Latin American Entrepreneurs: Many Firms but Little Innovation

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1 WORLD BANK LATIN AMERICAN AND CARIBBEAN STUDIES Latin American Entrepreneurs Many Firms but Little Innovation Daniel Lederman, Julián Messina, Samuel Pienknagura, and Jamele Rigolini

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3 Latin American Entrepreneurs Many Firms but Little Innovation FM_main_ENTinLAC_i-xvi.indd 1 11/21/13 5:30 PM

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5 Latin American Entrepreneurs Many Firms but Little Innovation Daniel Lederman, Julián Messina, Samuel Pienknagura, and Jamele Rigolini FM_main_ENTinLAC_i-xvi.indd 3 11/21/13 5:30 PM

6 © 2014 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved This work is a product of the staff of The World Bank with external contributions. Note that The World Bank does not necessarily own each component of the content included in the work. The World Bank therefore does not warrant that the use of the content contained in the work will not infringe on the rights of third parties. The risk of claims resulting from such infringement rests solely with you. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of The World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. Nothing herein shall constitute or be considered to be a limitation upon or waiver of the privileges and immunities of The World Bank, all of which are specifically reserved. Rights and Permissions This work is available under the Creative Commons Attribution 3.0 Unported license (CC BY 3.0) http://creativecommons.org/licenses/by/3.0. Under the Creative Commons Attribution license, you are free to copy, distribute, transmit, and adapt this work, including for commercial purposes, under the following conditions: Attribution—Please cite the work as follows: Lederman, Daniel, Julián Messina, Samuel Pienknagura, and Jamele Rigolini. 2014. Latin American Entrepreneurs: Many Firms but Little Innovation . Wash - ington, DC: World Bank. doi:10.1596/978-1-4648-0012-2. License: Creative Commons Attribution CC BY 3.0 Translations—If you create a translation of this work, please add the following disclaimer along with the attribution: This translation was not created by The World Bank and should not be considered an official World Bank translation. The World Bank shall not be liable for any content or error in this translation. All queries on rights and licenses should be addressed to the World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2625; e-mail: [email protected] worldbank.org. ISBN (paper): 978-1-4648-0012-2 ISBN (electronic): 978-1-4648-0013-9 DOI: 10.1596/978-1-4648-0012-2 Cover design: Critical Stages, Inc. Cover image: © Nicholas Wilton/Illustration Source; permission required for further reuse. Library of Congress Cataloging-in-Publication Data has been requested. FM_main_ENTinLAC_i-xvi.indd 4 11/21/13 5:30 PM

7 Contents Foreword xi ... ... Acknowledgments xiii Abbreviations ... xv Overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1. 1 Entrepreneurship is a driver of development ... Entrepreneurship is vibrant— but growth is weak ... 4 The region has many entrepreneurs but little innovation ... 7 Few companies enter export markets ... 10 Even large multinational corporations in the region are insufficiently innovative 13 ... How can policy enable innovative entrepreneurs? ... 16 Structure of the report ... 20 Notes ... 20 References ... 21 2. Entrepreneurship, Entry, and the Life Cycle of Firms in Latin America and the Caribbean: Are All Forms of Firm Creation Entrepreneurial? . . . . . . . . . . . . . . . . . 23 Low- level entrepreneurs, high- level entrepreneurs, and employees ... 24 Theoretical framework ... 26 38 Business creation in Latin America and the Caribbean ... 42 Beyond entry: Firm dynamics in Latin America and the Caribbean ... growth entrepreneurship: Culture, institutions, What is hindering high- ... 49 or the environment? Notes ... 54 References ... 56 3. . . . . . . . . . . . . 61 Entrepreneurship by Incumbent Firms: What Explains the Innovation Gap? What drives innovation? A conceptual framework ... 63 How innovative are firms in Latin America and the Caribbean? ... 67 What explains the innovation gap? ... 73 Notes ... 89 References ... 90 v FM_main_ENTinLAC_i-xvi.indd 5 11/21/13 5:30 PM

8 vi Contents Export Entrepreneurship . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 4. 96 ... Exporting as a transformative entrepreneurial act Contribution of export entrepreneurship in the medium term 98 ... 102 ... Descriptive benchmarking of export entrepreneurship Econometric benchmarking of export entrepreneurship 112 ... Export promotion policies ... 116 117 Concluding remarks ... 118 ... Notes 119 References ... Foreign Direct Investment, Multinational Corporations, and Innovation . . . . . . . . . . . . . . 121 5. 123 Foreign multinational corporations in Latin America and the Caribbean ... ... 131 Multilatinas Concluding remarks 136 ... Notes 136 ... ... 138 References . . . . . . . . . . . . . . . . . . . . . 141 6. Toward an Enabling Environment for Innovative Entrepreneurs What are the elements of an enabling environment for innovative entrepreneurs? 142 ... What explains the region’s innovation gap? The leading suspects ... 149 ... 150 Notes References ... 151 Boxes 2.1 32 Main databases used in the study ... Do training programs for entrepreneurs work? ... 43 2.2 Comparing firm size across age cohorts in Colombia using Enterprise Surveys 2.3 and administrative data ... 47 2.4 Importing entrepreneurs: Start- Up Chile ... 51 3.1 Risk, laws, macroeconomics, and the innovation gap in Latin ... 65 America and the Caribbean 3.2 Management matters: How better practices could increase productivity ... 70 in Latin America and the Caribbean 3.3 88 Do’s and don’ts of entrepreneurship ecosystems ... Can a whale in a swimming pool create a splash? Intel and the upgrading 5.1 of tertiary education in Costa Rica 129 ... Figures Type of employment, by GDP per capita 2 1.1 ... Innovation edge of medium and large firms over small firms in Latin America 1.2 ... 3 and the Caribbean, 2010 1.3 Relationship between type of employment and GDP per capita, 2010 ... 4 1.4 Firm dynamics: entry, age, and size ... 5 1.5 Employment growth in Colombia, by firm size and age 6 ... Percentage of firms in selected countries introducing a new product, 2006–10 ... 1.6 8 Investment in research and development (R&D) in selected country groups, 2008– 10 ... 9 1.7 Number of patents per capita granted by U.S. Patent and Trademark Office, 1.8 actual and benchmarked, by inventor’s country or place of residence ... 9 1.9 Management practices in selected economies ... 11 1.10 year survival rates in selected countries (differences with Average entry and one- respect to baseline) ... 12 1.11 Sources of export growth in selected countries, 2005– 07 and 2008– 09 ... 13 FM_main_ENTinLAC_i-xvi.indd 6 11/21/13 5:30 PM

9 Contents vii Innovation edge of foreign multinational corporations over local firms 1.12 14 in Latin America and the Caribbean ... Predicted productivity gains from entry of new multinational corporations 1.13 14 ... in selected country groups, countries, and economies 1.14 Spending on research and development (R&D) in Latin America and the Caribbean ... 15 1.15 Sectoral position of foreign subsidiaries relative to headquarters in selected country groups, countries, and economies, 2010–11 ... 15 1.16 Actual and benchmarked index of competition in 17 nontradable industries 17 in selected countries or economies ... ... 1.17 18 Income and engineering density in selected economies, 1900 ... 1.18 Number of engineers per million people in selected countries 18 Actual and benchmarked index of intellectual property rights in selected countries 1.19 ... 19 or economies, 2005 2.1 Model of entrepreneurship 27 ... Occupational choice and GDP per capita, 2010 ... 29 2.2 2.3 Income distribution in Latin America and the Caribbean by type of occupation, ... 31 circa 2011 2.4 Rate of formal business ownership in selected country groups, countries, 33 and economies, 2011 ... Share of firms with no employees in selected country groups, countries, 2.5 and economies, 2011 ... 35 Distribution of firm size in selected country groups, countries, and economies, 2011 ... 2.6 35 2.7 Push versus pull entrepreneurship in selected country groups, countries, and economies, 2011 ... 37 2.8 11 ... 39 New firm entry rates and GDP per capita in selected countries, 2004– 2.9 Time required to start a business in selected country groups, countries, and economies, 2004 and 2013 ... 40 2.10 Relationship between business formality and barriers to entry in selected countries, ... 41 various years 44 2.11 Employment growth in Colombia, by firm size and age cohort ... Net employment growth rates by firms in Colombia, by establishment age 2.12 ... and size, 1994– 2009 45 Employment in establishments in Colombia, by age of establishment ... 47 B2.3.1 Firm size in Latin America and the Caribbean, by age of firm, 2006– 2.13 10 ... 48 2.14 ... 49 Age distribution of top 100 firms in selected country groups Share of business establishments in Argentina owned by foreigners, 1910 ... 2.15 50 2.16 Entrepreneurship among immigrants and natives in the United States, by type of business and country ... 53 2.17 Marginal effects of years in United States on entrepreneurship gap between migrant and nonmigrant white men, by cohort of arrival and region ... 54 Extensive and intensive margins of innovation 65 3.1 ... 3.2 Percentage of firms in selected countries that introduced a new product ... in the past year 67 3.3 Average investment in research and development, by region and level of GDP, 2008– 10 ... 68 3.4 Number of patents per capita granted by U.S. Patent and Trademark Office, actual and benchmarked, by inventor’s country or place of residence ... 69 B3.2.1 Correlation between management quality and productivity in selected countries and economies ... 70 3.5 Management practices in selected countries or economies ... 71 3.6 Distribution of overall management scores in Brazil and the United States ... 72 FM_main_ENTinLAC_i-xvi.indd 7 11/21/13 5:30 PM

10 viii Contents Relationship between investor protection and time required to register property 3.7 and innovation in Latin America and the Caribbean ... 73 ... 3.8 75 Doing Business in selected country groups and countries, circa 2004 versus 2013 3.9 Relationship between competition and various aspects of innovation in Latin America and the Caribbean 76 ... 77 3.10 Appointment of head of regulatory agency in Latin America and the Caribbean ... 78 3.11 Level of allowed government intervention in regulatory decisions ... 3.12 Scope of action of regulatory agencies in Latin America and the Caribbean ... 78 3.13 79 Transparency practices of regulatory agencies in Latin America and the Caribbean ... Maximum fines imposed by regulatory agencies in selected countries in Latin 3.14 79 ... America and the Caribbean ... 81 Credit, investment, and innovation in Latin America and the Caribbean 3.15 3.16 Depth of financial systems in selected country groups and countries, 1995 and 2005 ... 82 Private equity and venture capital investments, by region, 2002– 11 ... 83 3.17 Number and size of private equity and venture capital deals in Latin America 3.18 11 ... and the Caribbean, by country, 2008– 83 84 Access to credit, by region and age of firm ... 3.19 Likelihood of spin- off firm after five years, by type of entrant ... 85 3.20 3.21 Engineering density and GDP of selected countries, 1900 ... 85 Actual versus perceived management quality in Argentina, Mexico, Chile, 3.22 and Brazil ... 87 3.23 ... 89 Domestic versus international spillovers in patenting activity 4.1 99 Strategic objectives of export promotion agencies, by region ... Share of total exports accounted for by new export entrants in seven countries 4.2 09 ... 100 in Latin America and the Caribbean, 2005– 4.3 Share of total exports accounted for by continuous exporters in seven countries in Latin America and the Caribbean, 2004– 09 ... 101 4.4 Export growth and its components in selected countries, 2005– 07 and 2008– 09 ... 103 4.5 Product entry, exit, and first- year survival rates of incumbent exporters in selected 07 and 2008– 09 ... 105 countries, 2005– Size of new product exports relative to incumbent products in selected countries, 4.6 09 ... 106 07 and 2008– 2005– Export growth of incumbent exporters in selected countries and its decomposition 4.7 07 and 2008– 09 ... 107 along the product dimension, 2005– Destination entry, exit, and first- 4.8 year survival rates of incumbent exporters in selected countries, 2005– 07 and 2008– 09 ... 109 Exports to new destinations as a share of total exports by incumbent exporters 4.9 07 and 2008– in selected countries, 2005– ... 110 09 4.10 Export growth of incumbent exporters in selected countries and its decomposition along the destination dimension, 2005– 07 and 2008– 09 ... 111 4.11 Conditional benchmarking of export entry rates by sector, 2005– 09 ... 112 Conditional benchmarking of one- 113 year export survival rates by sector, 2005– 09 ... 4.12 Conditional benchmarking of export entry rates in selected countries, 2005– 4.13 09 ... 113 4.14 Conditional benchmarking of one- year export survival rate in selected countries, 2005– 09 ... 114 4.15 year survival rate in selected Conditional benchmarking of export entry and one- countries after controlling for GDP per capita and comparative advantage, 2005– 09 ... 115 4.16 Partial effects of 1 percent increase in index of revealed comparative advantage on export entrepreneurship indicators in seven countries in Latin America and the Caribbean, 2005– 09 ... 115 FM_main_ENTinLAC_i-xvi.indd 8 11/21/13 5:30 PM

11 Contents ix Inward foreign direct investment and multinational activity 5.1 124 ... in Latin America and the Caribbean Difference in number of patents held by multinational parent and local firms 5.2 in home country in selected country groups, countries, and economies, 2010–11 125 ... 5.3 Difference in innovation between multinational affiliates and local firms 126 ... in the host economy in Latin America and the Caribbean, 2010 5.4 Product innovation by foreign multinational affiliates in selected country groups and economies, 2010 ... 127 5.5 Research and development by foreign affiliates of U.S. multinational 127 ... corporations in selected regions, 1998 and 2008 5.6 Sources of predicted productivity gains associated with entry of multinational corporations, by country groups, countries, and economies, 2002– 10 ... 130 Share of total revenues of 5.7 by country or country group of origin, multilatinas ... 132 2010 –11 5.8 Actual and benchmarked revenue of multinational corporations in selected ... 133 countries and economies, relative to given characteristics, 2010–11 5.9 Factors driving Brazilian firms to cross borders, 2010–11 ... 134 Sectoral position of foreign subsidiaries relative to headquarters in selected country 5.10 groups, countries, and economies, 2010–11 ... 134 Origin of reve 5.11 multilatinas, nues of ... 135 2010 Management practices by firms in the United States and selected countries 5.12 ... 135 in Latin America and the Caribbean, by type of firm 5.13 Research and development by multinational corporations in selected country groups, countries, and economies, 2010–11 ... 136 6.1 Actual and benchmarked access to credit by young firms in selected countries ... 143 6.2 Actual and benchmarked index of intellectual property rights in selected 145 countries or economies, 2005 ... 6.3 Actual and benchmarked contract certainty in selected countries 146 ... or economies, 2012 6.4 Actual and benchmarked index of competition in 17 nontradable industries in selected countries or economies ... 147 Actual and benchmarked index of openness to trade in selected countries, 2012 ... 6.5 148 6.6 10 ... 149 Actual and benchmarked share of engineers in selected countries, 2008– Ta b l e s 2.1 Socioeconomic characteristics of business owners in selected country groups, countries, and economies ... 34 2.2 Dynamics of manufacturing firms in Colombia ... 45 2.3 Five- year changes in size categories for establishments of different ages in Chile and Colombia ... 46 Firm characteristics in Latin America, the United States, and China 72 3.1 ... 4.1 Number of new and incumbent exporters in seven countries in Latin America and the Caribbean, 2005– 09 ... 100 4.2 Export growth by new entrants and incumbents in seven countries in Latin America and the Caribbean, 2004– 09 ... 101 4.3 Treatment effects of export promotion agencies in seven countries in Latin America and the Caribbean ... 117 6.1 Factors that may account for innovation deficits in 13 countries in Latin American and the Caribbean, 2005 ... 150 FM_main_ENTinLAC_i-xvi.indd 9 11/21/13 5:30 PM

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13 Foreword - rate than the United States and, more impor or almost a decade, emerging market economies, including several countries tant, were unable to take advantage of their in Latin America and the Caribbean relative underdevelopment by catching up to F (LAC), were regarded by analysts and inves - the United States and other developed econo - mies that became the sources of technologies tors as new engines of growth. Their growth that are now commonplace around the globe. before the global financial crisis sparked LAC did not need to invent, just to imitate enthusiasm that, after a short pause during and adopt technologies, as some economies the 2008 crisis, was cemented by vigorous in East Asia were able to do. recoveries in 2009 and 2010. A new story line All this is not to say that the recent enthusi - seemed to dominate: thanks to deep struc - - asm for LAC’s emerging markets was unwar tural changes, both domestic and global, the ranted. The enthusiasm was justified by the potential of emerging market economies had substantial and unprecedented social prog finally arrived. - ress in the region during this recent growth In the past few months, enthusiasm for spurt, as documented in a previous regional emerging markets appears to have soured. A notable slowdown has cast doubts on the flagship report, Economic Mobility and the sustainability of their high growth rates of the Rise of the Latin American Middle Class. past decade and revived old fears of macro That report provided evidence of remarkable - economic and financial turbulence. Phrases progress: such as “submerging economies” have become common in financial periodicals. • Nearly 70 million people were lifted The truth is that major LAC economies out of poverty in the past decade. experienced lackluster growth for decades • Approximately 50 million people before the boom of the 2000s. At the begin entered the ranks of the middle class - ning of the 20th century, a simple aver - between 2003 and 2009. age of the region’s gross domestic product • Income inequality, as measured by the per capita was about 38 percent that of the Gini coefficient, fell steadily, dropping from its peak of 0.58 in 1996 to the United States. By 2012, that ratio was about 35 percent. lowest level ever recorded in the region, The change implies that over 110 years, 0.52, in 2011, a decline of more than the large economies of LAC grew at a slower 10 percent. xi FM_main_ENTinLAC_i-xvi.indd 11 11/21/13 5:30 PM

14 xii WoRD FoRe - • About one-third of the poverty reduc • Improving logistics and infrastructure. tion was the result of social policies Modernizing ports, transport, and customs can add a competitive edge that transferred incomes to the poor, but labor market income during the - to products from the region. The cur boom years accounted for the remain rent infrastructure deficit also needs to - be addressed in order to end capacity ing two-thirds. In other words, growth constraints that become evident at low is required to sustain poverty reduction and middle class expansion. growth rates. Enhancing competition. • Although the What makes the productivity challenge press - region has globalized, many industries ing is precisely the fact that social progress has remain sheltered from competition. - been tied to growth. Thanks to current poli This protection has the dual negative cies, social programs can be maintained in the effects of reducing productivity growth short term. The risk is that these gains may be in those sectors and handicapping the lost if growth remains low for too long. - export sector, which relies on their ser With global tailwinds receding, the region vices and intermediate goods. will need to rely on its own devices to spur - • Improving the contractual environ growth. Those devices have only one name: ment. Although intellectual property - productivity. With scant domestic sav rights are not the only relevant aspect ings and receding external capital inflows, - of domestic institutions that affect pro income growth can be sustained only by pro - ductivity, innovation is unlikely to take ductivity gains. root without adequate protection. Leaders in the region are fully aware of the With LAC’s recent social gains, growing importance of boosting productivity. But what is this battle about? This report argues that it demands for access to good-quality services have increased. Middle classes expect not is about establishing an enabling environment only income gains so that their children will in which entrepreneurs can emerge, compete, - and innovate. It is about building an innova see even more progress in the future but also - improved public services for the current gen tive entrepreneurial class in which top-notch firms—firms that export goods, services, and eration. With increased productivity, private even capital—no longer look tepid in contrast incomes will rise, increasing public revenues and the state’s capacity to invest in service to entrepreneurial superstars elsewhere. Beyond generalities, the main elements of delivery. In time, if we win the productivity battle, we will enter into a virtuous cycle of - an enabling environment for entrepreneur stronger public sectors, higher growth, and ship and innovation include the following: opportunities for all. - The chal Building human capital. • lenge of raising the quality of education remains, but it goes well beyond test Augusto de la Torre, Chief Economist scores. For example, LAC has a historic Hasan Tuluy, Vice President Latin America and the Caribbean Region deficit of engineers, dating at least to the early 20th century. The World Bank Group FM_main_ENTinLAC_i-xvi.indd 12 11/21/13 5:30 PM

