Entrepreneurial Activity Are Closely Linked

Figure 8.2 presents a simple framework for the decision of (potential) entrepreneurs to start or expand a business or business project and the elements of the “entrepreneurial ecosystem” needed to support such efforts. These elements are discussed in greater detail by Cusolito and Maloney (2018) in Productivity Revisited, but they remain important at the local level.

Like any investor, an entrepreneur is fundamentally placing a bet, comparing an entrepreneurial project (that is, starting or growing a business) with an expected rate of return and risks against other alternatives, such as “safe” salaried work for an individual entrepreneur or simply another project for an existing firm. As Kerr, Nanda, and Rhodes-Kropf (2014), among others, argue, entrepreneurship is a form of experimentation in which entrepreneurs learn about the viability of a product or process in the local context. Could Kenya grow coffee in the highlands? Could Guangzhou become a manufacturing hub? Could Peru export asparagus? Could Penang become a global center for high-tech firms? Such experimentation entails both a process of managing risk and a process of learning—about the investment, about running a firm, and about evaluating and managing risk (see Maloney and Zambrano forthcoming).

FIGURE 8.2 The Determinants of Entrepreneurial Experimentation and Productive Entrepreneurial Activity Are Closely Linked

Opportunities

Global arrival of new ideas

Gap with frontier regions

Strengthening the Enabling Environment for Entrepreneurship

Potential returns to entrepreneurship • Enabling business environment • Availability of complementary factors and markets • Skilled labor • Capabilities of other firms • Fiscal incentives Cost of experimentation • Barriers to entry and weak institutions • Access to finance and risk management • Cost of failed experimentation and exit

• Bankruptcy • Social stigma • Ease of return to salaried work Information and the local innovation system

Source: Adapted from Cusolito and Maloney 2018.

Promoting the Capabilities of Entrepreneurs

Entrepreneur’s personality traits and regional culture • Risk attitude and patience • Entrepreneurial orientation • Ability to identify opportunities Human capital • Basic human capital • Management capabilities • Technological capabilities

Two sets of factors affect this experimentation: factors in the enabling environment (shown in the center section of figure 8.2), and factors pertaining to entrepreneurs per se—that is, human capital, very broadly construed (shown in the right-hand section of figure 8.2). Without a supportive enabling environment, capable entrepreneurs, either from the region or from outside, will not enter the market or thrive if they do. This is a critical consideration when contemplating fiscal incentives for firms to relocate. Conversely, even in a pristine experimental environment, dynamism will be limited without capable entrepreneurs.

This complementarity immediately highlights the complexity of appraising LED programs. In theory, any line in figure 8.2 can be considered an individual intervention, in the same way as building a road—although the indirect effects are often the focus more than the direct effects. The benefits of streamlining firm registration requirements can be measured in terms of the value of days saved, but beyond that, policy makers generally hope that new firms and industries will result as indirect effects, with potentially positive valuation effects from knowledge spillovers (see box 8.1). Raising the skills of a worker improves productivity—in ways that are measurable by standard individual (Mincerian) wage regressions, but the attraction of higher-tech local firms and global value chains (GVCs) is the ultimate goal, as well as the well-documented externalities associated with that added value. Managerial extension programs have been evaluated and shown to improve the productivity of firms, but externalities are important, too. A sizable literature, particularly focused on the Asian miracles, traces how firms, regions, and nations learning to use technology is a key to industrialization.

What differs from the appraisal of a transport project is that for LED investments, the complementarities are center stage. Policy makers may actually build a road purely to lower the costs of transport. This tends to be less the case for LED investments, where the analysis is often presented in the context of systems. Doing Business indicators take this systemic approach, serving as a global diagnosis of the business climate. Entrepreneurial ecosystems and national innovation systems are treated precisely as systems of interacting actors and institutions. Efforts to attract links of a GVC will approach infrastructure, training, regulation, and fiscal incentives as a systemwide package.

Hence, the discussion that follows highlights indirect and valuation effects that may be important to consider. However, given the systemic nature of LED investments, the discussion is not as didactic in employing the appraisal approach as in the previous chapters. This said, throughout the chapter, the discussion examines issues to keep in mind in designing and appraising LED-type interventions. The sections that follow discuss the complementary conditions needed to promote entrepreneurship, including the enabling environment at the subnational level and the local entrepreneurial capabilities.