UNGA FORSKARPRISET 2009
Economic growth and the quantity and quality of entrepreneurship
Kristina Nyström
Department of Transport and Economics The Royal Institute of Technology Drottning Kristinas väg 30 SE-100 44 Stockholm Sweden and The Ratio Institute P.O. Box 3203 SE-103 64 Stockholm Sweden E-mail:
[email protected]
1. Introduction
In recent years, researchers and policy makers has devoted a lot of attention to the role of entrepreneurship for economic growth. Many policymakers believe that improved levels of entrepreneurship are the salvation for economies struggling with declining economic growth rates and employment rates. To what extend does this belief rely on solid empirical evidence on the relationship between entrepreneurship and growth? Is it true that entrepreneurship unambiguously can be claimed to improve economic growth? In fact, previous empirical findings on the relationship between entrepreneurship and growth give an in some aspects scattered picture. A recent review of the empirical evidence by van Praag and Versloot (2007), conclude that entrepreneurs are important to employment growth and productivity. On the other hand, Henrekson and Stenkula (2007) and Nyström (2008), conclude that the empirical evidence regarding, in particular, the role of entrepreneurship for employment growth is unclear or even contradictory. For the firm level Shane (2009) even concludes that ”the typical start-‐up is not innovative, creates few jobs and generates little wealth” (Shane, p. 141). Based on the empirical evidence Shane (2009) argues that policy aimed at stimulating the “quantity” of entrepreneurship can be questioned. An increased focus on the “quality” of new firm start-‐ups is called for. In particular, a small number of high growth firms (gazelles) has been identified as “high quality entrepreneurship” due to their potential to generate jobs (see e.g. Henrekson and Johansson, 2009). Does this imply that the lions part of all new firms started around the world are of no importance to the economy? In this essay I will argue that even if a small amount of high quality entrepreneurs seem to be of particular importance for generating employment growth, the importance of a certain quantity of entrepreneurs should not be neglected. The entrepreneurial firms are crucial for the dynamic selection mechanism in the economy. Hence, they are influential even though most of them are not very successful, innovative and very few turn out to be gazelles. In this essay, I will firstly briefly review the empirical evidence on the role of entrepreneurship in a dynamic perspective. The review will focus on three aspects of economic growth, the effect on productivity, employment, and aggregate economic growth. 1 What is the empirical evidence and what are the policy implications? Such a review will help us to get a deeper understanding of the, in some aspects, inconclusive empirical evidence on the
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A more detailed review can be found in Nyström (2008)
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relationship between entrepreneurship and economic growth. Furthermore, it will help us to identify some important areas for future research in the entrepreneurship field.
2. Empirical evidence on the relationship between entrepreneurship and growth ENTREPRENEURSHIP AND PRODUCTIVITY The empirical literature that studies the role of entrepreneurship for productivity distinguishes between the productivity effect of internal re-‐allocation and external re-‐ allocation. Internal re-‐allocation refers to the productivity contribution from innovation or re-‐organization in existing firms. External re-‐allocation refer to contribution to productivity induced by the selection mechanisms associated with entry of more productive firms, exit of less productive firms and productivity gains due to decreases or increases of incumbent firms market shares. Several studies find that market selection mechanism contributes to a majority of the productivity growth. (See for example the studies by Disney et al., 2003; Hedén, 2005; Baldwin and Gu, 2006) and Foster et al., 2006.) Other researchers are less convinced about the positive relationship between productivity and external re-allocation. Scarpetta et al. (2002) find that a large share of the increase in labor productivity is due to internal re-allocation. Andersson (2006) shows that for the period 1997–2003 90 percent of labor productivity growth in Sweden was due to internal re-allocation. However, what these studies have in common is that they study a quite short period (only five years). Based on an extensive overview of the empirical results regarding importance of firm dynamics for productivity growth Ahn (2001) conclude that in the long-run new firms that survive are important to productivity growth. However, in the short run the effect of new firm formation on productivity may be even be negative. Furthermore, firm dynamics seem to be more important for productivity growth in service sectors compared to manufacturing sectors. In summary, there is convincing evidence of a long-run positive effect of new firm formation (and exit) on productivity growth.