15 Acknowledgments Reis, Pablo Sanguinetti, and Antoinette his report was prepared by a team led by Daniel Lederman, Julián Messina, Schoar. While we are very grateful for the Samuel Pienknagura, and Jamele guidance received, these reviewers are not T - responsible for any remaining errors, omis Rigolini. Important additional contributions sions, or interpretations. Additional insights were made by Paolo Benedetti, Claudio from Pablo Acosta, Tito Cordella, Leonardo Bravo-Ortega, Maggie Chen, Paulo Correa, Ana Paula Cusolito, Marcela Eslava, Ana M. Iacovone, Mariana Iootty de Paiva Dias, Gutierrez-Rocha, Mary Fernandes, Mario Esperanza Lasagabaster, Martha Martínez- Licetti, Marialisa Motta, Oltac Unsal, María Hallward-Driemeier, John Haltiwanger, Thomas Kenyon, Leora Klapper, William Pluvia Zuñiga, and other participants in Maloney, Yotam Margalit, David a workshop that took place on November McKenzie, Camilo Mondragón, Marcelo 15–16, 2012 are gratefully acknowledged. We also want to thank Mauro Lopes Mendes Olarreaga, Aitor Ortiz, Caglar Ozden, Markus Poschke, Douglas Randall, Miguel de Azeredo, Marcela Sánchez-Bender, and Sarzosa, Murat Seker, Marco Vivarelli, and the World Bank’s Latin America and the Lucas Zavala. The team was ably assisted - Caribbean Finance and Private Sector Devel by Juan Manuel Puyana, Juan Pablo Uribe, opment and International Trade teams for valuable comments. and Cynthia van der Werf. The work was Book design, editing, and production were conducted under the general guidance coordinated by the World Bank’s Publishing of Augusto de la Torre, Chief Economist for the Latin America and the Caribbean and Knowledge department under the super - Region of the World Bank. vision of Patricia Katayama and Mark Inge - bretsen. Last but not least, we thank Ruth The team was fortunate to receive advice and guidance from four distinguished peer Delgado and Jacqueline Larrabure Rivero for unfailing administrative support. reviewers: Caroline Freund, Jose Guillerme xiii FM_main_ENTinLAC_i-xvi.indd 13 11/21/13 5:30 PM

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17 Abbreviations BEEPS Business Environment and Enterprise Performance Surveys Central America Free Trade Agreement CAFTA CRC Centro Regional de Competencia para América Latina EAP4 Indonesia, Malaysia, the Philippines, and Thailand ECA Europe and Central Asia EPA export promotion agency FTA free trade agreement GDP gross domestic product GIPBP Global Investment Promotion Best Practices HS Harmonized System ICRG International Country Risk Guide ICS Investment Climate Surveys IPA investment promotion agency intellectual property rights IPRs Latin America and the Caribbean LAC Argentina, Brazil, Chile, Colombia, and Mexico LAC5 multinational corporation MNC PEVC private equity and venture capital PPP purchasing power parity R&D research and development RCA revealed comparative advantage SME small and medium enterprise TPF total factor productivity USPTO U.S. Patent and Trademark Office xv FM_main_ENTinLAC_i-xvi.indd 15 11/21/13 5:30 PM

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19 Overview 1 Entrepreneurship is a and was greatly strengthened by the seminal driver of development is that creative work of Joseph Schumpeter— entrepreneurs are not just byproducts of the Successful entrepreneurs are individuals who development process but important drivers of transform ideas into profitable commercial such a process. Entrepreneurs are key actors enterprises. This process often requires special income societies in the transformation of low- talents, including a capacity to innovate, to characterized by low productivity and often introduce new products, and to explore new employment into dynamic subsistence self- markets. It also requires an ability to manage economies characterized by innovation and a others, to assign priorities to tasks to increase remunerated workers. rising number of well- the efficiency of production, and to make the To the extent that causal links from entre - - best use of available resources. But these tal preneurship to productivity growth are at ents are not enough. Successful entrepreneurs work, there is room for using policy levers to thrive in favorable economic and institutional - quicken the development process by improv environments that enhance the expected ing the incentives and supportive institutions returns of innovation. When an enabling that facilitate innovation by entrepreneurs. environment exists, entrepreneurs take risks These analytical and policy issues motivate and invest in innovation, spurring productiv - this report, which explores the challenges ity gains through the dynamics of firm entry - growth, transforma faced by potential high- and exit and innovation by incumbent firms, tional entrepreneurs in Latin America and thus fostering economic development. the Caribbean (LAC). Why should policy makers care about Figure 1.1 depicts the transition from entrepreneurs, who tend to be among the self- employment toward wage employment better off in the population? The answer is that tends to go hand in hand with eco - simple: entrepreneurship is a fundamental nomic development. It shows that up to a driver of growth and development. Indeed, gross domestic product (GDP) per capita of one that is the basic premise of this report— about $2,000 (adjusted for purchasing power shared by most economists since Adam Smith 1 01_ENTinLAC_001-022.indd 1 11/21/13 4:00 PM

20 2 LATIN AMERICAN ENTREPRENEURS Type of employment, by GDP per capita F I G U R E 1.1 This stylized fact is shared across coun - tries, albeit with less intensity in the more advanced economies. It is not attributable to 100 observable differences in the distribution of workers’ skills or education across firms of 80 different sizes. size and large firms, which are Medium- 60 - typically run by the most dynamic entrepre - neurs, are also more likely to engage in vari 40 Workers (%) ous forms of innovation. They are more likely to export to foreign markets, obtain patents, 20 invest in research and development (R&D), - introduce new products, improve produc 0 tion processes, cooperate on innovation with 300 25,000 10,000 50,000 5,000 2,500 1,000 500 other firms, import new technologies, and GDP per capita export capital to establish affiliates in foreign Nonagricultural wage and salaried All agricultural workers markets (figure 1.2). Nonagricultural employer Nonagricultural own account Research on entrepreneurship in LAC may Nonagricultural unpaid deepen our understanding of the region’s Source: Gindling and Newhouse 2012. lagging productivity growth. Although LAC Note: Employment shares are calculated based on data from household surveys. GDP = gross experienced remarkable growth in the first domestic product. especially decade of the new millennium— parity), agricultural workers make up most compared with its own past and growth in of the labor force, followed by the nonagri - there are reasons the advanced economies— employed; wage employment cultural self- to doubt the long- term sustainability of such outside agriculture comes only third. The high growth rates. A significant part of the incidence of wage employment rises gradually recent growth spurt appears to be related to thereafter, becoming the most important type the commodity boom. Productivity growth of employment at a GDP per capita of about remains modest (Busso, Madrigal, and $5,000. In countries such as Canada and the - Pagés-Serra 2012), particularly in the non United Kingdom, more than 85 percent of tradable services sector (Pagés-Serra 2010), employment consists of salaried employees which through the natural process of struc - (Gindling and Newhouse 2012). tural transformation is attracting a growing employment to The transition from self- share of the LAC urban workforce. wage employment is part and parcel of the Measuring entrepreneurship is not an easy development process, in which entrepreneurs task, however, because it is related to the play a crucial role. Creative entrepreneurs individual talents and characteristics of a few are typically behind the most dynamic and elite businesspeople. Following Schumpeter productive firms— the ones that innovate, (1911), this report adopts a broad definition expand production, and generate jobs at a of entrepreneurship that focuses on what is 2 comparatively rapid pace. These firms not for the market. new Entrepreneurship thus only create employment opportunities, they includes firm entry into new or existing also create better employment. For a given markets (both domestic and foreign), the - set of skills, across the world, more pro - introduction of new products to the mar ductive firms, which tend to be the larger ket, and organizational improvements that ones, pay higher wages. In LAC, for exam - enable firms to improve the quality or price 25 employees) ple, medium firms (with 5– of their products or achieve more efficient pay 20– 40 percent higher wages than small modes of production. The report adopts var - firms, and large firms (with more than 25 ious terms to refer to this type of innovative 1 employees) pay 30– 60 percent higher wages. growth,” entrepreneurship, including “high- 01_ENTinLAC_001-022.indd 2 11/21/13 4:00 PM

21 w 3 OvER vIE Innovation edge of medium and large firms over small FIGURE 1.2 “high- end,” and Lerner’s and Schoar’s (2010) firms in Latin America and the Caribbean, 2010 “transformational” entrepreneurship. The important point is to differentiate entrepre - neurs with high growth potential from small Labor productivity employed individuals with low firms and self- growth potential. Exporter The report uncovers some bright spots. It finds that LAC is a region of entrepreneurs, Exports share - as evidenced by the large number of busi Invested in R&D ness owners per capita relative to countries with similar incomes per capita. Moreover, Patent abroad as the large number of entrepreneurs is not— Patent, trademark, mainly a reflection of a large often believed— or copyright informal sector in which low- productivity New or signicantly firms are constantly emerging and dying. The improved process - share of business owners with formally reg Patent in country istered firms is also relatively high in several LAC economies. New products introduced At the top end of the entrepreneurial Medium firms Technology from a foreign- spectrum, LAC experienced impressive Large firms owned company export entrepreneurship activity during 95% confidence Cooperates on innovation 2004– 09. Stimulated by global tail winds interval and augmented by comparative advantage, 0 30 10 40 50 20 recently implemented trade agreements, and Marginal eect (%) well- targeted export promotion policies, the region saw impressive survival rates by World Bank, based on data from 2010 Enterprise Surveys. Source: Note: Bars represent the marginal effect of a medium and large dummy variable in a regression exporters. It also witnessed the emergence 50, medium firms controlling for firm, sector, and country characteristics. Small firms have 0– — multilatinas of multinational enterprises— 100, and large firms more than 100 employees. Robust standard errors were calculated. Each 51– country has the same weight in the regional average. R&D = research and development. which are increasingly extending their influence beyond their countries’ borders, particularly into neighboring countries. productive than similar multinationals from These bright spots notwithstanding, the other regions. report identifies a glaring weakness in LAC’s The rest of this overview is structured as namely, the entrepreneurship landscape— - follows. The next section documents the sur low level of innovation. Firms in the region prising vibrancy of entrepreneurship in the suffer from a chronic and substantial inno - region, as measured by the large number of vation gap relative to comparator countries enterprises. It highlights the crucial distinc - and regions. This gap exists not only in terms tion between “small” and “young” firms. of R&D and patenting but also in terms of Businesses that grow rapidly and become product and process innovation. Innovation employment poles are more likely to be young gaps are found among small and large firms firms, but they are not necessarily small. The alike. Indeed, even the region’s superstar third section documents the acute shortfall — entrepreneurs— exporters and multilatinas - in innovation that characterizes LAC entre lag in important dimensions of innovation. - preneurship— in product innovation, pat Entry rates into exporting activities by LAC ents, R&D, and managerial practices. The firms have been particularly low, although fourth section examines various stylized facts incumbent exporters did become more about export entrepreneurship in the region, innovative under duress during the global including low entry rates coupled with solid are Multilatinas 09. financial crisis of 2008– survival rates and strong responsiveness to less innovative, less well managed, and less adverse circumstances. The fifth section 01_ENTinLAC_001-022.indd 3 11/21/13 4:00 PM

22 4 LATIN AMERICAN ENTREPRENEURS multilatinas fundamental policy question. Addressing it in examines the performance of the broader context of multinational corpora requires a change in policy paradigm from - tions in LAC, with a focus on their low level the current emphasis on supporting small of innovation. The last section discusses pos firms toward an emphasis on supporting - ups and young firms. start- sible links between entrepreneurship, innova - tion, and structural features of the enabling Figure 1.3 captures both the vibrancy of the entrepreneurial environment and some of environment in LAC. its deficits. It shows that in many countries in the region, the share of (nonagricultural) Entrepreneurship is vibrant— employers in the population is much larger but growth is weak - than in countries at similar levels of eco nomic development (panel a). However, these In contrast to commonly held views, LAC employers do not generate sufficient wage - is characterized by vibrant entrepreneur account employment, as the share of own- ship, as measured by the number of firms workers in the population is also above the per capita. The share of entrepreneurs in - the population is higher than in compar expected levels (panel b). This characteristic is linked to the large informal sectors that ator countries and regions. Perhaps more constitute a developing country hallmark. surprisingly, the incidence of formal busi - nesses is also high. This fact suggests that Entry into the higher end of the formal sector, measured by registration of new lim - the enterprise sector is much more than a large informal sector. However, the region ited liability firms, remains low in many LAC 3 relative to their level of economic countries lags in the nature of the businesses created. Firms in LAC tend to be smaller (in terms of development. Figure 1.4 (panel a) displays the number of employees) at birth than firms the relationship between firm entry (mea - in other regions at similar levels of develop sured by the average annual number of new - ment, and the growth process fails to com limited liability firms registered per 1,000 - 11) and age people during 2004– working- pensate for the initial gap in employment. Even the largest firms in LAC create fewer - the level of economic development (mea sured by the average per capita income for jobs than the largest firms in other regions. How to address the gap in firm growth is a the same period) across 129 countries. Entry FIGURE 1.3 Relationship between type of employment and GDP per capita, 2010 a. Nonagriculture, employer b. Nonagriculture, own account 8 40 HTI DOM 6 CRI COL 30 VEN ECU VEN SLV PRY HND MEX PER 4 URY BOL SLV GTM URY ECU PER 20 PRY BOL JAM CHL HND Percent COL Percent CHL CRI GTM JAM MEX 2 DOM 10 HTI 0 0 11 9 10 11 6 6 7 8 7 8 9 10 Log of GDP (PPP) per capita Log of GDP (PPP) per capita Non-LAC countries LAC countries Source: World Bank, based on data from Gindling and Newhouse 2012 and World Development Indicators. Note: Curves shows quadratic fitted values. GDP = gross domestic product. LAC = Latin America and the Caribbean. PPP = purchasing power parity. 01_ENTinLAC_001-022.indd 4 11/21/13 4:00 PM

23 5 OvER w vIE FI G U R E 1.4 Firm dynamics: entry, age, and size a. Entry rates and GDP per capita b. Average workers by rm age 300 20 250 15 200 10 150 Entry density 100 5 Number of employees 50 0 0 1–4 30–39 5–9 10–19 20–29 40+ 10 11 9 8 7 6 Log of GDP per capita EAP4 ECA High-income LAC Non-LAC countries LAC countries countries Panel a: World Bank, based on data from World Development Indicators and World Bank Group Entrepreneurship Snapshots (WBGES). Panel b: World Bank, based on data Sources: from 2006– 10 Enterprise Surveys. Note: Panel a: Each point represents the average between 2004 and 2011. Curve shows quadratic fitted values. GDP = gross domestic product. LAC = Latin America and the Carib - bean. Panel b: ECA (Eastern Europe and Central Asia): Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, Georgia, Kazakhstan, Latvia, Lithuania, FYR Macedonia, Moldova, Romania, Russian Federation, Serbia, Turkey, Ukraine, and Uzbekistan. EAP4: Indonesia, Malaysia, the Philippines, and Thailand. High income: Croatia, the Czech Republic, Hungary, Poland, the Slovak Republic, Slovenia, and Spain; LAC: Latin America and the Caribbean. The most recent survey available for each country was used. Each country has the same weight in the regional averages. Size at birth above 10,000 was replaced by “missing.” business declined steadily in the 2000s. LAC is positively associated with GDP per capita, was no exception, exhibiting stronger dereg - and in many LAC countries entry rates are ulation among countries that started with the below the expected level. However, there is substantial heterogeneity within the region, highest levels at the turn of the millennium. with some countries located above the bench However, the significant reduction in entry - mark. The most salient example is Costa barriers has not made a visible dent in the region’s entry rates of limited liability firms, Rica, with an entry rate of almost 16 new age people— four which lie at the high end of the formal sector. firms per 1,000 working- This failure could be interpreted as an indica - - times the international benchmark. Argen tina and Mexico, by contrast, exhibit rates of - tion that the effects of changes in entry bar riers come with a considerable lag. A more entry substantially below those suggested by plausible interpretation may be that either their GDP per capita. - entry barriers are not the most binding con The fact that on average LAC displays uninspiring rates of entry of formal limited straint to formal entry in LAC or that reduc - liability firms has led many observers to sin - ing entry barriers alone, without achieving a critical mass of complementary reforms, is gle out entry barriers as the main culprit. insufficient to spur entry. In the last decade, however, LAC countries made significant progress in reducing such - Another salient feature of LAC entrepre tape barriers. The burden imposed by red- neurship is that new firms do not grow as entry- related regulations is still higher in LAC much as firms in other regions and thus tend than in comparator regions. But the time to to remain small. Panel b of figure 1.4 plots set up a business, for instance, was halved in the average age of firms against the average less than a decade (World Bank 2013). number of employees for different regions. Moreover, the variance across countries It shows that LAC has the smallest new in the number of procedures, length of time, firms (in terms of number of employees) of 4 any region. and costs associated with setting up a new Even the largest new firms (the 01_ENTinLAC_001-022.indd 5 11/21/13 4:00 PM

