In Global Entrepreneurship, One Small Initiative Can Make One Huge Difference

Thursday, November 1, 2007

Entrepreneurs love to grumble about the roadblocks and delays created by bureaucrats. Government officials, they say, are slow, bumbling and concerned only about hewing to their rules and clocking out at 4:55 p.m.

But in a study of global entrepreneurship, Raffi Amit and Mauro Guillen, both Wharton management professors, have found that a simple, if smart, bureaucratic initiative mattered critically in determining a country’s level of entrepreneurship. Specifically, countries that created electronic business registries saw far higher levels of new business formation than those with traditional paper ones. Even the announcement that a country planned to establish an online log led to a jump in business registrations.

How could such a small change make such a big difference? “It represents the removal of red tape,” says Amit, an expert in entrepreneurship and academic director of the Goergen Entrepreneurial Management Program. “Red tape is the big barrier to entrepreneurial activity. It takes three months in some places to register a new company vs. doing it in 10 minutes on a website. An electronic registry removes all the intermediaries and the need to pay bribes.”

In other words, bureaucrats are obstructionist — at least until they start operating a server.

In cooperation with two staffers from the World Bank — Leora Klapper and Juan Manuel Quesada — Amit and Guillen gathered data from 84 countries in every region of the world. Their goal was to gauge levels of entrepreneurship and, as much as possible, explain why developed countries exhibit much higher levels of entrepreneurship than developing ones. Their research is summarized in a paper titled, “Entrepreneurship and Firm Foundation Across Countries.”

Economists, starting with the famed father of entrepreneurial studies, Joseph Schumpeter, have long understood that entrepreneurs contribute a great deal to economic vitality. John Maynard Keynes even chalked up economic surges to their “animal spirits.” But explaining why some countries produce so many more of these critical economic actors than others has proved tougher. Solving that riddle could be a key to jumpstarting growth in the developing world.

“One of the reasons why people at the World Bank are interested in this is that they believe one of the most effective ways to reduce poverty is to encourage entrepreneurship,” says Guillen, who is director of the Joseph H. Lauder Institute for Management & International Studies. “The rich countries in the world, for two or three decades after World War II, made many attempts to help development. Their programs were mainly about investing in big infrastructure projects and theymostly failed.” The hope is that fostering entrepreneurship will succeed where investing in fish farms didn’t.

Differences in the rates of entrepreneurship around the world are stark. At one extreme, Asia produces only 1.6 businesses per thousand people, while at the other, industrialized nations create 64.2 per thousand, Amit, Guillen and their co-authors say. On top of that, new businesses continue to enter the economy at a faster rate in developed countries than in developing ones. Industrialized countries see average entry rates of more than 10% a year, while developing onessee an average of about 7% to 8.5%.

More Than Public Databases

As the scholars dug deeper, they found that the bureaucratic hurdles business people love to hate explained these regional differences. “The fewer procedures required to start a business, the greater the number of registered firms — and the higher the entry rate,” they write. “There is also a significant relationship between the cost of starting a business (as a percentage of gross national income) and business density and the entry rate.” Where businesses are costly to launch — in both time and money — you see fewer of them. An electronic registry helps to cure these sorts of headaches.

In many countries, registries serve as more than just public databases. They become the nexus of policies relating to entrepreneurship. “The business registry is at the frontline in the effort to assure that businesses operate transparently and within the bounds of the law,” the scholars write. “It acts as a guarantor of a solid, legal business environment by fostering transparency.” Its information can also help to shape economic policy by giving policymakers scads of data about employment and the strengths and weaknesses of an economy’s sectors. And of course, it better enables governments to levy taxes on businesses.

Improvements brought by electronic registries show themselves quickly. Guatemala, Sri Lanka and Jordan each saw more than 20% increases in their number of new business registrations within just a few years of implementing their electronic systems. “In Jordan and Guatemala, the growth of new firms begins before the implementation of the reform, usually about four years earlier when the modernization plan was announced and initiated,” the scholars write.

A criticism of this study might be that electronic registries don’t actually capture levels of entrepreneurship but merely the movement of businesses from the informal sector — sometimes referred to as the underground economy — to the formal one. (Once it becomes easy to register, informal firms decide to do so.) Amit and Guillen argue that this sort of nitpick misses the point. If a government manages to encourage existing firms to register by cutting red tape, then it has still improved its entrepreneurial ecosystem. And chances are, a friendlier environment will lead to the formation of more companies.

While the study devotes much attention to business registries, it examines other drivers and obstacles to entrepreneurship, too.

Not surprisingly, the authors find that corruption saps business formation just as surely as red tape does. In countries with corrupt governments, bribery becomes a hidden tax on entrepreneurship. “In corrupt countries, everybody in government is on the take,” Amit says. “If somebody doesn’t have the resources to provide for that, he can’t move forward with his business.”

Political turmoil, often accompanied by corruption, plays much the same role. Amit, Guillen and their co-authors use the example of Peru, which has ridden a political rollercoaster since the late 1990s. “What we see is that firm registrations are incredibly sensitive to swings in the political cycle,” Guillen notes. In years of upheaval, like 1999 when then-President Alberto Fujimori tried to overrule the constitution and stand for a third term, the number of business formations sank. But in years of stability, like 2001 when the country elected a new leader, they soared.

“Like several other countries in Latin America, southern Asia and Africa, Peru hasn’t figured out yet what kind of political institutions it wants to have,” he adds. “They’ve had short periods of very open, transparent policies and then suddenly the government gets corrupt. This is reflected in the data. You can see it over a relatively short period and with minimal time lags. It’s reassuring to see that it matters who’s in charge and what kinds of policies they introduce.” Guillen says that Peru’s example confirms the large and growing body of evidence that good governance helps to propel economic growth.

Service vs. Retail Businesses

Although Amit, Guillen and their co-authors found many common themes throughout the countries they studied, they did observe a difference in the sorts of companies that entrepreneurs are starting in the developed and developing worlds. In industrialized countries, service businesses predominated among new firms, but in the developing counties, wholesale and retail trading outfits did.

Continue Reading “In Global Entrepreneurship, One Small Initiative Can Make One Huge Difference

Source: Knowledge@Wharton (link opens in a new window)