ENTREPRENEURSHIP AND EMPLOYMENT GROWTH Quite a few authors have tried so summarize the empirical results on the relationship between entrepreneurship and employment growth. (See for example van Praag and Versloot, 2007, Henrekson and Stenkula, 2007 and Nyström, 2008 for recent summaries). As previously mentioned their conclusions are sometimes contradictory. How should we interpret these empirical results? It has been argued that a dynamic
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perspective needs to be applied in order to reconcile the full effects of entrepreneurship on employment growth. Fritsch and Mueller (2004) argue that the employment effects of new firm formation occur in three steps. Firstly, a direct employment effect, which is, associated a new firm entering the market and employing people. This effect induces a positive employment effect. Secondly, the selection mechanisms set in, which might cause a negative employment effect. The selection mechanism occurs due to that increased competition may force some of the incumbent firms to close down. In addition, we know that most of the new firms do not survive. Finally, and perhaps the most important according to Fritsch and Mueller (2004) indirect supply-‐side effects sets in. The indirect effects refers to that we assume that these new firms influence already incumbent firms. If a new firm brings an innovation to the market it may cause improvements in production in other firms or might stimulate further innovations, which further increases efficiency. Furthermore, resources will be re-‐allocated to other and expanding markets. However, this increased efficiency and increased competition does not necessarily imply an increase in employment. Nevertheless, Fritsch and Mueller (2004) find that the indirect employment effects of new firm formation might be positive and actually be more important than the direct employment effects. The dynamic process described above is a long-‐term process and it may take up to ten years until the positive employment effect can be observed (Fritsch, 2008). How the dynamics related to these indirect supply side effects occurs more explicitly is something that is yet quite vague. How does this re-‐allocation of, for example, labor actually take place? This is clearly a process future research need to study closer. Recently, matched firm-‐employees datasets has become available in some countries. These databases makes it possible to examine the re-‐allocation processes by means of following the employment history of individuals employed in new expanding, contracting and exiting firms. Another important finding in the empirical literature on the relationship between entrepreneurship and employment growth is that the employment effect varies substantially across time and space. Why do we find a negative effect of entrepreneurship on employment growth in certain industries and regions? Two main hypotheses have been put forward. One hypothesis is the imperfect selection mechanism hypothesis, which implies that for some reason firms with low productivity remain on the market while high productivity firm exit. The fastest growing industries in terms of employment growth is, for example, characterized by both high entry and exit rates (Nyström , 2009). Hence, market turbulence is important for the selection mechanism to work properly. In some cases government interventions is one explanation to why these selection mechanisms do not seem to work properly (see e.g.
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Fritsch and Schroeter, 2009). A second explanation put forward is the overcrowding hypothesis which imply that if a particular market has reached certain threshold additional entry has no or even negative effect employment effects. Why do entrepreneur still try to enter such industries? If barriers to entry are low and entrepreneurs are overconfident regarding their chances of success overcrowding may be a plausible hypothesis. Furthermore, public subsidies aimed at stimulating entrepreneurship might cause such overcrowding (Fritsch and Schroeter, 2009). Hence, the policy lesson that can be made is that public policy that interfere with market selections mechanisms might not be beneficial for the economy in the long run perspective.
ENTREPRENEURSHIP AND AGGREGATE ECONOMIC GROWTH Due to the lack of comparable cross-‐country data on entrepreneurship, there are few studies on the relationship between entrepreneurship and economic performance at the country level available (Carree and Thurik, 2003). Most studies available are based on self-‐employment as a measure of entrepreneurship. More recently, data from the Global Entrepreneurship Monitor (GEM) has been used. There is clearly a need of comparable cross-‐country data on, in particular, new firm formation. Such data would make it possible for researchers to learn more about how different institutional settings may influence the quantity and quality of entrepreneurship. The empirical evidence on the relationship between entrepreneurship and aggregate economic growth so far provide somewhat ambiguous results. Nevertheless, most of the studies show results that imply that entrepreneurship have positive effects on aggregate economic growth. Studies that find a positive relationship between entrepreneurship and economic growth are, for example, Klapper et al. (2007) and Acs et al. (2004). Again, these studies show that there seem to be a substantial time lag before the positive effect can be observed (see e.g. Reynolds et al., 2004 and Carree, and Thurik, 2008). Carree et al. (2002) raise the question whether there is an ‘equilibrium’ level with respect to the quantity of entrepreneurship in a country. The equilibrium level of entrepreneurship is defined with regard to the deployment stage of each country. In their empirical study, they find that entrepreneurship below as well as above the ‘equilibrium’ level have negative consequences for aggregate economic growth. Van Stel et al. (2005) find that in countries, which can be regarded as relatively rich, there is a positive relationship between entrepreneurship and economic growth, while it is was negative in less developed countries. An extended version of Carree (2002) again finds that entrepreneurship levels below the equilibrium level have a negative effect on
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growth. However, in this study they do not find any negative effect of deviations above the equilibrium level of entrepreneurship (Carree et al. 2007). In summary, the quantity of entrepreneurship increase economic growth at least up to a certain level. Some studies try to distinguish between qualitative aspects of different types of entrepreneurship i.e assuming that they have different potential for creating economic growth. Wong et al. (2005) define high growth potential entrepreneurs using the following characteristics: who have employment growth potential, have effect on the market, have a global customer base and use new technology. They find that high growth potential entrepreneurship does have a positive effect on economic growth. Contrary to what might be expected Reynolds et al. (2004) find that the relationship between opportunity-‐based entrepreneurship and growth seems to decrease over time while the relationship between necessity-‐based1 entrepreneurship and growth tends to increase over time.