24 6 LATIN AMERICAN ENTREPRENEURS importance for the design and effectiveness 90th percentile of the size distribution of new firms) are about half the size of new firms in of SME support programs. 5 The empirical basis for emphasizing this Moreover, differences in size other regions. distinction is illustrated by a detailed analysis widen as firms age: LAC firms that are 40 or of the dynamics of (formal) manufacturing more years old are on average half the size of firms the same age from high- - income coun - firms in Colombia by Eslava and Haltiwan tries and Eastern Europe and Central Asia ger (2013), as well as by research on firm third the size of firms in the dynamics in the United States. Figure 1.5 (ECA) and one- presents some of the results on the impor middle- income countries of East Asia and - tance of firm size versus firm age for the gen - Indonesia, Malaysia, the Pacific (EAP4)— eration of employment in Colombia. Panel a Philippines, and Thailand. focuses on “continuers” (that is, firms that Policy makers in LAC have typically tried remained alive throughout the sample period) to address the lackluster growth of firms by focusing on smallness per se. Together with and therefore abstracts from firm entry and a concern about employment, this focus has exit. Growth increases with size and declines taken the form of a myriad of government- with age, as stands to reason (that a firm that sponsored programs that support small and did not expand quickly during its youth or age years is arguably less likely to medium enterprises (SMEs). Eligibility for middle- enjoy a growth spurt in old age). However, accessing support depends largely on size, typically measured by the number of employ differences in growth rates are much more - ees. The evidence in this report casts doubt marked along the age dimension than along on this overemphasis on smallness and points the size dimension. Firms of all sizes grow to the need to shift the focus toward young fastest in their early years, especially their first four years. (rather than small) firms. Most young firms Even more interesting is the fact that the are small, but a relatively large share of small firms are not young— a distinction this report average growth rates of firms in their early that is, firms years increase rapidly with size— highlights as having potentially critical FI G U R E 1.5 Employment growth in Colombia, by firm size and age b. All establishments a. Continuers 0.6 0.10 0.4 0.05 0.2 Growth rate Growth rate 0 0 –0.2 –0.05 Small Medium Large Medium Small Large Size of rm Size of rm 5–9 years 15+ years 10–14 years 0–4 years All Age of rm: Source: Eslava and Haltiwanger 2013. Note: Small: fewer than 50 employees; medium: 51– 200 employees; large: more than 200 employees. Growth rates are defined as in Davis, Haltiwanger, and Schuh (1996). They are the change in employment between two consecutive periods divided by the average employment between the two periods. 01_ENTinLAC_001-022.indd 6 11/21/13 4:00 PM

25 vIE w 7 OvER that are young and large grow the most, mak - abilities of private agents, and using risk- ing the largest contribution to job creation. sharing arrangements to align incentives This fact contradicts the popular belief that could help governments try to pinpoint firms most employment generation occurs among worthy of public sector support. small firms. The confusion stems from the failure to distinguish between the stock of The region has many firms and their growth dynamics. Even if at entrepreneurs but little any point in time small firms were to account innovation for most of the jobs in the economy, it does not follow that all small firms (independent There are many potential reasons why LAC of age) are equally responsible for employ - firms grow as slowly as they do. One is the lack of innovation. Entry is just the beginning ment generation over time. Rather, it appears of the story. In order to grow, or even survive, that job creation comes from young firms, firms need to continuously innovate. regardless of their size. It is in this domain of entrepreneurship When all firms in the Eslava- Haltiwanger sample (not just firms that stayed alive that businesses in LAC score relatively badly. LAC firms introduce new products less fre - during the sample period but also firms that - were created or died during that period) are quently than firms in otherwise similar econ examined, the picture changes in an import - omies, high- end entrepreneurs tend to be far ant respect (panel b of figure 1.5). Although - away from global best practices in the man - - agement of their enterprises, firms’ invest young firms continue to be the main contrib ment in R&D is low, and patent activity is utors to employment growth, the role of size is reversed, with small firms dominating. The well below benchmark levels. Some of the most successful LAC firms average employment growth rate of small have managed to grow out of their national firms up to four years old jumps from 4 per - cent for continuers to 53 percent for all firms. boundaries during the last decade and are - This result stems from the fact that the vast now competing on world markets. The suc cess of high- majority of entrants are small, and by con - end companies such as Vale, Embraer, and CEMEX notwithstanding, struction the growth rates of newly created firms are highest. innovation in LAC is limited, with even some Hence, the evidence on firm dynamics in underperforming multilatinas of the giant - their peers from other countries. Many for Colombia suggests that young rather than mal firms in the region are engaged in some small firms are the main employment cre - ators. This evidence is consistent with recent form of innovation, but the intensity of findings for the United States (Haltiwanger, innovation tends to be low or poorly suited Jarmin, and Miranda 2013). Further research to raise productivity. Figure 1.6 shows the - percentage of firms that developed or intro could determine the role of young firms in duced a new product (product innovation) in employment generation across LAC. However, increasing the effectiveness selected countries between 2006 and 2010. of programs aimed at supporting firm (and The LAC countries are bunched toward the 6 On average, firms in low end of the scale. employment) growth may call not just for a the region are 20 percent less likely to have shift of emphasis from small to young firms. introduced a new product than the middle- A deeper understanding of the characteristics income countries in ECA— and the picture of young firms of all sizes that enable them appears even grimmer for most of the Carib - to survive and thrive in market economies bean, where the likelihood of introducing - is also necessary. Unfortunately these char a new product drops to half that of firms acteristics of young dynamic firms remain in ECA. unknown, thus making policy making in this Figure 1.6 measures the share of firms area complicated. Coordinating efforts with involved in innovation activities, which is the private sector, leveraging the screening 01_ENTinLAC_001-022.indd 7 11/21/13 4:00 PM

26 8 LATIN AMERICAN ENTREPRENEURS Percentage of firms in selected FI G U R E 1.6 uninformative about the quality and intensity countries introducing a new product, 2006–10 - of innovation, two factors strongly associ productivity firms. Datasets ated with high- exploring these fundamental factors in a St. Lucia Dominica comparable way across countries are of poor Jamaica quality. The few available indicators suggest Antigua and Barbuda Nicaragua that the quality of innovation in LAC may be Venezuela, RB as much of an obstacle to firms’ growth and Mexico Guyana productivity as the quantity. Trinidad and Tobago Figure 1.7 shows aggregate investment in St. Kitts and Nevis Ecuador R&D. Panel a compares regional averages St. Vincent and the Grenadines - as a percentage of value added in manufac Malaysia Dominican Republic turing (the sector where most R&D takes El Salvador place). Panel b benchmarks R&D against Uzbekistan Uruguay the average of countries at similar stages of Guatemala 7 Average R&D investment in development. Romania Spain thirds the five largest LAC economies is two- Bolivia that of China when expressed as a percentage Honduras Costa Rica third of manufacturing value added and one- Chile when expressed as a percentage of GDP. For Paraguay Colombia - the remaining LAC countries, R&D invest Greece ment is about a third that in China when Peru Turkey expressed as a percentage of manufacturing Argentina value added and a tenth that of China when Suriname Bulgaria expressed as a percentage of GDP. These Korea, Rep. innovation gaps are worrisome. Azerbaijan Grenada A second feature that distinguishes LAC Kazakhstan from China and high- income countries is the Germany Croatia preponderant role the public sector plays in Ireland R&D (the public sector also accounts for a Ukraine Hungary large share of R&D in ECA) (Pagés-Serra Georgia 8 2010). - This is not to say that the public sec Poland Moldova tor in LAC invests excessively in R&D: as a Slovak Republic percentage of GDP, it invests much less than Macedonia, FYR Russian Federation income countries. The finding China or high- Thailand rather reflects how little private LAC firms Serbia Czech Republic invest in innovation. Albania The extent to which lower levels of R&D Latvia Armenia - are likely to translate into lower produc Bosnia and Herzegovina tivity and economic growth is, of course, Slovenia Lithuania influenced by many factors. But panel b of Belarus figure 1.7 indicates that economies that expe - 60 80 100 0 20 40 rienced periods of sustained growth often Percent had bursts of R&D investments that placed LAC countries Other countries them well above their peers (relative to the blue line). LAC’s low levels of R&D, and the Source: 10 Enter World Bank, based on data from Seker 2013 and 2006– - prise Surveys. fact that little of it is conducted by the private Note: LAC = Latin America and the Caribbean. sector, appears to be one of the main culprits documented history behind the region’s well- of low productivity growth. 01_ENTinLAC_001-022.indd 8 11/21/13 4:00 PM

27 vIE 9 w OvER FI G U R E 1.8 Investment in research and FI G U R E 1.7 Number of patents per capita granted by U.S. Patent development (R&D) in selected country groups, and Trademark Office, actual and benchmarked, by inventor’s country or place of residence 20 0 8 – 10 LAC countries Uzbekistan a. R&D by region Haiti Other countries Bolivia Paraguay Other LAC or economies Albania El Salvador Benchmark Indonesia ECA Honduras Kazakhstan Bosnia and Herzegovina Guatemala LAC5 Peru Azerbaijan Colombia China Ecuador Macedonia, FYR Dominican Republic High-income Philippines Ukraine countries Turkey Venezuela, RB 10 14 16 6 8 2 4 12 0 Serbia R&D/manufacturing value added (%) Belarus Georgia Business enterprise Government Oman India Higher education Private nonprot Thailand Armenia Foreign Mexico Jamaica Brazil b. R&D by level of GDP Uruguay United Arab Emirates 5 Argentina Israel Saudi Arabia Latvia Poland 4 Chile Russian Federation Finland China Korea, Trinidad and Tobago Rep. 3 Portugal Slovak Republic Lithuania St. Kitts and Nevis 2 Greece R&D (% of GDP) China Croatia Brazil Costa Rica Costa Bulgaria 1 Rica Kuwait India Uruguay Antigua and Barbuda Argentina Colombia Czech Republic Mexico Malaysia 0 Guatemala Hungary 100,000 10,000 1,000 100 Spain Slovenia GDP per capita (PPP) Italy New Zealand Ireland France Sources: Panel a: World Bank, based on data from World Development Norway Belgium Indicators (WDI) and UNESCO. Panel b: Updated from Lederman and United Kingdom Maloney 2003 using WDI. Australia Note: For countries and economies included in each group, see note 4. Austria GDP = gross domestic product. PPP = purchase power parity. R&D = Hong Kong SAR, China Singapore - research and development. The blue line is a regression-fitted line esti Netherlands mated with data from 1996 to 2011 covering 119 countries. Denmark Canada Germany Sweden Finland A similar picture emerges from data on Korea, Rep. - patents. Figure 1.8 shows the number of pat Switzerland Israel ents per million people that inventors from Japan - different countries received from the U.S. Pat 1 10,000 1,000 100 10 ent and Trademark Office (USPTO) between Patents per 1 million people 2006 and 2010. No LAC country exhibits a Source: World Bank, based on data from USPTO 2012 and World Development Indicators. level of patents that approaches that of high- Note: Dots represent predictions from a multivariate regression analysis that includes the log of patents income countries, and most LAC countries per million people on the log of gross domestic product (GDP) (adjusted for purchasing power parity), the log of population, and the log of merchandise exports to the United States. They indicate where each country stands with respect to countries with similar levels of GDP, population, and merchandise exports to the United States. The regression used all countries and economies for which data were available; the figure presents only comparator countries. Data are averages for 2006–10. LAC = Latin America and the Caribbean. 01_ENTinLAC_001-022.indd 9 11/21/13 4:00 PM

28 10 LATIN AMERICAN ENTREPRENEURS - managers and entrepreneurs. Factors exter received fewer patents than their middle- income country peers. Brazil, for instance, - nal to the firms, such as the business envi registered only 5 patents per million people ronment and other country characteristics, between 2006 and 2010, half the number per are also likely to explain the region’s deficit in managerial practices and hence process capita of China (10) and slightly less than a innovation. quarter the number per capita of Bulgaria (22). To be sure, part of these differences can be explained by lower levels of economic Few companies enter development and lower exports to the United export markets States (which imply fewer incentives to apply for patents from the USPTO). But even after Accessing new markets through trade is arguably a salient manifestation of transfor controlling for per capita income, population - size, and exports to the United States, the pat mational entrepreneurship. Barring firms that - ent intensity in most countries in the region - benefit from high rents, only firms with supe rior performance can thrive in export mar - remains below their benchmark, including Brazil (figure kets. In fact, most new entrants into export 1.8). markets do not survive beyond one year. R&D and patenting are proxy measures of This report documents a number of styl - the intensity and quality of innovation. They ized facts that characterize LAC exporting indicate only indirectly how firms perform in terms of process innovation. An additional firms. In particular, although entry rates into exporting activities remain significantly dimension is the quality of management practices, which can be assessed following - below those in (poorer) comparator coun tries, the survival rates of the few firms that the methodology developed by Bloom and Van Reenen (2007). attempt to export tend to be at or slightly above benchmark levels. Moreover, analysis Figure 1.9 compares management prac - of the contraction of foreign demand during tices of manufacturing firms across different - 09 suggests that exporting entre dimensions for a number of high- income and 2008– preneurs respond well to pressure: in the LAC countries as well as China and India (the face of the crisis, they nimbly opened new sample of comparator countries is dictated by countries in which management surveys exporting firms and developed new export products, in the process penetrating new were conducted). LAC countries other than - Mexico score toward the bottom of the dis export markets. Thus, it seems that the old tribution, with management practices closer adage “necessity is the mother of invention” to those of Chinese and Indian firms than to applies to export entrepreneurship. The high- income countries. Given that LAC firms report also provides evidence that export promotion policies that help entrepreneurs face higher labor costs than firms in China - surmount certain barriers to entry by pro and India, poor management practices in the viding information about global markets. region pose a more severe competitive disad - vantage for them. - Research conducted for this report bench marked entry and survival rates in the Part of the LAC “management gap” can be explained by firm characteristics. Firms region using a new firm- level database, the income countries have a larger share in high- World Bank’s Exporter Dynamics Database 9 of employees with college degrees, are larger, . (figure 1.10) The results are striking: virtually all and are more likely to be multinationals LAC countries in the sample show export - than firms in LAC. These firm characteris entry rates that are below the benchmark. - tics explain at most a third of the manage In contrast, in Asia, the Middle East, and ment gap between the median firm in LAC even Africa, entry rates of firms into export - and the United States, however. Part of the ing activities are above the benchmark. remaining two- thirds of the gap could be LAC countries fare better in the survival explained by the training and ability of LAC 01_ENTinLAC_001-022.indd 10 11/21/13 4:00 PM

29 w 11 OvER vIE Management practices in selected economies FI G U R E 1.9 c. Performance monitoring a. Overall management practices b. Operation management Sweden United States United States United States Germany Japan Germany Sweden Germany Canada Japan Sweden Japan Canada Canada France United Kingdom Australia United Kingdom New Zealand Italy Mexico France Italy Italy France Australia Australia Mexico United Kingdom Portugal Poland Greece Poland Northern Ireland Argentina New Zealand New Zealand Portugal Argentina Portugal Mexico Chile Northern Ireland Republic of Ireland Brazil Chile Argentina Northern Ireland Chile Republic of Ireland Republic of Ireland China Greece Greece China Poland China Brazil Brazil India India India 3.0 3.0 2.5 2.0 3.0 3.5 2.5 2.0 2.5 3.5 2.0 3.5 Mean score Mean score Mean score e. Talent management d. Target management Japan United States Canada Germany United States Japan Germany Sweden United Kingdom Italy Canada Poland France Sweden Australia Northern Ireland Italy United Kingdom Mexico Poland Australia Mexico Republic of Ireland New Zealand China Northern Ireland Portugal France Republic of Ireland Chile New Zealand Argentina Greece Brazil Greece Argentina Portugal China India Chile Brazil India 3.5 2.5 3.5 3.0 2.0 2.5 3.0 2.0 Other countries LAC countries or economies Mean score Mean score Source: Maloney and Sarrias 2012. Note: Surveys sampled manufacturing firms with 100– 5,000 employees recorded in Orbis. LAC = Latin America and the Caribbean. 01_ENTinLAC_001-022.indd 11 11/21/13 4:00 PM

30 12 LATIN AMERICAN ENTREPRENEURS Average entry and one- F I G U R E 1.10 year survival rates in selected However, exporting entrepreneurs tend countries (differences with respect to baseline) to display a significant capacity to adapt to and cope with adverse circumstances, which suggests that greater competitive pressures Chile could be an antidote to the dearth of inno - El Salvador end export entrepreneurs vation among high- Costa Rica in LAC. The agility of incumbent exporters Colombia is illustrated by their reactions to the drop Bulgaria in foreign demand in 2008– 09. During Mexico Guatemala this period, average LAC export growth Macedonia, FYR by incumbent exporters was negative. But Peru their sales of new products raised exports Ecuador by 3 percent on average, and their sales to Jordan new destinations raised exports by 4 percent Morocco Mauritius Rocha (Fernandes, Lederman, and Gutierrez- South Africa 2013). Furthermore, the contribution of Dominican Republic new exporters (entrants) to national export Mali growth increased when the global crisis hit Senegal in 2008, even though entry rates did not rise. Nicaragua Bangladesh 07), During the steady growth period (2005– Kenya incumbent exporters played a dominant role Burkina Faso in explaining export growth in both LAC Tanzania LAC countries, among all types and non– Pakistan of exporters (natural resource based, simple Cameroon Iran processing, and diversified manufactures) Cambodia (panel a of figure 1.11). In contrast, new Malawi - exporting firms were an important contrib Niger utor to exports in LAC during 2008– 09. Uganda Export growth in LAC during the global 0.2 0.3 0.4 0.1 –0.1 0 –0.3 –0.2 crisis would have declined more sharply Log of GDP per capita than it did if exports by new entrants had Average entry rate Average 1-year survival rate of new entrants not compensated for the exit of incumbent firms (panel b of figure 1.11) and incumbent Source: Estimations by Ana M. Fernandes and Daniel Lederman (World Bank), based on data from exporters had not found new markets. - the World Bank’s Exporter Dynamics Database, World Development Indicators, and World Inte grated Trade Solution (WITS) database. Export promotion services also appear to Figure shows estimates of each country’s dummy variable from an econometric model that Note: - increase entry and survival rates and there also includes (the log of ) GDP per capita (adjusted for purchasing power parity), the Vollrath (1991) - index of revealed comparative advantage at the six- digit level of the Harmonized System (HS) clas fore overall export activity. The economic digit sification, industry dummies, and year dummies. The industry dummies are defined at the two- justification for export promotion is often level of the HS. The excluded benchmark country is Albania. Data are for 2005– 09. based on some form of information failure, related to the public good nature of infor - mation that leads to its underproduction by private firms. For instance, existing exporters - dimension, with survival rates of the (rela have no incentives to share information about tively small number of) firms that enter into foreign market conditions and opportunities exporting markets above the benchmark. with potential competitors after incurring the However, no LAC country appears to be costs of discovering how to export profitably an overachiever on the survival front when (Hausmann and Rodrik 2003). compared to most of the other developing In research conducted for this report, countries included in the database, as shown Lederman, Olarreaga, and Zavala (2013) use in figure 1.10, after controlling for GDP firm surveys from seven LAC countries from per capita. 01_ENTinLAC_001-022.indd 12 11/21/13 4:00 PM

