first measure of entrepreneurship potential is considered in this Index. The question is, to what extent do government laws, regulations, policies and practices enable individuals to be self-employed or restrict and even stop self-employment. This can be measured.

Measurement Two: The commercial contract and its connection to entrepreneurship

The second major Index measurement looks at the extent to which commercial contract laws and the application of those laws, enable self-employed people to have effective control of the commercial contracts upon which they rely for their business activity. If self-employed people have little or no effective control of the contracts into which they enter, their capacity to conduct business and be entrepreneurial is constrained or even neutered. They may in fact be forced out of business.

The reasons for this are related to the management of commercial risk. The extent to which risk can be managed by self-employed people, heavily impacts on their capacity to be entrepreneurial.

There are two primary ways of measuring this as it impacts on self-employed people. The first is to look at the structure of the commercial contract as opposed to the content of it. The second is to consider the ability to effect quick and cheap dispute resolution under contract. Both of these items impact in a very real way on the ability and willingness of self-employed people to engage in business.

The structure of a commercial contract is at law quite clear. Conceptually for a commercial contract to actually be accepted as a contract it must have certain features. One of those features is that each of the parties to the contract has equal rights to 'control' the terms of the contract. For example, if a contract has a term that enables one party to change the terms of the contract without reference or approval from the other party the 'contract' is not a true contract. Many lawyers dispute this. They say that a commercial contract is exclusively a product of 'offer and acceptance'. This Index rejects that proposition on conceptual and practical grounds.

When two large organizations enter a contract, say a government department and a large firm, the two organizations will ordinarily spend considerable time and money on lawyers assessing, debating, negotiating and redrafting the contract. When the contract is finally signed it can be safely said that the trigger of 'offer and acceptance' between the two parties occurred with the full knowledge and consent of the two parties. However take a different scenario, that involving a large government department and a self-employed individual.

If the government department has a standard form contract that they use when engaging, say information technology specialists, and that contract enables the department to change the scope of the work without approval from an IT consultant, is it a genuine contract, even if a consultant accepts the contract?

This is what we refer to as the 'structure' of the commercial contract as opposed to the content. And there are examples where laws have been created to ensure that this commercial contract structure is required. Most examples occur under consumer protection law usually under the tag of 'fair contract' law.

The second area of measurement is the capacity of self-employed people to enforce or have contract disputes resolved quickly and cheaply. If an individual cannot enforce a contract or have a dispute resolved quickly and cheaply this increases the commercial risk under contract. Unfortunately it is all too common that for a self-employed person to fix a contract problem the legal expense and time required far outweighs the value of the contract work itself. Where this occurs it makes more commercial sense to suffer a loss. Thus commercial risk is increased because although the law may allow for contracts to be enforced, the practice of the law makes this too expensive to do so.

This has been recognised particularly under consumer law. Consumer protection laws frequently provide comparatively cheap and quick consumer dispute resolution processes. This is done to 'protect consumers' but the real broader benefit is to increase the level of trust that consumers have in their purchasing decisions. The more trust consumers feel toward the commercial transactions they undertake the more likely they are to undertake those transactions.

So to it is with self-employed people who are in fact in a very consumer like position when engaging in business. Self-employed people have limited practical capacity to enforce contracts or affect dispute resolution if the processes of the law are drawn out and/or expensive. Like consumers, people are less inclined to be self-employed, or if self-employed become limited in their preparedness to take (sensible and considered) commercial risks, to be entrepreneurial and to innovate. The consequence is a diminution of the economic development potential that resides within a community through self-employed people.

Summary

Currently government laws and regulation affecting the issues mentioned in this paper are not tracked from the perspective of their impact on self-employed people. Yet the impact is direct and profound on the capacity of self-employed people to exist as entrepreneurial players in societies. The Index will create measures for assessing this.



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