An important determinant of entrepreneurial performance is the effort that entrepreneurs devote to their ventures. Effort is needed as a productive input to help ventures survive and grow. Because expenditure of effort is typically costly, entrepreneurs must decide carefully how much effort to supply. Entrepreneurs must also decide whether to expend their effort on productive, socially unproductive – or even destructive – activities.

Baumol (1990, 1993a) famously distinguished between productive and unproductive entrepreneurship. Baumol's central premise is that although the entrepreneurial spirit is fairly uniformly distributed across different places and periods of time, institutions and cultural norms – which describe the ‘rules of the game’ – can either encourage entrepreneurs to engage in socially productive activities or give them incentives to engage in socially unproductive or destructive behaviour by generating profits at the expense of others. Baumol (1990, 1993a) cites several examples of unproductive and destructive entrepreneurship from the ancient world, early China and medieval Europe. He observes that the materially unproductive activity of abstract puzzle solving attracted greater social status in medieval China than wealth creation did. In the same period, enterprising but destructive Europeans sought booty through wars, banditry and piracy.

The allocation of effort to manipulate the economic environment rather than to engage in trade and the production of wealth goes by the name of ‘rent seeking’. The first section of this chapter explains how modern-day entrepreneurs also respond to incentives to devote effort to rent-seeking activities, and analyses the economic implications of this behaviour.