31 OvER w 13 vIE Sources of export growth in selected countries, 2005– F I G U R E 1.11 09 07 and 2008– b. Decomposition, 2008–09 a. Decomposition, 2005–07 Ecuador Chile Costa Rica Peru Peru Ecuador Natural Colombia South Africa resources Natural resources Chile Costa Rica South Africa Nicaragua Bangladesh Cambodia Cambodia Bangladesh Guatemala Nicaragua Dominican Republic Guatemala El Salvador Dominican Republic Simple processing El Salvador Simple processing Egypt, Arab Rep. Brazil Egypt, Arab Rep. Mexico Brazil Mexico Manufacturing Manufacturing LAC countries LAC countries of LAC Average countries of LAC Average countries –0.1 0 0.2 0.3 –0.2 0.3 0.1 –0.1 0 0.1 0.2 0.4 Export growth rate Export growth rate Exiters Entrants Incumbents Fernandes, Lederman, and Gutierrez-Rocha 2013, based on data from the World Bank’s Exporter Dynamics Database. Source: 07. LAC = Latin America and the Caribbean. Note: Figures for Ecuador in panel a are for 2006– transitional dislocations. Although the elim - 2006 and 2010 to analyze the effectiveness ination of inefficient local firms may not ulti of export promotion services. They find that - firms that used export support services have mately be bad for a country’s economy, in the a significantly higher probability of entering short term it may adversely affect workers and create social and political tensions. and surviving in export markets. This report provides evidence that multi - national corporations have had significant Even large multinational net positive impact in LAC economies in corporations in the region are recent years: the positive impacts from tech - insufficiently innovative nology transfers, knowledge spillovers, and Under the right business environment and linkages have overwhelmingly dominated - contractual conditions, multinational corpo the negative impacts from greater competi - rations can be good for the local economy. tion in product and factor markets. The full They tend to be more productive and to use potential of multinational corporations has - the latest technologies; through their engage not been fully realized, however, because ment with and support of local suppliers, they multinational affiliates in LAC behave like - can transfer knowledge and better technol local firms, investing very little in innovation. ogies to the local economy, which raise the Thus, either LAC is not attracting the most quality of inputs and the productivity of firms innovative multinationals or the obstacles (Moran 2001; Javorcik and Spatareanu 2005). that local firms face to innovate also act as At the same time, they can have nega - barriers to innovation for foreign firms oper - tive impacts: by competing in local product ating in the region. and factor markets, they can drive less effi - The recent emergence of multilatinas cient local firms to exit, thereby generating has not changed this picture. On average, 01_ENTinLAC_001-022.indd 13 11/21/13 4:00 PM

32 14 LATIN AMERICAN ENTREPRENEURS conduct less research than their Multinationals are also more likely than multilatinas - peers from other regions. The large major local firms to apply for a patent, trademark, - - or copyright; collaborate for innovation pur ity of their business is concentrated in Bra poses with other institutions; invest in R&D; zil, Mexico, and Chile. They therefore miss - the opportunities presented by greater inte - and adopt foreign technologies. The differ gration, both regionally and globally. When ences are even larger for efforts to improve - expand abroad, typically to multilatinas the quality of products. Multinational corpo rations are 21 percentage points more likely neighboring countries, their affiliates often - to engage in quality- operate in the same sector as the parent com improving investments and 25 percentage points more likely to have pany, suggesting that these firms are driven by the search for larger markets and the international quality certifications than local firms, perhaps because they are more likely desire to diversify country risk rather than to export. the desire to establish linkages and clusters, thereby deepening their involvement in pro Figure 1.13 quantifies the relative impor - - ductive networks and global value chains. tance of the competition and knowledge - transfer channels, in order to assess the The higher productivity and more innova impact of the entry of multinational cor - tive behavior of multinational corporations porations on firm- level and aggregate pro relative to local firms in LAC are reflected - ductivity. The estimations use a sample of in many dimensions. Everything else equal, manufacturing firms from 60 countries, the probability that a firm introduces a new 5 of which are in LAC (Argentina, Brazil, product is about 11 percentage points higher owned firm operating in LAC for a foreign- Chile, Colombia, and Mexico). The results than for domestic firms, and the probabil - are striking: other things equal, doubling the number of multinational corporations in ity of introducing a new process is about LAC would increase aggregate productivity 5 percentage points higher (figure 1.12). Innovation edge of foreign multinational F I G U R E 1.12 F I G U R E 1.13 Predicted productivity gains corporations over local firms in Latin America and the Caribbean from entry of new multinational corporations in selected country groups, countries, and Has an international quality certication economies Invested to improve quality control or obtain certication 4.0 Uses foreign technology 3.5 New or signicantly improved product 3.0 Invested in research and development 2.5 2.0 New or signicantly improved process 1.5 Cooperates on innovation with others Percentage points 1.0 Filed for patent, trademark, or copyright 0.5 25 0 15 10 20 5 0 LAC5 China High-income ECA Additional likelihood by MNC aliates economies (percentage points) Market reallocation Knowledge spillover Signicant at 10% Not signicant at 10% Alfaro and Chen 2013. Source: World Bank, based on data from 2010 Enterprise Surveys. Source: Figures are for the manufacturing sector only. Bars represent total Note: Note: Figures are for the manufacturing sector only. Bars are the coefficients of a dummy variable tak - - productivity gains from doubling the probability of multinational cor ing the value 1 if the firm is foreign owned in a regression of innovation variables. Additional controls poration entry, estimated though a structural model. For countries and include country and industry fixed effects. Standard errors are clustered at the industry level. MNC = economies included in each group, see note 4. multinational corporations. 01_ENTinLAC_001-022.indd 14 11/21/13 4:00 PM

33 15 OvER vIE w F I G U R E 1.14 Spending on research and development (R&D) by 3.8 percent. This number is six times in Latin America and the Caribbean - income econo higher than in ECA or high- mies and seven times higher than in China. a. R&D spending by foreign b. R&D spending by multinational Moreover, in contrast with other regions, corporations, by home region aliates of U.S. multinationals, knowledge spillovers run the entire show in 1998 and 2008 LAC: they explain almost all the estimated 100 30 aggregate productivity gains from entry of 90 multinational corporations. 25 80 Alas, the full potential of productivity 70 gains from knowledge spillovers from mul - 20 60 tinational corporations in LAC is not being 15 50 fully realized, in part because of very low Percent 40 - levels of R&D by foreign companies oper 10 30 multilatinas. The share of ating in LAC and 20 - R&D in LAC accounted for by U.S. multi 5 10 national corporations, for instance, is only 0 0 US$ of R&D per thousand US$ of revenue about one- fifth the share of R&D done by 1998 2008 ECA India EAP4 - the same companies operating in Asia. More LAC5 China Africa Europe and Canada over, trends are not encouraging: the share of Asia Middle East economies High-income R&D performed by U.S. multinational cor - LAC porations in LAC fell 1.2 percentage points, to just 3.9 percent of total R&D, between Panel a: National Science Board 2012; panel b: World Bank, based on data from Orbis. Sources: Note: Panel a covers only the manufacturing sector. For countries and economies included in 1998 and 2008 (panel a of figure 1.14). each group in panel b, see note 4. welcome multilatinas, The emergence of as it is, has not fundamentally changed the - innovation picture. To be sure, the num Sectoral position of foreign subsidiaries relative to F I G U R E 1.15 headquarters in selected country groups, countries, and economies, ber of multilatinas is still small, and they 2 010 –11 - are concentrated in three countries (Bra - zil, Chile, and Mexico). But despite tower ing over other LAC companies in size, they 60 are not sufficiently innovative. On average, 50 from the manufacturing sec - multilatinas - tor invest only $0.06 per $1,000 of reve 40 1.14). This nue on R&D (panel b of figure figure stands in sharp contrast with R&D 30 intensity in high- income economies and even 20 China and the four economies of EAP4. For example, multinationals from EAP4 invest 10 $1.70 in R&D for every $1,000 of revenue— Share of foreign subsidiaries (%) almost 30 times the R&D investment of the 0 ECA China and LAC EAP4 High-income multilatina. average economies India A partial explanation for the low level of Location of headquarters may be found in multilatinas innovation of Upstream (relative to parent) Horizontal - their motives for sending capital abroad. Mul Downstream (relative to parent) appear to set up operations abroad tilatinas mainly to expand the markets in which they Source: World Bank, based on data from Orbis. sell and to diversify country risk rather than The sectoral position was calculated using the input- Note: output matrix for the United States. to integrate into global value chains. A subsidiary is defined as downstream if the parent company’s sector is a net supplier of the sub - sidiary’s sector. A subsidiary is defined as upstream if the subsidiary’s sector is a net supplier of the - Figure 1.15 divides the subsidiaries of mul parent company’s sector. For countries and economies included in each group, see note 4. LAC = tinational corporations from different regions Latin America and the Caribbean. 01_ENTinLAC_001-022.indd 15 11/21/13 4:00 PM

34 16 LATIN AMERICAN ENTREPRENEURS - more important for growth as LAC contin into three groups: companies operating in the same sectors as headquarters (horizon - earned achieve ues to consolidate their hard- - tal activity), companies providing inputs to ments on the macroeconomic and financial stabilization fronts. headquarters (upstream activity), and com - panies obtaining inputs from headquarters Pinpointing the enablers of innovative entrepreneurship is complex, however, (downstream activity). Almost half of foreign because of the intricate interactions and inter subsidiaries of multilatinas operate in the - - dependencies between the various dimen same sector as their headquarters compared - sions of the enabling environment that matter 40 percent for other regions. Sub with 30– sidiaries of multinational corporations from for innovation. These components include the other regions are thus more likely to establish clarity and reliability of legal rights (includ - vertical (upstream and downstream) link - ing intellectual property rights) and the judicial process, the quality of information - ages with their headquarters. The implica tion is that many multilatinas disclosure and accounting standards, regula - fail to transfer tions and policies (including procompetition knowledge to the home economy through their involvement in global value chains. This policy) that affect industry and commerce, - access to suitable financial services, the qual lack of integration may be exacerbated by the border activity of ity of human capital (education and skills), fact that most of the cross- takes place in large countries in multilatinas and programs and policies that promote the region (Brazil, Chile, and Mexico jointly or support business development or R&D. account for 70 percent of total ’ multilatinas - Complexity also arises because both entre - preneurial innovation and its possible deter revenues); less than 15 percent of multilati - minants may be affected by common factors nas ’ revenues comes from outside LAC. and hence jointly determined. For instance, an economy’s contractual environment may How can policy enable simultaneously affect both access to credit innovative entrepreneurs? and innovation. In a tribute to innovation as the key to Some areas where policy action may be most fruitful can nevertheless be identified growth, Yale University’s Robert Shiller (2013) recently asserted that “capitalism is by highlighting some of the dimensions of the enabling environment that are vital to inno culture. To sustain it, laws and institutions - vation and on which LAC countries signifi - are important, but the most fundamental role - is played by the basic human spirit of inde cantly underperform. - pendence and initiative.” But where should Competition is a first and highly plausi policy makers look for remedies to cure the ble candidate. To be sure, the relationship - low growth and low innovation of LAC enter between competition and innovation may shape, as Aghion and - U follow an inverted prises if not in the laws and institutions that others (2005) compellingly argue: too much - shape the enabling environment for entrepre neurs? The answer surely lies well beyond the competition may weaken the incentives to traditional concern with laws and regulations innovate for firms that lack basic capabilities that impose barriers to entry per se. and are far from the technological frontier, - whereas too little competition may not pro The main policy challenges seem to be related to deeper structural features of the vide sufficient incentives to invest in innova - tion. The evidence suggests, however, that enabling environment for innovative entre - preneurship, including not only laws and LAC suffers from too little rather than too - much competition, particularly in the mar institutions but also endowments such as - kets for inputs and nontradable services. This infrastructure and the quantity and qual - ity of human capital. These elements of the lack of competition undermines the incen enabling environment are likely to be even tives to innovate, as enterprises can remain 01_ENTinLAC_001-022.indd 16 11/21/13 4:00 PM

35 w 17 OvER vIE F I G U R E 1.16 Actual and benchmarked index of competition in profitable by dint of their market power 17 nontradable industries in selected countries or economies rather than their innovative efforts. Without a perceived necessity to innovate, the private United States sector may not give birth to invention. LAC countries Bulgaria Figure 1.16 benchmarks LAC countries Other countries Romania Poland or economies in terms of revealed market concentration Canada Benchmark Hungary in industries that are arguably not subject Russian Federation 10 Lithuania Most LAC to international competition. Czech Republic Norway - countries appear at the upper end of the dis Colombia tribution of the (nontradable) market con - Latvia Korea, Rep. centration index, and all but two (Colombia Japan Portugal and Brazil) exhibit average levels of market United Kingdom Switzerland concentration well above their international Macedonia, FYR China benchmarks. Hence, competition should Italy remain at the top of the policy agenda in Ireland Germany most LAC economies. Croatia Serbia A second fundamental factor behind the Belarus Thailand lack of innovation in LAC seems to be its Spain Sweden - human capital gap, particularly in the edu Austria cation quality dimension. The region lacks Finland Netherlands the type of human capital— engineers and Argentina Greece - that is likely to produce inno scientists— Denmark Brazil vative entrepreneurs. A country’s stock of Bosnia and Herzegovina human capital is often measured by average Singapore Australia years of schooling of the labor force and by Belgium Turkey the quality of education, assessed through Mexico France standardized scholastic test scores. LAC Philippines Malaysia - countries underperform international com Moldova parators on both measures, especially quality Israel New Zealand (Ferreira and others 2013). However, human Kuwait Hong Kong SAR, China capital for entrepreneurship and innovation Ecuador Kazakhstan - only partially overlaps with general curric Indonesia Chile - ula and is probably badly captured by gen Peru eral schooling attainment or achievements. Albania Saudi Arabia Hence, it is worth also examining the region’s India Uruguay chronic shortage of scientific and engineering Dominican Republic Oman training. Guatemala Bolivia LAC has long suffered from a dearth of Jamaica engineers: despite higher income per capita, United Arab Emirates Paraguay Argentina, Chile, and Mexico all had lower Venezuela, RB Trinidad and Tobago densities of engineers than Spain and Portu - Nicaragua El Salvador 1.17). Such historical gaps gal in 1900 (figure Costa Rica Honduras - appear to be important. Maloney and Valen 0.4 0.6 0.2 0.8 0 cia Caicedo (2012) find a positive association Herndahl index between engineering density in the 1900s and per capita income in the 2000s. World Bank, based on data from World Development Indicators and firm- level data from Orbis. Source: LAC countries still have fewer engineers Note: Bars show the average Herfindahl index of concentration of revenues across a selection of two- digit nonfinancial services sectors for which data were available for more than 80 countries. than the median country and fewer than - A value of 1 represents a market captured entirely by a single firm (the highest level of concen would be expected given their current level 10. Dots tration); lower values indicate less concentration. Revenues were averaged across 2007– represent a benchmark predicted value from a regression for each sector with (log of ) population and GDP (adjusted for purchasing power parity) as explanatory variables. The regression model was estimated for each of 17 sectors separately; the dots are the averages of all sectors. The regression used all available countries. The figure presents only comparator countries. LAC = Latin America and the Caribbean. 01_ENTinLAC_001-022.indd 17 11/21/13 4:00 PM

36 18 LATIN AMERICAN ENTREPRENEURS Number of engineers per million FI G U R E 1.18 F I G U R E 1.17 Income and engineering density in people in selected countries selected economies, 1900 LAC countries 180 Honduras United States, north Other Guyana countries 150 Uruguay Benchmark El Salvador 120 Brazil Argentina United States 90 Indonesia Colombia 60 United States, south Mexico Venezuela, RB Serbia Spain Portugal 30 Saudi Arabia Chile Brazil Engineers per 100,000 male workers Colombia Argentina Mexico Chile Peru 0 Turkey 8.0 7.0 9.0 8.5 6.5 6.0 7.5 Hungary Log of GDP per capita (US$ in 1900) Netherlands Armenia Maloney and Valencia Caicedo 2012. Source: Note: GDP = gross domestic product. Norway United States Latvia Croatia of development (figure 1.18). Even the larger Sweden and more advanced countries in the region Bulgaria (Brazil, Chile, Colombia, and Mexico) have Belgium relatively few engineers. Greece LAC students may be inclined toward Germany - nonscientific studies for at least two poten Denmark tial reasons. First, for historical reasons, Japan LAC universities have long emphasized the Malaysia Portugal humanities; law; and social, economic, and Austria political fields of study, possibly constraining Lithuania their ability to educate more engineers and Poland scientists. Switching their emphasis would Slovenia require very aggressive public policy, such as Switzerland the United States adopted when it developed Spain mining and engineering studies in the early Czech Republic 20th century. Second, young people may be New Zealand attracted to fields of studies that are relevant Slovak Republic to pressing problems faced by their societ - Ireland ies, which may explain why LAC may have Finland formed many sociologists and more macro Ukraine than micro economists. Given the progress Thailand the region has made in taming macro insta - 20 30 0 10 Engineering graduates per million - bility, there may be more incentives for stu inhabitants, ages 15–24 dents to embark on scientific careers. That said, a big push to expand engineering and Source: World Bank, based on data from World Development Indicators - scientific education at the secondary and ter and UNESCO 2013. - Bars show average number of engineering graduates per million peo Note: tiary levels may be required to accompany ple ages 15– 24. Dots are a benchmark predicted by a regression with (the rising demand for such careers. log of ) population and GDP (adjusted for purchasing power parity) as the explanatory variables. The regression uses all the available countries. The figure presents only comparator countries. Data are averages for 2008– 10. LAC = Latin America and the Caribbean. 01_ENTinLAC_001-022.indd 18 11/21/13 4:00 PM

37 vIE 19 OvER w Actual and benchmarked index of intellectual F I G U R E 1.19 - Factors that affect firms’ economic perfor property rights in selected countries or economies, 2005 mance may also adversely affect innovative entrepreneurship, although the nexus may LAC countries Guyana not be as straightforward as often believed. Thailand Other countries Despite substantial reform, business regu - Indonesia or economies Dominican Republic lations may still hamper innovative behav - Costa Rica Benchmark ior. Which specific regulations bite and how Paraguay Haiti much damage they cause, however, remain Nicaragua Saudi Arabia questions for future research. Honduras Although the region underperforms in Grenada Guatemala terms of financial services, such as long- Venezuela, RB term credit and venture capital, young firms Peru Jamaica - in LAC are not necessarily more credit con Uruguay Bolivia strained than young firms in other regions. El Salvador This potential link requires careful research, Malaysia Brazil but prima facie, it is difficult to categorically Ukraine Russian Federation state that lack of access to finance is a sig - Colombia nificant cause of the region’s innovation gap. Ecuador Trinidad and Tobago To be sure, as documented in the report on Hong Kong SAR, China (de la Torre, Financial Development in LAC India Mexico Ize, and Schmukler 2012), the region’s gap in Argentina Lithuania - bank credit is significant and has been grow Turkey ing over the past 15 years. However, much New Zealand China of this gap appears to be explained by LAC’s Israel Australia turbulent macro and financial history and by Norway the shortage of promising productive projects Romania Philippines (that is, a shortage of innovation) rather than Poland by credit rationing and credit supply-side Slovak Republic Singapore constraints per se. Moreover, the constraint Chile Greece that seems to be most relevant for bank credit Switzerland supply in LAC is weaknesses in the contrac - Spain Austria - tual (rather than the informational) envi Czech Republic ronment, which can undermine both credit Korea, Rep. Portugal supply and entrepreneurial innovation. Germany Hungary - The role of the contract enforcement envi Bulgaria ronment in the region’s innovation deficit is Sweden United Kingdom also nuanced. Insufficient intellectual prop - Belgium France erty rights may be an issue (figure 1.19), and Canada - other weaknesses in the contractual environ Italy Japan ment may also hinder innovation. But indexes Finland - of contract viability and the risk of expro Ireland Denmark priation do not indicate that LAC countries Netherlands United States - systematically underperform relative to com 3 4 5 2 parators in other regions. More research is Park index (as of 2005) therefore needed to understand the subtleties - of, and complex interactions and interdepen Source: World Bank, based on data from World Development Indicators and Park 2008. dencies between, the fundamental underpin - - Note: The Park index is the sum of five components: coverage of patents in eight industries; partici pation in five international property rights (IPR) treaties; duration of protection (relative to a global nings of LAC’s peculiar combination of many standard, such as 15– 20 years for patents); the existence of up to three enforcement mechanisms; entrepreneurs and little innovation. and the existence of up to three types of restrictions on patent rights. Bars show the 2005 Park index for each country. Dots show the predicted percentage of firms from a regression that includes (the log of ) population and GDP (adjusted for purchasing power parity) as explanatory variables. The regression used all available countries. The figure presents only comparator countries. LAC = Latin America and the Caribbean. 01_ENTinLAC_001-022.indd 19 11/21/13 4:00 PM

