The last post about entrepreneurship rates around the world (from World Bank data) raises an obvious question: what is the relationship between the rate of entrepreneurship and the rate of economic growth? Does a higher rate of entrepreneurship mean faster economic growth? This is sort of the holy grail of entrepreneurship research, and I'm not claiming to be original, but we have some cross-country data here so let's see what we come up with.
Our most basic intuition is that, yes, more entrepreneurship should mean more innovation, higher productivity (new, more productive firms ideally push out, or make more productive, existing firms), and thus higher wages and a higher standard of living. The World Bank researchers who put together this dataset have found that entry rates (the rate of new business entry) is positively correlated with a country's per capita income. So perhaps more entrepreneurship does make a country richer. Or, obversely, richer countries have more entrepreneurship because there is greater scope (financial, psychological, societal) for taking the entrepreneurial leap. Of course, the World Bank researchers also show a positive correlation between entry rates and the business density rate: how many firms there are per capita. How do you get a higher business density rate? By creating more (surviving) firms, of course. So we're already on sort of a circular path of logic: to get more entrepreneurship, you need . . . more entrepreneurship. Right. Well, let's see what else we have.
How about growth rates? Whether or not causation runs from income level to entrepreneurship or vice versa, we should also be interested in the rate of growth, which can be more important than the absolute level of income. So first we'll take the 2005 entry rates from the previous map, and compare them against GDP growth rates for 2005:
There doesn't appear to be much of a relationship between current-year entry and current-year growth. So this is interesting but certainly not very revealing. And it makes sense--we would expect entrepreneurship rates to pay economic dividends down the road if new firms are to be allowed time to grow. They will certainly create a lot of jobs at the time of their founding, but their contribution to GDP growth will come if they expand their revenues and payroll and contribute to productivity. Naturally, then, we need to compare 2005 entry rates and subsequent growth.
Not much here either. (Note: I have removed two outliers, Azerbaijan and Armenia because their growth rates are astonishingly high, as in 26 and 14 percent in 2005, reflecting more their starting points than performance.) OK, so maybe we haven't given the new firms in 2005 enough time to grow and contribute. It would be nice to go back to an earlier year and make comparisons between entry and subsequent growth, but we will lose some countries along the way due to data limitations. But let's say causation runs the other way, that growth increases entrepreneurship. We can look backward from 2005 to economic growth in the preceding few years. Perhaps this will tell us something:
Well, sort of, but not really. There are plenty of countries the grow quickly, leading to low entrepreneurship rates; countries that grow slowly yet still have high entry rates. And there are plenty of countries that have high (low) entrepreneurship and low (high) subsequent GDP growth rates. Based on this very quick and very rudimentary glance at entry rates and economic growth, can we say anything of substance regarding the relationship, if any, between entrepreneurship and economic growth?
First, we have to make caveats about data. The data I've just used and the graphs just presented are far from perfect and far from being conclusive about the growth-entrepreneurship link. Entry rates, while more or less consistent within countries, will vary across countries for different reasons--quality or ease of data collection being the biggest. And we might also consider that developing countries will have a larger "informal" sector and so some amount of economic activitiy won't get captured by entry rates or macreconomic statistics. Comparing entrepreneurship across countries, moreover, may not mean anything if the quality or nature of entrepreneurship differs. Richer countries could tend to have more "higher quality" entrepreneurs because they have immediate access to cutting edge technology and know-how. This would lead us down an unsatisfactory vicious/virtuous circle path.
It may also be the case that GDP and GDP growth aren't the best indicators to look at; it might be better to dig into specific industries, or measures like personal income, happiness, etc. Of course, there are also continuing doubts about the usefulness of GDP itself as an economic indicator, as Michael Mandel ably discussed a couple of weeks ago.
In any case, notwithstanding these data issues, the above charts do present some interesting puzzles. For example, entry rates are pretty steady from year to year for any given country, while growth rates, even in developed countries, are more volatile. If the rate at which people form new firms is consistent, and if new firms are important to economic growth, why does growth bounce around so much? One answer is that there is a lot more that goes into growth than new firm formation. This is sort of troubling because it suggests that raising the entrepreneurship rate in any given country won't provide any sort of payoff (at least not in the next few years). It suggests a (harder) focus on the population of firms that gets founded and their survival and performance. And it also takes us back to the squishy issue of quality: a low (high) entrepreneurship rate could tell us nothing about the (poor) (good) quality of those firms.
At some point, it's probably inevitable that such an analysis resorts to qualititative factors. If you work backward from economic growth, locating the sources of such growth, you will likely focus on innovation. Where do innovations come from? From new and existing firms, although the conventional typology is that former account for more incremental innovations while the latter generally create breakthrough innovations. So entrepreneurs create those innovations that drive growth. That's the familiar narrative, and it could be true irrespective of entry rates.
I need to end this post at some point, and we're not going to come to anything resembling a resolution, so I'll just end by throwing it open to readers. Your thoughts? Charts? Arguments?