3. Conclusions and policy implications
This essay has briefly reviewed the empirical evidence on the relationship between entrepreneurship and economic growth in terms of productivity, employment growth and aggregate economic growth. Most empirical evidence show that entrepreneurship has an important role for generating economic growth in a long run perspective. However, the employment effects of entrepreneurship may vary significantly across time and space. Hence, entrepreneurship seems to be a necessary but not sufficient condition for economic growth. How should then policy makers respond to this evidence? As previously mentioned policy makers have started to show an increasing interest in trying to identify “high quality entrepreneurs”. Shane, (2009) argue that government officials will have a low probability of “picking the winners”. Instead, he proposes that they should avoid supporting firms with low probability of generating jobs and decrease the incentives of starting such jobs, i.e. an “avoiding the “losers” strategy. Identifying, “losers” is equally or even more difficult than to pick winners. In fact, we can expect it to be much more difficult. There are quite a lot of empirical research on survivors and successful entrepreneurs to lean on. The research area devoted to firm exit is much less explored. Strategies aimed at either “picking winners” and “avoiding losers” will be difficult and dangerous strategies to implement. Some additional examples will illustrate this point. Gazelles are often identified as a group of high quality entrepreneurs. Contrary to what
1 Necessity-based entrepreneurship refers to entrepreneurship initiated by lack of other employment opportunities such as for example unemployment.
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most of us expect the high technology firms are not overrepresented among gazelles. Instead young, small and firms in the service sector are overrepresented among gazelles (Henrekson and Johansson, 2009). Only very few gazelles manage to show continued growth and the strategies implemented that results in a gazelle are constantly changing (Parker, Storey and Witteloostuijn, 2005). With access to the blunt tools available to identify projects that should be avoided, most of us would hesitate to invest in a project initialized by an, at the time, recently divorced, unemployed, single-mother, who wants to publish a children’s book with a ten year old magician as the main character. In fact, many publishers turned the manuscript down, probably based on their strategies to avoid “investing in losers”. They almost certainly regret this decision now since J. K Rowling’s book project about Harry Potter turned out to be a tremendous success story.1 In fact, a government institution (The Scottish Arts council) managed to identify this project as a “winner” since they provided her with a grant in order for her to finish the first book on Harry Potter. In summary we can find examples of situations were government officials manage to “pick winners” among losers, as well as they would sometimes “pick losers” out of winners. The important point is that it would be dangerous to expect government officials to have better possibilities than customers, venture capitalist or business angels to judge which entrepreneurial projects that are viable. What is then the role of public policy? Baumol (1990) argues strongly for his hypothesis that the total amount of entrepreneurs in a society may vary but that the allocation between productive, unproductive an even destructive entrepreneurship vary much more. The institutional environment, i.e “rules of the game“, ultimately determine if entrepreneurs will engage in productive or unproductive activities. Hence the challenge for policy makers is to provide a good institutional environment which re-‐allocates entrepreneurs towards productive entrepreneurship, instead of unproductive or destructive entrepreneurship.2 In the search for qualitative entrepreneurship, institutions and the quantity of entrepreneurship are not unimportant. Not all teams playing in the soccer World Cup have the same odds to become champions. Most years, countries like Brazil. Argentina, France and Italy are the teams playing the finals. In the short run, it would probably be more efficient (but extremely boring) to just let these four teams play the World Cup. However, in the end other teams would not make any efforts to create a good team. Such a strategy will have devastating effects on the quality of soccer games played all 1
In 2008 J.K. Rowling was the only billionaire author on Forbes’ list among the world richest (Thompson,
2008). 2
See Boettke and Coyne, (2009) for a recent review of the role of institutions for entrepreneurial activities.
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over the world. Instead, we set up rules that give all countries the opportunity to qualify for the World Cup. When the whistle blows, the rules of the game are equal to all players. Under such circumstances, the rules of the game will create incentives to improvement in all teams. Occasionally surprises happen and even the Swedish soccer team might end up playing the finals.
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