38 20 LATIN AMERICAN ENTREPRENEURS to increase when conditions are favorable. Structure of the report LAC countries appear to underperform The report uses a fictional story to illustrate poorer countries in terms of both entry and the characteristics of entrepreneurs and the survival rates. complex tradeoffs they face. Javier Vizzi, a Chapter 5 studies the role of foreign direct young man from Mendoza, Argentina, had investment and multinational corporations in class upbringing. His a comfortable middle- fostering a more entrepreneurial LAC. It first - parents provided him with a decent educa owned firms operating analyzes how foreign- tion, and he did not waste the opportunity. in LAC generate positive aggregate and firm- After graduating from a local university, he level spillovers. It then turns to the emergence found his first job with a local winemaker of multinational corporations from LAC and rapidly moved up the ranks. After direct - ( multilatinas ) and their impact on LAC’s ing the Buenos Aires branch of the winery entrepreneurial potential. for a few years, Javier started his own com - Chapter 6 concludes by mapping the ele - pany. He wanted to produce higher- quality ments of an enabling environment in LAC, in wines with potentially higher profit margins. an attempt to explain the region’s innovation - This endeavor required extensive experi - gap. Its brief review of empirical benchmark mentation, which his previous employer was ing exercises indicates a few priority policy unwilling to undertake. Javier took risks and areas. engaged in activities that were uncommon in his region. He hired international consul - Notes tants to teach him the latest techniques in wine- making and marketing experts to find World Bank calculations based on data 1. the best ways to sell his wines. A few years from 2010 household surveys from 15 LAC after opening, the winery had 50 employees countries. and exported a small selection of bottles to 2. Schumpeter (1911) defines entrepreneurship the United States. as “(1) The introduction of a new good ... or of a new quality good. (2) The introduction The rest of the report comprises five chap - of a new method of production... (3) The ters that track the difficult choices that entre - opening of a new market... (4) The conquest preneurs like Javier typically face at home of a new source of supply of raw materials and abroad. Chapter 2 discusses the creation manufactured goods... (5) The car or half- - of new firms and firm dynamics in LAC. It rying out of the new organization of any pays particular attention to the nature of industry...” the business being created, distinguishing 3. The LAC region comprises the following between formal and informal and small and countries: Antigua and Barbuda, Argentina, large enterprises. The chapter sets the scene Bolivia, Brazil, Chile, Colombia, Costa Rica, for the rest of the report by elaborating on Dominica, Dominican Republic, Ecuador, the key distinction between transformational El Salvador, Grenada, Guatemala, Guyana, Honduras, Jamaica, Mexico, Nicaragua, Par - and low- growth entrepreneurs. aguay, Peru, St. Kitts and Nevis, St. Lucia, St. - Chapter 3 focuses on barriers to innova Vincent and the Grenadines, Suriname, Trin- tion faced by survivors (incumbent firms) idad and Tobago, Uruguay, and República along both the product and process dimen - Bolivariana de Venezuela. sions. It also discusses the policy areas gov - 4. Throughout this chapter we use the following ernments can explore to enhance innovative groups of economies unless otherwise noted. entrepreneurship. LAC5 includes Argentina, Brazil, Chile, Chapter 4 examines a different form of Other LAC Colombia, and Mexico. includes entrepreneurship, namely, the exploration Bolivia, Costa Rica, the Dominican Repub- of new markets through exports. The mes - lic, Ecuador, El Salvador, Guatemala, Hon- sage is loud and clear: the key to success duras, Nicaragua, Paraguay, Peru, Uruguay, and República Bolivariana de Venezuela. in export markets is survival, which tends 01_ENTinLAC_001-022.indd 20 11/21/13 4:00 PM

39 vIE w 21 OvER Caribbean includes Antigua and Barbuda, References Cuba, Dominica, Grenada, Guyana, Haiti, Aghion, P., N. Bloom, R. Blundell, R. Griffith, Jamaica, St. Kitts and Nevis, St. Lucia, St. - and P. Howitt. 2005. “Competition and Inno Vincent and the Grenadines, Suriname, and - Quar vation: An Inverted U Relationship.” Trinidad and Tobago. (Eastern Europe ECA 120 (2): 701– terly Journal of Economics 28. and Central Asia) includes Albania, Armenia, Alfaro, L., and M. X. Chen. 2013. “Market Azerbaijan, Belarus, Bosnia and Herzegovina, Reallocation and Knowledge Spillovers: The Bulgaria, Georgia, Kazakhstan, Latvia, Lith- Gains from Multinational Production.” NBER uania, FYR Macedonia, Moldova, Romania, Working Paper 18207, National Bureau of the Russian Federation, Serbia, Turkey, Turk- Economic Research, Cambridge, MA. menistan, Ukraine, and Uzbekistan. EAP4 Bloom, N., and J. Van Reenen. 2007. “Measuring includes Indonesia, Malaysia, the Philip- and Explaining Management Practices across High-income economies pines, and Thailand. Firms and Countries.” Quarterly Journal of include Australia; Canada; Hong Kong SAR, Economics 122 (4): 1351– 408. China; Israel; Japan; the Republic of Korea; Busso, M., L. Madrigal, and C. Pagés-Serra. Kuwait; New Zealand; Oman; Saudi Ara- - 2012. “Productivity and Resource Misalloca bia, Singapore; Switzerland; the United Arab - tion in Latin America.” BE Journal of Macro Emirates; the United States; and all countries 30. : 1– economics 13 (1) in the European Union not included in ECA. Davis, S. J., J. Haltiwanger, and S. Schuh. 1996. The set of economies from each group used in Cambridge, Job Creation and Destruction. figures throughout this chapter varies accord- MA: MIT Press. ing to data availability. - de la Torre, A., A. Ize, and S. L. Schmuk 5. The typical LAC firm at the 90th percentile Financial Development in Latin ler. 2012. has fewer than 25 employees, as opposed to America and the Caribbean: The Road income countries and 40 in ECA and high- Washington, DC: World Bank. Ahead. almost 55 in East Asia and the Pacific (EAP4). https://openknowledge.worldbank.org Grenada is a regional outlier. Its performance 6. /handle/10986/2380. reflects the small number of firms rather than Eslava, M., and J. Haltiwanger. 2013. “Young the high incidence of new products. - Businesses, Entrepreneurship, and the Dynam on R&D 7. The OECD (2002) Frascati Manual ics of Employment and Output in Colombia’s statistics, which is used around the world, Manufacturing Industry.” Working paper, excludes investments in soil analysis and min- CAF, Caracas, Venezuela. eral exploration from R&D activities. Conse- Enterprise Surveys (database). World Bank Group, quently investments in innovation in agriculture Washington, DC. http://www.enterprisesurveys and mining tend to be underreported. .org /. 8. R&D data are classified as “productive- Exporter Dynamics Database. World Bank, sector” R&D when financing comes from Washington, DC. http://data.worldbank.org a company that participates in the market. /data-catalog/exporter-dynamics-database. Companies can be publicly owned, blurring Fernandes, A. M., D. Lederman, and M. Gutierrez- the distinction between “private” and “pub- Rocha. 2013. “Export Entrepreneurship and lic” R&D. In this report, as in others, such as Trade Structure in Latin America during Good is used to private Pagés-Serra (2010), the term and Bad Times.” World Bank Policy Research characterize “productive- sector” R&D. Working Paper 6413, Washington, DC. This exercise took into consideration cross- 9. Ferreira, F. H. G., J. Messina, J. Rigolini, L.-F. country differences in GDP per capita, sec- López- Calva, M. A. Lugo, and R. Vakis. 2013. specific effects toral composition, and year- Economic Mobility and the Rise of the LAC (such as the global recession of 2008– 09). Middle Class. Washington, DC: World Bank. The distinction between tradables and non- 10. Gindling, T. H., and D. L. Newhouse. 2012. tradables is important. Domestic market “Self- Employment in the Developing World.” concentration could be high in the sense that Policy Research Working Paper 6201, World few domestic firms participate in an industry, Bank, Washington, DC. but if domestic firms compete with imports, Haltiwanger, J., R. Jarmin, and J. Miranda. domestic market concentration would be a 2013. “Who Creates Jobs? Small versus Large poor proxy for competition. 01_ENTinLAC_001-022.indd 21 11/21/13 4:00 PM

40 22 LATIN AMERICAN ENTREPRENEURS Orbis (database). Bureau van Dijk, Amsterdam, the versus Young.” NBER Working Paper 16300, Netherlands. http://www.bvdinfo.com/en-us National Bureau of Economic Research, Cam - /products/company-information/international bridge, MA. /orbis-(1). Hausmann, R., and D. Rodrik. 2003. “Develop - - The Age of Productiv Serra, C., ed. 2010. Pagés- Journal of Develop - ment as Self- Discovery.” ity: Transforming Economies from the Bottom ment Economics 72 (2): 603– 33. - American Devel Washington, DC: Inter- Up. Javorcik, B., and M. Spatareanu. 2005. “Disen - opment Bank. tangling FDI Spillover Effects: What Do Firm Park, W. 2008. “International Patent Protection, - Perceptions Tell Us?” In Does Foreign Invest 66. 1960 – 20 05.” Research Policy 37: 761– - ment Promote Development?, edited by The Schumpeter, J. 1911. Theorie der Wirtschaftlichen odore Moran, Edward Graham, and Magnus Entwicklung. Leipzig: Duncker & Humblot. Blomström, 45– 72. Washington, DC: Center Seker, M. 2013. “Innovation Performance in for Global Development. - Latin America and Caribbean Region.” Back Lederman, D., and W. Maloney. 2003. “R&D ground paper for this report. and Development.” Policy Research Working - Shiller, R. S. 2013. “Why Innovation Is Still Capi Paper 3024, World Bank, Washington, DC. 17. A u g u s t New York Times, talism’s Star.” Lederman, D., M. Olarreaga, and L. Zavala. - UNESCO (United Nations Educational, Scien 2013. “Export Promotion and Firm Entry tific and Cultural Organization). 2013. Data and Survival: Evidence from a Panel of LAC Center, Institute for Statistics. http://stats.uis Firms.” World Bank, Washington, DC, and .unesco.org/unesco/ReportFolders/Report University of Geneva, Geneva. Folders.aspx. Lerner, J., and A. Schoar. 2010. “Introduction USPTO (U.S. Patent and Trademark Office). to International Differences in Entrepreneur - 2012. “Patents by Country, State, and Year: ship.” In - International Differences in Entre All Patent Types.” Washington, DC. http:// 13. Cambridge, MA: National preneurship, 1– www.uspto.gov/web/offices/ac/ido/oeip/taf Bureau of Economic Research. /cst_all.htm. Maloney, W. F., and M. Sarrias. 2012. “What Vollrath, T. 1991. “A Theoretical Evaluation Makes LAC Managers So Bad?” World Bank, of Alternative Trade Intensity Measures of Washington, DC . Review of Revealed Comparative Advantage.” Maloney, W. F., and F. Valencia Caicedo. 2012. World Economics 80. 2: 265– Part II: Engineers, Innovative Capacity and Doing Business 2013: Smarter World Bank. 2013. Development in the Americas. World Bank, Size Regulations for Small and Medium- Washington, DC . Enterprises. Washington, DC: World Bank. Moran, T. 2001. Parental Supervision: The New World Bank Group Entrepreneurship Snap - Paradigm for Foreign Direct Investment and shots (WBGES). World Bank, Washington, Development. Washington, DC: Institute for DC. http://www.doingbusiness.org/data International Economics. /exploretopics/entrepreneurship. National Science Board. 2012. “Science and Engi - World Development Indicators (database). World neering Indicators 2012.” National Science Bank, Washington, DC. http://data.worldbank Foundation, Arlington, VA. .org/data- catalog/world- development operation OECD (Organisation for Economic Co- - indicators. and Development). 2002. Frascati Manual: World Integrated Trade Solution (WITS) (data - Proposed Standard Practice for Surveys on base). World Bank, Washington, DC. http:// Research and Experimental Development. wits.worldbank.org/wits/. Paris: OECD. 01_ENTinLAC_001-022.indd 22 11/21/13 4:00 PM

41 Entrepreneurship, Entry, and the 2 Life Cycle of Firms in Latin America and the Caribbean: Are All Forms of Firm Creation Entrepreneurial? Contrary to popular perception, Latin America and the Caribbean has a vibrant entrepre- neurial sector. Indeed, the share of entrepreneurs, employers, and formal businesses is larger income regions. Firms are smaller than in other regions at similar levels than in other middle- of development, however, with even the largest firms creating fewer jobs than their coun- terparts in other regions. These patterns are reproduced in other environments. After long periods in the United States, migrants from the region are about as likely as natives to own small businesses, but few of them own large, employment- generating firms. - ntrepreneurship is multifaceted; sim new market. The two extremes are inversely - ple definitions fail to capture the het - related. If there are many dynamic entrepre E erogeneity of innovative acts included neurs in the economy, there will be an abun - under this umbrella. Most definitions view dance of good jobs, reducing the incentives - the creation of new firms as a critical dimen for start- ups with low growth potential. sion of the entrepreneurial process. Indeed, Conversely, too few innovative entrepreneurs entry has been considered central to the will generate few employment opportunities, complex process of entrepreneurship since pushing some workers who may not have the seminal work of Schumpeter (1934). an innate ability or interest in running their However, not all entry is the same: simply own business to accept employment oppor - working for oneself or creating an enterprise tunities with low growth potential. Although creating is not the same as engaging in job- both types of entrepreneurs are found in all entrepreneurship. countries, the lack of good jobs in developing Some business owners create their firms - countries suggests that low- growth entrepre very much in the Schumpeterian tradition, neurship may be more prevalent at low levels with the goal of creating something new of development. to bring to the market, revolutionizing the Not surprisingly, this tremendous hetero - economy, and creating jobs. Others create geneity in entry motives translates into a no their firms in response to grim employment less heterogeneous picture in the distribution prospects, as a mean of subsisting rather of incumbent firms. As in a forest, where than creating a new product or entering a small and large trees coexist, large and small 23 02_ENTinLAC_023-060.indd 23 11/21/13 5:42 PM Entrepreneurship, Entry, and the Life Cycle of Firms in Latin America and the Caribbean

42 24 LATIN AMERICAN ENTREPRENEURS bias toward smaller firms generates insuf - firms compete even within very narrowly - ficient formal employment opportunities. In defined sectors. Large firms are the larg the absence of better employment prospects, est employers in every sector. In the United many people end up working for themselves, States, for instance, the largest 5 percent of fueling a vicious cycle of small size and few firms accounted for more than 75 percent good jobs for future job seekers. of employment by the end of the 2000s; The chapter ends by investigating whether in Mexico, the largest 10 percent of firms the behavior of entrepreneurs in LAC is accounted for 70 percent of employment linked to the environment in which they (Bartelsman, Haltiwanger, and Scarpetta operate or has deeper causes, perhaps linked 2009). At the same time, the vast majority of firms are small. In high- - to cultural roots or human capital character income countries, istics. It finds that historically, people in the about 70 percent of firms had fewer than five employees in 2010 (Klapper and Randall region have not been predisposed to become entrepreneurs who transform the business 2012). In Argentina, Brazil, Chile, Colombia, environment. Most large firms in the region and Mexico (LAC5), 9 of every 10 firms have fewer than five employees. Indeed, slightly at the beginning of the 20th century were foreign owned. Even in the United States— in more than 60 percent of business owners in the Latin American region report having no an environment that is more conducive to people from LAC are less entrepreneurship— paid employees (Klapper and Randall 2012). This chapter has a double purpose. First, entrepreneurial than migrants from other regions of the world. But there is some room it examines the process of business creation for optimism. Migrants from LAC slowly in Latin America and the Caribbean (LAC), adapt to the new business environment. After benchmarking its performance against that long periods in the United States, they catch of other regions and characterizing the nature of entry across countries. Second, it up with natives and migrants from other regions in ownership of small- studies the life cycle of firms in the region, scale firms. They continue to lag in ownership of large the frequency with which they grow, and dif - ferences in the process across countries and companies, however. type of firm. The chapter does not provide an - in- depth analysis of the behavior of incum Low- level entrepreneurs, bent firms, the subject underlying most of the high- level entrepreneurs, following chapters. Instead, it provides an and employees overview of business dynamics in the region, The story of a fictional family of Italian leaving the discussion of the determinants of - immigrants illustrates the different motiva these dynamics for the rest of the report. - The chapter shows that there is substan tions that may trigger the creation of new firms. The Vizzis settled in Mendoza, Argen tial creation of new firms in LAC countries, - tina, at the beginning of the 20th century to at both the low and high ends of the entre - preneurial spectrum. Indeed, in the formal work in the fields. The eldest of their three - sector, the process of creation (and destruc children, Maria, had no opportunity to go to tion) does not differ much from that found in school. As soon as she learned to read and other regions at similar levels of development write, her parents asked her to help with the and even shares some characteristics found crops. Her brothers, Lucio and Javier, were luckier. By the time they reached school age, in more advanced countries. However, the - Maria was 15 and contributing to the house vast majority of new businesses in LAC are hold income, so their parents could pay for microfirms that will remain tiny throughout their life span. Even firms that grow rapidly their studies. The boys did not waste their opportunities, finishing high school and never catch up in size with firms the same age in other parts of the world. This strong enrolling in college. Their parents were very 02_ENTinLAC_023-060.indd 24 11/21/13 5:42 PM

43 C CLE of fIRMS IN LATIN A MERICA ANd ThE Cy ARIbbEAN 25 ThE y, ANd ENTREPRENEURShIP , ENTR LIfE loan, bought a trolley, and in a matter of proud to see their sons become economists weeks was selling alfajores on the streets of (although they never quite understood what Mendoza. She had no intentions to grow her economists exactly did). business, preferring to stay below the radar - The three siblings saw few opportuni screen of the government. Hence, she never ties for progress in the fields; as soon as they formally registered her business. could, they went to the province’s capital to look for jobs. Being hard workers, they soon Lucio and Javier were luckier with the - recession. Lucio worked in the public sec found themselves with their first paid jobs. Maria worked in a restaurant at the train tor, where wages and jobs were relatively station. Lucio and Javier started as clerks. insulated from business cycle fluctuations. Lucio found a job as an accountant for He was happy with his job, which was not very challenging but paid a good salary and the local government. Javier found a job at provided him with a lot of free time. He was Vinos Torreón, a family firm that produced known and sold one of the soon to be well- not ambitious. He accepted a promotion as wines from the area. Life was good. Wages a manager, but after a few stressful months were not spectacular, but they were enough returned to his old job. All he wanted was to enjoy a quiet life, perhaps raising a couple of to allow all three siblings to save some money children one day. and send some cash to their parents every other month. The 1981 recession hit the winery, but Javier had no trouble keeping his job. He Life was soon to change for them all. In had the rare ability to create an affable and 1979, passenger service between Mendoza and Chile was terminated. Business at the workers relaxed work environment where co- were happy, becoming more reliable and restaurant fell steadily, and by the end of more committed to their job. Javier enjoyed 1980, Maria found herself searching for a the process and knew he was good at it. His new job. At first Maria was optimistic. During bosses also recognized his talent. Hence, it came as no surprise when his company asked her time at the restaurant, she learned how him to run the small office the company was to cook, which she thought would give her planning to open in Buenos Aires. plenty of opportunities in the many restau - rants in the city. But the 1981 recession had The Buenos Aires office was a success. hit hard. As a result, she was able to find only - Javier learned a lot about the wine busi temporary jobs, which provided no job stabil - ness and developed a wide network of cli - ents. Buenos Aires exposed him to the great ity and did not allow her to use her recently French, Italian, and Spanish wines, which acquired cooking skills. he learned to love. He had talked with wine After six months, money was starting to - become a serious concern. One day Maria experts around the world and had the con viction that conditions in Mendoza were was walking down the street after another quality wines, not right for producing top- failed attempt to see a chef when she stopped just decent table wines like Vinos Torreón. at the gate of a school to watch a group of Prospects were promising, but every time he children playing football. When the bell rang, tried to convince the company’s owners of the kids ran to the exit, briefly greeting the added parents waiting at the gates before scram the need to move upward in the value- - bling toward a little trolley from which a man chain, they looked at him with incredulity. Feeling increasingly frustrated, he decided was selling alfajores de maizena, A rgentina’s sweet biscuits. In that second Maria saw the the time had come to move on, perhaps to start his own business. light: “I could do this!” she thought out loud. Soon enough, she put her passion and the Javier quit his job in 1987 and went back skills acquired at the restaurant into a new to Mendoza. After talking to more than 100 venture. She asked her brothers for a small local farmers, he found the right hill on which 02_ENTinLAC_023-060.indd 25 11/21/13 5:42 PM

44 26 LATIN AMERICAN ENTREPRENEURS to plant his grapes. The soil was perfect and - similar teachers and peers, but they have dif ferent abilities and ambitions. Javier has the the orientation ideal. Now he needed money. rare ability to motivate others. He can make Obtaining it proved more difficult than Javier - had expected. Local bankers in Mendoza did everyone more productive by identifying peo ple’s relative strengths and combining them not understand his business plan. Why waste all that money bringing oak barrels from effectively. Lucio does not have this ability. France when local barrels worked just fine? Although he is a good worker, he is not moti - vated by the challenge of change, and he finds They thought he was a visionary enthusiast. management stressful. He will never be inter - In Buenos Aires it was not much easier, but ested in running his own business. (These in the end he managed to convince a banker entrepreneurial skills are studied in detail in of the merits of his project. Once money was secured, he bought the land, registered the CAF 2013.) new business with the relevant authorities, Entrepreneurs like Maria are abundant. On average, 28.8 percent of income earners hired a small group of laborers, and planted the first grapes. In 1990, he produced his first in LAC are self-employed or small employ - 1 ers. wine; by 1993, he employed 50 workers. Few of them ever hire workers. In This story highlights some of the features Colombia, for example, only 0.3 percent of the self- employed became employers in of entrepreneurism in every economy in the - world. All three siblings started as wage earn a three- year period (Mondragón and Peña - ers; two of them decided to become entrepre - 2010). In contrast, high- growth entrepre neurs like Javier are extremely rare: less than neurs, albeit for different reasons and with different sets of skills. Maria and Javier have 0.4 percent of income earners in LAC own 2 a business employing 50 workers or more. different education levels, which are typically associated with different levels of ability to However, their contribution to employment is huge: some 45 percent of employees in transform a raw idea into a business project. LAC work for medium-size and large firms On average, transformational entrepreneurs (firms employing 50 workers or more). Wage like Javier have more years of schooling than potential entrepreneurs like - employees like Lucio represent the most com low- growth- - Maria. The nature of the business they cre mon type of worker in the region, accounting for the remaining 70.8 percent. ated is also different. Maria adopted a well- established business model. Her prospects for growth are probably low. In contrast, Javier Theoretical framework created something new by introducing high- Most of this report focuses on the different quality wines in an area specialized in table wines. entrepreneurial activities that innovators like Javier put in place. Before focusing on Javier- Education is clearly related to the type of business created. As shown later in this chap type entrepreneurs, this chapter starts by - comparing the differences between the three ter, formal business owners are much more siblings highlighted in the story in a more likely to have attended college than informal formal setting. business owners. On average, across coun - The main ingredients of this fictional story tries in LAC, 21 percent of people with a - can be built into a simple theoretical frame - tertiary degree own a business. About 15 per work following Poschke (2013a). Consider cent registered their business; 6 percent did a population that is heterogeneous in “abil - not. Among people with only primary educa - tion the pattern is reversed: about 9 percent ity,” as proxied, for example, by educational own an informal business and 5 percent own attainment. Workers with different abilities a formal enterprise. Education is not the only can choose to work for themselves (that is, determinant of entrepreneurship, as the con - to become entrepreneurs) or for someone trast between Javier and Lucio shows. Javier else (that is, to work as wage employees). and Lucio went to the same schools, had The value of dependent employment can be 02_ENTinLAC_023-060.indd 26 11/21/13 5:42 PM

45 ENTREPRENEURShIP y, ANd ThE LIfE Cy CLE of fIRMS IN LATIN A MERICA ANd ThE C ARIbbEAN 27 , ENTR FIGURE 2.1 Model of entrepreneurship a. Two types of entrepreneurs b. Taxes and evasion B’ B C A D Value of employment (wages) Value of employment (wages) A’ Employees a a L H Ability Ability Subsistence Transformational entrepreneurs entrepreneurs Employment Entrepreneurship 2013a . Poschke Source: - some cases, entrepreneurship serves as a buf thought of as a linear function of ability: the more able an individual is, the higher the fer before workers find better employment opportunities. In others, where the income - value of becoming an employee (for simplic ity, measured by wages), as shown by the red obtained from the small business is higher than the wage offered by the market, low- lines in figure 2.1. What is the value of entrepreneurship? In end entrepreneurship becomes permanent. ability entrepreneurs are labeled contrast with wage employment, the value These low- - low- growth- of entrepreneurship does not need to be lin potential entrepreneurs or, for simplicity, low- growth entrepreneurs. ear in ability. At the high end of the ability Hence, the value of entrepreneurship is spectrum, the value of entrepreneurship is a convex function of individual talent (and - high, because the value of a great entrepre neurial idea or great management skills can education), as depicted by the orange curves 3 The payoff functions for wage in figure 2.1. be spread across inputs used in the firm, employment and entrepreneurship intersect augmenting these inputs. The idea that an and a < a a . Individuals with a twice, at entrepreneur’s ability multiplies the value of H L L a or become entrepreneurs; individuals a > inputs in the production process goes back H with intermediate skills (for example, Lucio to the seminal work of Lucas (1978). Hence, in our fictional story) become employees. for very high- ability individuals, becoming High- ability individuals like Javier become an entrepreneur is more lucrative than being entrepreneurs because their ability allows an employee. These individuals are “transfor - them to expand the marginal product of the mational entrepreneurs” (following Schoar ability individuals like firm’s inputs. Low- ability entrepreneurs, or high- 2010), high- Maria become entrepreneurs because the growth-potential entrepreneurs. expected payoff from entrepreneurship is Entrepreneurship is also more valuable - higher than the payoff from wage employ than employment at the low end of the abil - ment, a finding that is very much in line with ity distribution, for a variety of reasons. Self- the evidence reported by Maloney (2004). employment may serve as an alternative to Thus, there is no market segmentation in the dependent employment after job loss, when ability entrepreneurs are likely model. High- - finding a job takes a long time. This motiva to run larger, more complex firms than their tion is important in developing countries. In 02_ENTinLAC_023-060.indd 27 11/21/13 5:42 PM

46 28 LATIN AMERICAN ENTREPRENEURS a prediction con - entrepreneurship moves to the left, from A ability counterparts— low- firmed by the data analyzed in this chapter. to A ʹ - . However, the reduction in the num To be sure, ability and the relative pay ability entrepreneurs reduces - ber of high- offs of entrepreneurship versus paid employ - the number of large firms hiring workers, reducing the wage rate, as illustrated by the ment are not the only factors determining movement to the right of the wage schedule. an individual’s occupational choice. Some - ability workers who previously found it Low- individuals with a natural talent for entre advantageous to work as employees now find preneurship may dislike the risk involved in dependent employment less valuable, opting entrepreneurism. Alternatively, employees for entrepreneurship. In the new equilibrium, with no particular talent for entrepreneurism may want to be their own bosses. They may the number of low- ability entrepreneurs increases, as depicted by point D. Thus, when prefer opening their own business even if the monetary value of dependent employment is taxes fall more than proportionally on large firms, rising taxation reduces employment in higher. If such preferences are uncorrelated larger firms and, through lower wages, stim - with ability, the main insights of this simpli - ulates the creation of small enterprises. fied theoretical framework remain valid. In In the real world, the distinction between the presence of preference heterogeneity, it low- would still be true that the average ability of ability entrepreneurs is and high- blurred; it is probably better approximated end entrepreneurs is higher than that of high- - employees and low- end entrepreneurs. by a bimodal distribution with a concentra tion of entrepreneurs at the low and high ends One of the important insights of the the - of the ability distribution but a continuum oretical discussion here is that it helps us 5 The heterogene - understand that, in general equilibrium, fac - across the ability spectrum. ity of real world experiences is captured in a tors affecting firm profits also affect wages, very rough manner in the data. and thus may alter both the value of entrepre - This chapter uses several proxies for the - neurship and that of employment. An excel two types of entrepreneurs that help approxi - lent example is the effect of changes in firm mate the heterogeneous nature of entrepre - related taxes. Many rules and regula - size– neurship around the world in general and in tions apply only to firms above a certain size LAC in particular. Depending on the data, or are enforced more strictly for larger firms. income countries, for example, low- employed, In many high- ability entrepreneurs are self- own unregistered businesses, have no small firms are exempted from employment 4 In low- protection and severance payments. employees, and were pushed into entrepre - income countries, where tax eva - - neurship by lack of opportunity in the for and middle- ability entrepreneurs are sion is pervasive, taxation is expected to fall mal sector. High- more than proportionally on larger firms. employers, own registered businesses, and were pulled into entrepreneurship because Larger firms also face stricter enforcement of payment of nonwage benefits to workers, as they had a great idea or saw a good business opportunity. Almeida and Carneiro (2011) show for Brazil. Panel b of figure 2.1 shows the impact contingent taxes of an increase in firm size– Employers, employees, on entrepreneurship. The increase in taxes and the self- employed - reduces firms’ profits, muting the incen One fundamental distinction is the ability or tives to become a high- ability entrepreneur. - willingness of the entrepreneur to hire work The threshold for high- ability entrepreneurs - ers. Our framework predicts that transfor shifts to the right, from point B to C. At the mational entrepreneurs will run larger firms - low end of the ability distribution, the gen than low- growth entrepreneurs, because their eral equilibrium effects become fundamental comparative advantage lies precisely in orga - for occupational choice. If wages were fixed, nizing the working environment. A rough ability entrepreneurs would the share of low- empirical counterpart of this distinction that ability also fall, as the threshold for low- 02_ENTinLAC_023-060.indd 28 11/21/13 5:42 PM

47 ThE LIfE Cy CLE of fIRMS IN LATIN A MERICA ANd ThE C ARIbbEAN 29 y, ANd , ENTR ENTREPRENEURShIP is easily found in household surveys around including agricultural of occupation shares— - workers, self- the world is the separation between employ employed, employers, wage 6 employed. employees, and nonpaid employees (in gen - ers and self- eral family members who work in the family Following Gindling and Newhouse with gross 2.2 examines the correlation business without a regular wage)— (2012), figure Occupational choice and GDP per capita, 2010 FIGURE 2.2 b. Nonagriculture, wage and salaried a. Agricultural workers 100 100 80 80 CHL URY CRT 60 60 JAM VEN SLV GTM DOM SLV COL PRY BOL ECH HND 40 40 HTI HND PER PER BOL PRY ECU GTM HTI COL 20 20 JAM VEN SLV MEX Agricultural workers (%) DOM CHL CRI URY NonAg, wage and salaried (%) 0 0 8 11 6 7 9 10 6 7 11 8 10 9 Log of GDP (PPP) per capita Log of GDP (PPP) per capita c. Nonagriculture, unpaid d. Nonagriculture, employer 8 6 SLY 6 CRI 4 PER HND ECU MEX ECU BOL GTM VEN PRY PRY VEN MEX 4 SLV GTM URY 2 PER DOM BOL URY COL HND COL CHL CRI JAM CHL HTI JAM 2 DOM 0 NonAg, unpaid (%) NonAg, employer (%) HTI 0 –2 10 11 6 7 8 9 7 11 6 10 9 8 Log of GDP (PPP) per capita Log of GDP (PPP) per capita LAC countries Non-LAC countries e. Nonagriculture, own account 40 HTI DOM COL 30 VEN SLV HND PER URY BOL ECU 20 PRY JAM CHL CRI GTM MEX 10 NonAg, own account (%) 0 8 9 10 11 7 6 Log of GDP (PPP) per capita Source: World Bank based on Gindling and Newhouse 2012 and data from World Development Indicators. Note: Curves show quadratic fitted values in each panel. GDP = gross domestic product. LAC = Latin America and the Caribbean. NonAg = nonagricultural. PPP = purchasing power parity. 02_ENTinLAC_023-060.indd 29 11/21/13 5:42 PM

48 30 LATIN AMERICAN ENTREPRENEURS domestic product (GDP) per capita across 74 The simple theoretical framework also 7 countries. generates an implicit distribution of income, - At very low levels of GDP per cap ita, the vast majority of workers are involved growth entrepreneurs earn less in which low- than wage employees, who in turn earn less in primary activities or, if they work outside than transformational entrepreneurs. Indi - - agriculture, unpaid labor. As GDP per cap ita rises, the share of workers in agriculture - vidual heterogeneity with regard to prefer ences for entrepreneurship would widen the declines and self- employment increases. This pattern is consistent with a move to cities, distribution of income within each group, where a new form of informal employment, - but it should still be the case that on aver nonagricultural self- - age the income of the transformational entre - employment, is com preneurs exceeds that of employees, which mon. As GDP per capita continues rising, the employed. In shares of self- exceeds the income of the self- employed and unpaid family - seeking empirical support for this prediction workers decline, hand in hand with mono of the framework, we continue with the par tonic increases in the shares of employers and - 8 allel between self- employed and low-growth- Although these patterns are paid employees. section of countries, potential entrepreneurs, as well as employers obtained from a cross- they are very consistent with the evolution of and high- growth entrepreneurs, studying employment over time that takes place as self- their distribution of income together with 9 countries develop. that of wage employees in LAC countries 10 using data from household surveys. They are also consistent with our sim - Figure 2.3 shows the distribution of ple theoretical framework if technological annual income across the three groups for the change more than proportionally benefits ability individuals. In this scenario, a LAC5 countries as a group and for 11 other high- pattern that is the reverse of that shown in countries in the region for which comparable 11 In both figure 2.1 (panel b) emerges. Technologi - data is available (“Other LAC”). ability individuals cal advances push high- groupings, the differences in the distributions confirm the predictions of the theory. On into entrepreneurship. At the other end of the spectrum, better technologies provide - average, employers dominate the income dis ability individuals to enter tribution of employees, and the lowest paid incentives for low- workers are own- account workers. entrepreneurship, but higher wages induced There is an important exception to this by technical change more than outweigh the rule. Panels c and d present the cumulative direct effect of technology on occupational distribution functions of the three groups. choice. Thus, technical change reduces the The horizontal differences are informative share of low- ability workers moving into self- employment. about the income distances between each - group at each percentile of the income dis Considering its level of development, LAC tribution. In both LAC5 and Other LAC, stands out as a fairly entrepreneurial region employers are better off than paid employees when benchmarked against the rest of the only after the 20th percentile; the bottom world. Its share of employers is well above 20 percent of paid employees do better than the share predicted by GDP per capita (panel the bottom 20 percent of employers. 2.2). However, these employers d in figure A second important stylized fact is that do not generate sufficient wage or salaried the distributions of entrepreneurs (both low- employment, as the share of own- account end) have higher variances than workers is also above expected levels (panel e end and high- the distribution for employees. This pattern 2.2). These data suggest that there is in figure may indicate the ex post realization of one something in the nature of the firms created in LAC that prevents them from generating important dimension of entrepreneurship not 12 High- and low- ability sufficient paid employment for the working- discussed so far: risk. entrepreneurs appear to face higher ex ante age population. This report tries to provide risk than paid employees. some answers as to why this is the case. 02_ENTinLAC_023-060.indd 30 11/21/13 5:42 PM

49 LATIN y, ANd ThE LIfE Cy CLE of fIRMS IN , ENTR A MERICA ANd ThE C ARIbbEAN 31 ENTREPRENEURShIP Income distribution in Latin America and the Caribbean by type of occupation, circa 2011 FIGURE 2.3 b. Distribution in Other LAC a. Distribution in LAC5 0.8 0.6 0.6 0.4 0.4 Density Density 0.2 0.2 0 0 2 0 6 2 0 4 10 8 6 8 4 10 Log of labor income Log of labor income d. Cumulative distribution in Other LAC c. Cumulative distribution in LAC5 1.0 1.0 0.8 0.8 0.6 0.6 probability population 0.4 0.4 0.2 0.2 Cumulative Cumulative 0 0 4 2 4 6 8 10 8 10 0 0 2 6 Log of labor income Log of labor income Wage employee Employer Self-employed Source: Socio-Economic Database for Latin America and the Caribbean (SEDLAC). Note: Distribution includes people ages 25– 65 years with positive income. Distribution is weighted so that each country has the same importance. Outliers (points in the top or bottom 0.5 percent for each country and category) are excluded. For countries included in each group, see note 11. Low- growth and high- growth - work, or for their own or their family’s busi entrepreneurs ness. Respondents who answered “yes” to employment may provide a rough proxy Self- - employed but “no” to being a busi being self- for low- growth entrepreneurs, but the group employed ness owner were classified as self- is highly heterogeneous. Professionals, and not considered as business owners in this including doctors, architects, lawyers, and analysis (Klapper and Randall 2012). journalists, often work as freelancers and On average, 15 percent of adults in LAC employed, even if they are consequently self- report owning a business. This figure is do not necessarily own a business. The dis - exactly in line with the average in the rest tinction between self- employed workers and of the developing world. It hides substantial business owners is blurred and not easily group heterogeneity, however: owner - within- - identifiable from household surveys. How - ship ranges from less than 10 percent in Uru ever, the Gallup World Poll Survey (described guay and Panama to more than 20 percent in box 2.1) separates the two. People who in Bolivia, Colombia, Ecuador, and Haiti. responded affirmatively to the question “Do An additional 12 percent of adults in LAC - you currently own a business?” were clas employed but not owning a report being self- - sified as business owners. Adults were clas business. employed if they worked even sified as self- A follow- up question was added in the - minimally in the last seven days for them Gallup World Poll Survey to investigate selves, as a freelancer, performing contract the importance of formal versus informal 02_ENTinLAC_023-060.indd 31 11/21/13 5:42 PM

50 32 LATIN AMERICAN ENTREPRENEURS Main databases used in the study BOX 2.1 SEDLAC Exporter Dynamics Database The Exporter Dynamics Database covers measures Economic Database for Latin America The Socio- - of exports growth and selected characteristics of and the Caribbean (SEDLAC) compiles the micro exporters in 38 developing and 7 developed coun data from the main household surveys carried out - tries. The firm- - in LAC countries. Great effort is made to standard level information, collected directly - ize the data to allow cross- country comparability. from customs information, is available primar ily for the period 2003– 10. Information includes The database includes information from more than 200 household surveys carried out in 25 countries basic characteristics of exporters (numbers, size, (Argentina, the Bahamas, Belize, Bolivia, Brazil, growth); their concentration and degree of diver - Colombia, Costa Rica, Chile, Dominica, the Domin - sification in products and markets; their dynam - ican Republic, Ecuador, El Salvador, Guatemala, ics (entry, exit, and survival); and the average unit - Guyana, Haiti, Honduras, Jamaica, Mexico, Nica - prices of the products they trade. More informa tion is available at http://econ.worldbank.org ragua, Panama, Paraguay, Peru, Suriname, Uruguay, and República Bolivariana de Venezuela). In each /exporter- dynamics- database. period, the sample of countries represents more than 97 percent of the total population. The database Gallup World Poll Survey mainly covers the 1990s and 2000s, although it also The Gallup World Poll Survey surveyed more than has information for previous decades on a few coun - - 150,000 adults in 148 economies in 2011. The sur tries. More information is available at http://sedlac vey is representative of the adult population in each .econo.unlp.edu.ar/eng/. country. The core questionnaire includes detailed information on demographics (gender, age, marital World Bank Enterprise Surveys being and life/job status, education); income; well- satisfaction; trust in institutions, family, and strang - The World Bank’s Enterprise Surveys database ers; and jobs. The World Bank and the Bill & Melinda includes firm- level information on a representative Gates Foundation recently partnered to include - sample of registered firms in the nonagricultural for information on the use of formal and informal pay - mal private sector. The surveys cover a broad range ments, savings, credit, and insurance. More infor - of business environment topics, including corruption, mation is available at http://www.worldbank.org infrastructure, crime, competition, access to finance, /globalfindex and http://www.gallup.com/strategic and performance measures. The World Bank collects consulting/en- us/worldpoll.aspx. face interviews with top to- these data through face- - managers at and owners of more than 130,000 com Orbis panies in more than 135 economies. The database includes about 187 surveys from about 100 countries. Orbis is a commercial database compiled by the 1,800 interviews are conducted Typically, 1,200– Bureau Van Dijk. It contains standardized finan - size in larger economies, 360 interviews in medium- cial accounting information on companies world - - economies, and 150 in smaller economies (for exam wide, with an emphasis on private sector firms. It ple, the survey for The Gambia in 2006 included 33 contains information on more than 100 million firms, the one in Ecuador in 2010 included 366 firms, listed and unlisted companies, including 50 million and the one Brazil in 2009 included 1,802 firms). In in Europe, 30 million in the Americas, and 15 mil - LAC, firms with five or more employees are included, Pacific region. The database covers lion in the Asia- and firms owned 100 percent by the state are 2002– - 11, but the availability of information var excluded. Two different surveys are conducted, one ies greatly depending on the country. Orbis does for service industry firms and another for the manu - not follow a particular sampling strategy, which facturing sector; both surveys contain a common poses serious questions on the extent of the data’s core set of questions. The last and most complete representativeness. Listed firms present the most wave of data are for 2009– 10. More information is complete level of information. More information available at http://data.worldbank.org/data- catalog is available at http://www.bvdinfo.com/Products /enterprise- surveys. Information/International/Orbis- /Company- (1). 02_ENTinLAC_023-060.indd 32 11/21/13 5:42 PM

51 y, ANd LIfE Cy CLE of fIRMS IN LATIN A MERICA ANd ThE C ARIbbEAN 33 , ENTR ENTREPRENEURShIP ThE Rate of formal business ownership in selected country FIGURE 2.4 business ownerships. People identified as groups, countries, and economies, 2011 - business owners were asked: “Have you for 13 mally registered your business?” - Respon 100 dents who answered “yes” were classified as formal business owners; respondents who 90 answered “no” were classified as informal 80 business owners. 70 More than half of the businesses owned 60 in LAC are not formally registered, a share similar to China (56 percent) and the EAP4 50 89.0 countries (Indonesia, Malaysia, the Philip - 40 Owners (%) pines, and Thailand) in East Asia and Pacific 70.3 30 (60 percent) but much higher than in Eastern 45.4 44.0 43.0 20 40.3 40.0 Europe and Central Asia (ECA) (30 percent) and high- income economies, where only 1 in 10 19.0 every 10 businesses is not formally registered 0 High- LAC5 China Caribbean Other India EAP4 ECA (figure 2.4). Within LAC, Chile, Ecuador, income LAC Panama, Paraguay, and Uruguay stand out economies Formal rm Informal rm - as the countries with the highest rate of busi ness formality. More than half of business Source: Klapper and Randall 2012, based on data from Gallup World Poll Survey. owners in these countries formally registered Note: The sample includes only the working- age population. Each country or economy has the same weight in the regional average. For countries and economies included in each group, see - their businesses. In contrast, less than 30 per note 11. cent of business owners in the Dominican Republic, El Salvador, Guatemala, and Haiti reported doing so. have only elementary education. Similar pat - Do business owners of formal and infor - terns are found in the other country groups. mal firms look alike? The propensity of The gender gap is consistent across the two people to engage in different forms of entre - types of business owners but differs greatly in preneurial activities— and job creation— magnitude and across country groups. The naturally depends on social and individual difference between men and women is larger characteristics, such as gender, culture, and for formal business ownership. In LAC5, religion (Iyer and Schoar 2010; Ardagna and - for instance, 8.8 percent of men own a for Lusardi 2010; Djankov and others 2005). mal business, compared with 5 percent of The typical formal and informal business women; 9.4 percent of men and 7.2 percent owner has very different socioeconomic char - of women own informal firms. Similar differ - acteristics (table 2.1). Compared with the ences are found in the other middle- income general population, formal business own - regions, with China and India standing out ers tend to be older, male, urban, and well - at the two extremes of the distribution. Chi educated, with an income in the upper level nese women are almost as likely as men to be country income distributions. of the within- formal entrepreneurs, and India has the larg - Informal business owners are also older and est gender entrepreneurship gap. more likely to be men, but there is no clear One of the striking features of businesses relationship with income, and they are likely in LAC is their small size. Indeed, the most to be less educated than the average worker. common firm in LAC has no employees, In LAC5, for example, about 9 percent of according to survey respondents who own an adults with elementary education as their - establishment. Such bias toward micro estab highest educational credential own an infor - lishments is evident among formal firms; it is mal business, as opposed to some 6 percent even more marked among informal ones. In of adults with tertiary education. In contrast, Caribbean countries, more than 70 percent of among formal business owners, 15 percent unregistered business establishments have no have tertiary education and just 5 percent employees, according to business owners. This 02_ENTinLAC_023-060.indd 33 11/21/13 5:42 PM

52 7. 0 4.0 6.0 8.0 % 11. 0 11. 0 11. 0 11. 0 11. 0 13 . 0 12 . 0 12 . 0 14.0 10.0 10.0 18.0 Informal India 1.0 1.0 1.0 1.0 5.0 5.0 5.0 5.0 5.0 4.0 3.0 2.0 3.0 3.0 2.0 3.0 % Formal 7. 0 1.0 9.0 9.0 9.0 5.0 3.0 6.0 8.0 6.0 % 11. 0 11. 0 11. 0 14.0 10.0 10.0 Informal China 7. 0 7. 0 7. 0 7. 0 7. 0 7. 0 9.0 2.0 3.0 6.0 6.0 8.0 6.0 8.0 % 13 . 0 10.0 Formal 5.0 8.0 % 11. 0 15. 5 15. 3 13 . 8 13 . 0 12 . 5 12 . 8 12 . 5 12 . 0 13 . 0 13 . 5 13 . 5 14.0 10.0 Informal EAP4 7. 0 7. 3 7. 3 9.3 5.5 2.5 4.5 3.8 3.0 6.5 8.5 6.8 6.3 8.3 % 12 . 0 13 . 3 Formal 1.7 1.6 3.2 2.8 2.5 2.1 3.2 3.5 2.0 2.0 3.4 2.9 2.9 2.3 3.1 2.6 % Informal ECA 7.1 7. 5 1. 2 1.0 1.3 4.9 3.7 3.5 4.9 4.0 2.4 0.8 3.2 2.7 2.2 4.3 % Formal 1.0 1.0 1.1 1.0 1.1 0.7 0.9 0.5 0.9 0.5 0.8 0.6 0.9 0.9 0.8 0.8 % Informal High Income 7. 3 1. 8 9.4 9.7 5.5 4.8 4.9 4.6 8.0 8.0 6.6 6.3 % 11. 0 13 . 8 10.3 10.7 Formal 9.3 9.7 9.3 9.7 9.3 9.3 9.0 9.0 9.0 4.3 6.0 8.7 8.0 % 11. 7 12 . 3 10.3 Informal Caribbean 7. 0 7. 7 7. 7 2.3 3.7 4.7 4.0 4.7 6.3 6.7 8.7 6.0 6.0 6.3 % 10.3 23.3 Formal 7. 7 9.2 9.8 9.2 9.3 9.5 9.8 9.9 9.3 3.6 % 11. 2 12 .9 10.6 10.0 10. 2 10. 2 Informal Other LAC age population) 7. 0 7. 0 9.3 5.2 5.8 5.5 2.6 4.7 4.8 3.8 6.2 8.5 8.0 8.8 % 13 . 3 16.3 Formal 7. 8 7. 2 9.2 9.4 9.0 5.8 3.8 3.4 8.0 6.4 8.4 8.0 8.6 8.2 8.6 % 10.4 Informal LAC5 7. 6 7. 0 7. 6 5.6 5.0 5.2 5.2 2.4 2.2 6.4 8.2 6.0 8.8 8.2 % 15. 0 14.0 Formal Socioeconomic characteristics of business owners in selected country groups, countries, and economies Klapper and Randall 2012, based on data from Gallup World Poll Survey. Each country or economy has the same weight in the regional average. For countries and economies included in each group, see note 11. 64 24 TABLE 2.1 Note: (business owners as percentage of working- Source: 15 – Age 25– 65+ Tertiary % of business owners Secondary Elementary Education Gender Male Setting Urban Female Rural 3 Income quintile 1 (top) 2 5 (bottom) 4 34 02_ENTinLAC_023-060.indd 34 11/21/13 5:42 PM

53 ENTREPRENEURShIP LIfE Cy CLE of fIRMS IN LATIN A MERICA ANd ThE C ARIbbEAN 35 , ENTR y, ANd ThE Share of firms with no employees in selected country FIGURE 2.5 percentage is very similar to that observed groups, countries, and economies, 2011 in LAC5 and Other LAC. In contrast, the - figures are 56 percent in EAP4 and 35 per cent in Europe and Central Asia (figure 2.5). 80 As expected, informal businesses tend to be 70 smaller, but even among formal businesses in 60 LAC, almost half have no employees. Group - ing formal and informal businesses together 50 makes the bias toward microfirms in LAC 40 even more striking (figure 2.6). Although the Firms (%) 30 share of firms with more than five employees reaches 20 percent in high- income economies, 20 it barely reaches 3 percent in LAC. 10 0 Other High- Caribbean LAC5 China India EAP4 ECA LAC income Push versus pull factors economies Economists have long tried to understand Informal rm Formal rm - the determinants of business creation. Fol lowing Vivarelli (2013), the traditional view Source: Klapper and Randall 2012, based on data from Gallup World Poll Survey. Note: Each country or economy has the same weight in the regional average. For countries and gives the expected level of profit a prominent economies included in each group, see note 11. role (Orr 1974; Khemani and Shapiro 1986). More recent studies in this stream of litera - Distribution of firm size in selected country groups, FIGURE 2.6 ture highlight not only profit expectations countries, and economies, 2011 but also other pull factors, such as economic growth and high innovative potential (see Acs and Audretsch 1989a, 1989b; Geroski 1995). 100 Authors such as Knight (1921); Schum - 90 peter (1934, 1939); and Oxenfeldt (1943) 29.8 80 33.7 34.2 drew attention to the characteristics of the 38.8 44.7 founder of a new firm, highlighting the 70 47.9 importance of individual heterogeneity and 50.7 60 43.3 the desire to innovate and put new ideas into 50 practice as drivers of entrepreneurial spirit. Firms (%) 40 Potential entrepreneurs seem to be strongly 68.1 influenced by specific psychological attitudes, 63.1 62.4 30 58.2 such as the desire to be independent, the need 49.8 45.7 20 38.3 37.1 for autonomy in the workplace, an aspiration 10 to fully exploit previous job experience and acquired ability, and the desire to be socially 0 LAC5 China High- Other India Caribbean EAP4 ECA useful and to acquire social status (see Creedy LAC income and Johnson 1983; Evans and Leighton economies 1990; Vivarelli 1991, 2004; Blanchflower 0 50+ 6–50 Employees: 1–5 and Meyer 1994; Blanchflower and Oswald 1998; Zacharakis, Bygrave, and Shepherd Klapper and Randall 2012, based on data from Gallup World Poll Survey. Source: in the form of 2000). Pursuit of these goals— Each country or economy has the same weight in the regional average. For countries and Note: economies included in each group, see note 11. profitability, growth, or simply the desire to is associated with put in place original ideas— foundation of a new firm is not fostered by - a view of entrepreneurship in which the entre absolute profitability but by the difference preneur is pulled into business creation. between expected profits and current local In the occupational choice model out - wages in the same sector, taking into account lined at the beginning of this chapter, the 02_ENTinLAC_023-060.indd 35 11/21/13 5:42 PM

54 36 LATIN AMERICAN ENTREPRENEURS A third explanation for entrepreneurship the surrounding environmental conditions. may simply be “entry mistakes” (Cabral 1997; The introduction of relative considerations Geroski and Mazzucato 2001). Such mistakes opens the door to examine entrepreneurs who are pushed into entrepreneurship rather are likely to result in early failure, turbulence, - and churning. Mistakes may occur if poten - than pulled by absolute profits. One can eas tial entrepreneurs are overconfident (Dosi and ily extend the relative approach to consider - the risk differential between the two occu - Lovallo 1998; for an experimental econom pational alternatives (Kihlstrom and Laffont ics exercise, see Camerer and Lovallo 1999). 1979; Parker 1997; Cressy 2006). Parker (2006) discusses both the psychology literature, which gives reasons for expecting The implication of comparing the relative entrepreneurs to be especially prone to over - virtues of self- employment versus dependent optimism, and previous empirical evidence employment means that entry may have a countercyclical component. It is in periods of showing that optimism is significantly and positively associated with the propensity to slow growth and profit prospects that many be an entrepreneur (de Meza 2002; Åstebro small firms are created, simply as an alterna - - 2003; Coelho, de Meza, and Reyniers 2004). tive to the prospects of dependent employ A set of questions in the Gallup World Poll ment, which become less attractive (see Highfield and Smiley 1987; Hamilton 2000). Survey sheds some light on the importance of pull versus push factors in LAC (see Klapper Pushing this argument further, founding a and Randall 2012 for details). The poll asked new firm may be an alternative to uncertain - business owners if each of the following rea future career prospects or represent an escape sons was a very important reason why they from unemployment (see Oxenfeldt 1943; Evans and Leighton 1990; Storey 1991, started their business, allowing for multiple responses: 1994). The empirical evidence suggesting the important role of job losses in fostering entry A. You could not find a suitable job. is indeed quite robust (see Storey and Jones You were afraid of losing your job. B. 1987; Santarelli, Carree, and Verheul 2009). You saw an opportunity to make more C. - A complication in identifying the push fac money. tor is related to the fact that in general, times D. You wanted to be your own boss. of low job finding rates are usually recessions, E. You had a great idea for a business. which may also imply lower expected profits from self- Factors A and B are clearly associated with employment. The contemporane - push motives for entrepreneurship; factors ous presence of these two channels has made it hard to identify unemployment push entre D and E are more likely to be pull motives, - - preneurship in the data. The use of micro although they may also constitute an addi data has helped researchers overcome this tional incentive to entrepreneurship among problem. Using data from the National Lon people who were pushed. Factor C can be - associated with both push and pull factors; gitudinal Survey of Youth, Rissman (2007) - documents the presence of push entrepreneur it is harder to interpret. For instance, in our framework, all potential entrepreneurs com - ship among young men in the United States. pare expected profits with expected wages; Millán (2012) finds a similar pattern in sev - making money is thus always a motive for eral European countries, using data from the starting a business. For this reason, response European Community Household panel. - C (to which more than 70 percent of respon Thus, in some situations, a business owner dents answered affirmatively) was disre - - may be pushed rather than pulled into entre preneurship. When unemployment and the garded in the analysis. risk of failure of entrepreneurial projects are Entrepreneurs who were pushed into entrepreneurship are those who answered incorporated, push factors will more than proportionally discourage entrepreneurship - positively to questions A or B. Pulled entre ability individuals (Poschke 2013c). by high- preneurs are defined as survey respondents 02_ENTinLAC_023-060.indd 36 11/21/13 5:42 PM

55 ARIbbEAN ThE LIfE Cy CLE of fIRMS IN LATIN A MERICA ANd ThE C y, ANd 37 , ENTR ENTREPRENEURShIP who answered “no” to A and B and “yes” LAC stands out as the region where push to D or E. A residual category, which covers factors are most clearly linked to informal some 8 percent of the business owners, was entrepreneurship and pull factors with for - mality. More than 50 percent of pull entrepre - neither pulled nor pushed; it is ignored in the neurs in LAC register their business, against analysis. just 30 percent of pushed entrepreneurs (fig - One in every two business owners in LAC - ure 2.7, panel b). Differences are also posi is pushed into entrepreneurship, the same tive but smaller in other regions dominated proportion as in ECA and about twice as income economies. About income countries, such as EAP4, many as in high- by middle- - where there is a difference of about 10 per income 60 percent of entrepreneurs in high- countries are pulled by great ideas for a busi centage points in the share of formal business - owners that were pulled versus pushed into ness or a desire to be their own bosses against entrepreneurship. In regions where infor - 45 percent in LAC and 40 percent in ECA (figure 2.7, panel a). Guatemala, Honduras, mality is almost nonexistent, such as high- Brazil, El Salvador, Peru, and Haiti lie above income countries and ECA, or informality is the regional average, with more than 50 per - the predominant form of ownership (India), - cent of business owners pushed into entre differences between pull and push factors are preneurship. In the Caribbean, almost 70 not fundamental for formality status. percent of business owners declared having The differences between push and pull factors are also significant for the capacity opened a business out of fear of losing their job or because jobs were not available. Uru - (or willingness) of the entrepreneur to gen - guay, Chile, and Mexico, the countries with erate employment. Pull entrepreneurs are the lowest share of push entrepreneurs in the more likely to have employees. This differ - ence is largest in India, where the likelihood region, still lie above the 28 percent push that an entrepreneur generates at least one entrepreneurship that characterizes high- job is more than 25 percentage points higher income countries. Push versus pull entrepreneurship in selected country groups, countries, and economies, 2011 FIGURE 2.7 b. Dierence between push and pull factors a. Pull and push entrepreneurship 30 70 25 60 20 50 15 ull entrepreneurs p 40 10 5 30 push and 0 20 –5 rms pulled – % of rms pushed 10 –10 % of Percentage of –15 0 ECA ECA EAP4 India India EAP4 LAC5 LAC5 China China Other LAC Other LAC Caribbean Caribbean High-income High-income economies economies + 1 employee Push Formal Pull Source: Klapper and Randall 2012, based on data from Gallup World Poll Survey. Note: The sample consists of the working- age population only. Each country or economy has the same weight in the regional average. For countries and economies included in each group, see note 11. 02_ENTinLAC_023-060.indd 37 11/21/13 5:42 PM

56 38 LATIN AMERICAN ENTREPRENEURS - market growth (Malchow- if he or she was pulled into entrepreneur Møller, Schjern - ing, and Sørensen 2011). Indeed, industrial ship as opposed to pushed. In LAC, 43 per - dynamics (that is, the entry and exit of firms) cent of pull entrepreneurs have at least one 40 percent of total produc - accounts for 20– employee, against 30 percent of those who tivity growth in eight selected Organisation were pushed. The largest difference between pull and push entrepreneurs is observed in - for Economic Co-operation and Develop the Caribbean (15 percentage points), closely ment (OECD) countries, according to OECD (2003), supporting the idea that entrepre - followed by EAP4 (13 percentage points) neurs represent one of the driving forces of and LAC5 (12 percentage points). Excluding China, a clear outlier in the sample, this dif - economic growth and structural change - ference is smallest in Other LAC (5 percent (Audretsch and Keilbach 2005; Foster, Halti - age points). wanger, and Syverson 2005). The reasoning is that new entrants can displace obsolescent These findings suggest that entrepreneurs - set up businesses for a large variety of rea firms in a process of “creative destruction” (see Schumpeter 1939, 1943), which may be sons and that such differences are important determinants of the type of business activity an important micro determinant of produc - tivity dynamics that eventually results in eco - that will be developed. Entrepreneurs who 14 nomic growth. are pulled into entrepreneurship are more likely to end up registering their business and Recent studies based on data from the hiring more workers than entrepreneurs who Global Entrepreneurship Monitor have identified a U - are pushed into entrepreneurship because of shaped relationship between a country’s rate of entrepreneurial activ - the fear of losing their jobs or lack of better employment opportunities. The proportion ity as measured by net entry and its level of economic development (Reynolds and oth of businesses that are created because of push - ers 2001; Wennekers and others 2005). The factors is much larger in developing regions, including LAC, than in high- - creation of new firms is very active in both income coun - highly developed and extremely poor coun tries. However, push and pull factors are two tries, a fact that emphasizes the multifaceted sides of the same coin. If there are insufficient phenomenon of entrepreneurship and demys - high- end entrepreneurs, or the entrepreneurs tifies simplistic mechanical links between that exist generate little employment, there firm creation and innovation, productivity will be fewer good jobs for jobseekers and growth, and economic development. Indeed, growth some of them will be pushed into low- potential forms of entrepreneurship. The rest only when transformational entrepreneurs of this chapter investigates the creation and are distinguished from low- growth entrepre - neurs is a positive linear relationship between dynamics of formal firms. - economic development and entrepreneur ship restored (Carree and others 2007; Acs Business creation in Latin 2008; Acs, Desai, and Klapper 2008). In America and the Caribbean developing countries, a positive relationship New firm formation may play a crucial role between entrepreneurship and job creation is in fostering competition, inducing innova - employment with - detectable only when self- - tion, and boosting the emergence of new sec out employees and informal companies are tors, as discussed by Wennekers and Thurik excluded from the analysis (Ghani, Kerr, and (1999) and Dejardin (2011). Entrepreneurs O’Connell 2011). leading the new small firms may compensate - Identifying transformational entrepre for the restructuring of mature sectors and neurs and distinguishing them from low- the downsizing of larger incumbent firms. growth entrepreneurs is a hard task. The Ultimately, new firms may contribute sub - previous analysis of push versus pull factors stantially to job creation, provided that the offers some hints, however. For instance, net effect of new entrants brings about overall registered business owners in developing 02_ENTinLAC_023-060.indd 38 11/21/13 5:42 PM

57 MERICA LIfE Cy CLE of fIRMS IN LATIN A ThE ANd ThE C ARIbbEAN 39 ENTREPRENEURShIP , ENTR y, ANd countries are more likely to be pulled into and Dominica (4 new firms). Argentina and Mexico stand at the opposite end of the entrepreneurship than business owners who distribution, with rates of entry substan - did not register their business, suggesting that registered business owners have a higher tially below those suggested by their GDP per capita. likelihood of becoming transformational The relatively weak performance of LAC entrepreneurs. As the focus of this study is on transformational entrepreneurs, we start the countries in formal business creation raises the question of what determines entry and discussion by examining the creation of for - mal businesses. Is LAC lagging behind in net the even more important question of how the formal entry? process of business creation can be enhanced in the region. In an attempt to answer these Figure 2.8 displays the relationship - questions, the literature has attributed a between firm entry and the level of devel opment across 129 countries. Perhaps as prominent role to regulatory barriers. The expected, entry, as measured by firm reg - importance of entry costs as an obstacle to - age people, is istration per 1,000 working- and conse the creation of new businesses— quently a healthy reallocation of productive weakly positively associated with GDP per capita. Formal entry rates in LAC tend to - has been docu factors in the economy— be below the level predicted by their income mented as a limiting factor in firms’ invest - per capita, although differences with respect ments (Nicoletti and Scarpetta 2003) and an to the predicted values are not always large obstacle to productivity and growth (Alesina and others 2005) and the creation of new and there is substantial heterogeneity within the region. By far the most dynamic economy firms (Klapper, Laeven, and Rajan 2006). Within a sample that includes 85 developed in the region is Costa Rica, with an average entry rate of almost 16 new firms per 1,000 and developing countries, entry regulation age people between 2004 and 2011, working- has also been found to promote corruption followed by St. Kitts and Nevis (6 new firms) and larger unofficial economies (Djankov - and others 2002). Could the removal of reg ulatory barriers spur the creation of formal New firm entry rates and GDP per FIGURE 2.8 businesses in the region? capita in selected countries, 2004– 11 We examine the association between entry and the share of formal business in the total business population on the one hand and two 20 - different indicators of administrative barri ers to entrepreneurship on the other. The first 15 indicator of entry barriers is the total cost of setting up a business, obtained from Doing Business data. This indicator includes an 10 imputation of the monetary costs associated Entry density with the numbers of days needed to set up a 5 business and the direct monetary cost related to fees and other taxes for a sample of 132 15 economies. 0 The second indicator is a summary mea - 8 11 7 6 10 9 sure of barriers to entrepreneurship that is Log of GDP per capita calculated as a weighted average of three Non-LAC countries LAC countries subindexes: an indicator of regulatory and administrative opacity, an indicator of World Bank, based on data from World Development Indicators and Source: World Bank Group Entrepreneurship Snapshots (WBGES). administrative barriers to start- ups, and an Note: Each point represents the average between 2004 and 2011. Curve indicator of barriers to competition. Each shows quadratic fitted values. GDP = gross domestic product. LAC = Latin America and the Caribbean. subindex ranks countries on a scale from 0 to 02_ENTinLAC_023-060.indd 39 11/21/13 5:42 PM

58 40 LATIN AMERICAN ENTREPRENEURS worldwide deregulation in product markets. 6, with 0 representing lax and 6 representing strict regulations. country variance in the number of The cross- procedures, the time, and the cost associated There is great heterogeneity across LAC tape barriers to entry countries in these red- with setting up a business declined steadily between 2004 and 2013, as countries have 2.9). In Guatemala, it takes 37 days, (figure - 12 procedures, and the equivalent of 52 per become more aware of the need to create 17 cent of GDP per capita to open a business; in a more favorable business environment. Despite progress, however, the burden Chile it takes 7 days, 7 procedures, and the tape regulations in the region equivalent of 5 percent of GDP per capita (in imposed by red- contrast, in Canada, it takes just one admin - is still higher than in other regions of similar income per capita, such as ECA or EAP4. istrative procedure to set up a new business). Great heterogeneity across countries is We examine next the association between entry and formal business ownership and also present in the broader summary measure barriers to entrepreneurship around the of barriers to entrepreneurship. The average score for OECD countries excluding Mexico world. We present partial correlations that control for differences in GDP and popula is 1.36. This score is lower than in the best- - tion across countries because entry barriers scoring country in LAC (Colombia at 1.79), tend to be concentrated among developing where the framework is much more business countries. The analysis yields very similar friendly than in the worst- scoring countries results for barriers to entry and barriers to (Honduras 3.65, Argentina 3.28, and Nica - 16 ragua 3.18). d in figure 2.10). entrepreneurship (panels a– LAC countries have made significant The partial correlations are weakly negative and not uniformly statistically significant. progress in reducing such barriers in the - last few years. The time to set up a busi - For similar levels of entry barriers or barri ness was halved in less than a decade (see ers to entrepreneurship, there is tremendous figure 2.9), reflecting a general trend of variability in the degree of formalization and entry. Moreover, in countries such as Peru and Brazil, where regulation was expected to be a major obstacle to business formaliza - Time required to start a business in selected country FIGURE 2.9 groups, countries, and economies, 2004 and 2013 tion, levels of entry are in broad accordance with the level of development. 140 These findings do not imply that barri - ers to entry need not be detrimental to firm 120 performance and resource reallocation. The 100 literature documents the obstacles imposed by entry barriers for a variety of outcomes, 80 - including employment in dynamic service sec Days tors (Messina 2006), firm investment (Alesina 60 and others 2005), and the creation of new 40 firms (Klapper, Laeven, and Rajan 2006). The weak associations of the data here may reflect 20 the fact that other counteracting forces blur 0 the cross- country correlations under study. It ECA India EAP4 LAC5 China should also be noted that most of the litera - Other LAC Caribbean ture cited relied on OECD data or included a High-income economies income countries. very limited set of middle- 2013 2004 The analysis raises a question about the Source: World Bank 2011. relevance of regulatory barriers for the for - Each bar represents the average for each region. The thin lines show the standard deviation Note: mation of new businesses in developing coun - for the countries within each region. For countries and economies included in each group, see note 11. tries. It may be that in developing countries 02_ENTinLAC_023-060.indd 40 11/21/13 5:42 PM

59 LIfE Cy CLE of fIRMS IN LATIN A MERICA ANd ThE C ARIbbEAN ThE 41 y, ANd ENTREPRENEURShIP , ENTR Relationship between business formality and barriers to entry in selected countries, FIGURE 2.10 various years b. Formal business owners vs. a. Entry density vs. cost of starting a business cost of starting a business 15 0.4 Slope: −0.00 Slope: −0.00 CRI -value: 0.46 p -value: 0.76 p 10 0.2 PRY HTI ECU BOL 5 0 NIC HND CHL PER COL URY JAM MEX Entry density CRI BRA ARG TTO GTM BRA PER CHL URY 0 −0.2 COL GTM KNA BOL MEX VEN ARG SLV DOM DOM JAM SLV LCA DMA SUR Formality (% of business owners) −0.4 −5 100 200 400 600 200 0 −100 0 −200 Cost, income per capita (%) Income per capita (%) d. Formal business owners vs. c. Entry density vs. barriers to entrepreneurship barriers to entrepreneurship 0.3 15 Slope: −0.12 Slope: −0.41 p -value: 0.03 p -value: 0.83 0.2 10 NIC HND 0.1 CRI 5 0 PER COL Entry density MEX PER CRI COL 0 −0.1 ARG MEX ARG SLV SLV DOM −0.2 Formality (% of business owners) −5 0 1.5 0.5 1 0.5 1 −0.5 1.5 −0.5 0 Barriers to entrepreneurship (index) Barriers to entrepreneurship (index) e. Entry density vs. governance f. Formal business owners vs. governance 0.4 15 Slope: 1.75 Slope: 0.08 p -value: 0.00 CRI p -value: 0.00 0.2 10 PRY HTI ECU 0 BOL 5 NIC CHL HND COL PER URY MEX Entry density CRI BRA ARG TTO GTM BRA PER −0.2 CHL COL URY 0 GTM MEX BOL KNA VEN ARG DOM DOM SLV SLV JAM DMA LCA SUR Formality (% of business owners) −0.4 −5 0 –1 −0.5 −1.5 1 0.5 −1.5 −1 −0.5 1 0.5 0 Governance (index) Governance (index) Non-LAC countries LAC countries Source: World Bank, based on data from World Development Indicators, 2012; World Bank Entrepreneurship Database; Klapper and Randall 2012; Wölfl, Koz - luk, and Nicoletti 2009; and Kaufman, Kraay, and Mastruzzi 2010; and Worldwide Governance Indicators. Note: Each point represents the residuals of the regression between each variable, gross domestic product (GDP) adjusted for purchasing power parity, and population. Panels a and e use the average for 2004– 2011; panels b, c, d, and f use the average for 2004– 09. The slope is the coefficient of a regression between the two variables. The p - value shows the significance of the coefficient. LAC = Latin America and the Caribbean. 02_ENTinLAC_023-060.indd 41 11/21/13 5:42 PM

60 42 LATIN AMERICAN ENTREPRENEURS businesses because of more limited access to what matters for the business environment is finance or capacity to deal with burdensome the quality of broader institutional and policy regulations. However, even in the United arrangements, which may range from respect States, the typical small business is engaged of the rule of law (Botero and others 2004) to in low-growth entrepreneurship, does not the development of other markets, including - necessarily represent an engine of employ finance and insurance. ment creation, and has no intention to grow To shed some light on this hypothesis, - (Hurst and Pugsley 2011). Thus, targeting we correlate our measures of entry and for - small business as the sole criteria of entrepre mality with a broader index, the Worldwide neurship programs may involve substantial Governance Indicator (WGI), which sum - - inefficiencies. Moreover, even if some mar marizes information on the degree of voice ket failures are concentrated among small and accountability in the economy, political businesses, little is known about the type of stability and absence of violence, government - effectiveness, regulatory quality, the rule of policies that may be successful in promot ing entrepreneurship; the few studies that law, and control of corruption (Kaufman, - - attempt to scrutinize these types of interven Kraay, and Mastruzzi 2010). The index esti tions are inconclusive (box 2.2). mates the quality of governance on a scale of – 2.5 to 2.5 that increases in the quality of Recent studies have tried to distinguish between low- governance. Because this indicator is collected growth and high- - growth entre preneurs (see Gindling and Newhouse 2012; annually, all of the information on entry rates Fafchamps, Woodruff, and Yin 2013). In for the period 2004– 11 can be exploited, 18 parallel, some studies have emphasized the which adds some precision to the estimates. important distinction between young and The cross- correlations of entry and the small firms as sources of growth. Most of the - share of formality with the quality of gov ernance are highly consistent and suggest creating process among small businesses job- that in countries with better governance, the in the United States is accounted for by new - entrants and young businesses (Haltiwan share of business owners and the creation of ger, Jarmin, and Miranda 2013). In contrast, - new formal firms are higher, even after con trolling for GDP and population. The impli small mature businesses have on average neg - - ative net job creation. There is also consid cation, which deserves further scrutiny, is - that to stimulate a better business climate in erable heterogeneity in terms of job creation - - the quest for a vigorous and vibrant entrepre within any definition of firm class. Haltiwan neurial sector, governments should examine ger (2011) shows that the typical small or the overall business environment rather than median young business in the United States displays very low growth, but average growth specific aspects of it. is high for this group because a small fraction of firms are growing very rapidly. Beyond entry: Firm dynamics in LAC does not seem to be lagging tre - Latin America and the Caribbean mendously behind in the creation of new The importance of entry in the process of businesses. However, the productivity perfor - structural change and productivity dynam - mance of the region during the last decades ics is hard to dispute. It is probably for this has been very disappointing. Total factor reason that all governments have specific productivity in the manufacturing sector has - programs to support entry and the perfor not increased since the 1970s, and it actually mance of small firms. Indeed, if small busi - declined in some countries (Busso, Madrigal, nesses are the engines of net job creation (as and Pagés-Serra 2012). The combination of suggested by Neumark, Wall, and Zhang these two facts suggests that the problems - 2011 for the United States), there is possi of resource misallocation and inefficiencies bly a role for public support because of the may lie either in the nature (rather than the presence of market failures. Small businesses number) of the businesses created or in the are likely to face greater barriers than larger postentry performance of firms. Chapter 3 02_ENTinLAC_023-060.indd 42 11/21/13 5:42 PM

61 ENTREPRENEURShIP ThE LIfE Cy CLE of fIRMS IN LATIN A MERICA ANd ThE C ARIbbEAN 43 , ENTR y, ANd BOX 2.2 Do training programs for entrepreneurs work? cant effects in three out of six estimations, ranging - The typical micro or small business in a develop from 3 percent to 57 percent. However, it is unclear ing country does not implement many of the busi - whether training merely speeds up or permanently ness practices considered standard in the devel - increases the rate of entry, as the control group oped world. For this reason, entrepreneur training of one program seems to catch up after two years programs have become increasingly popular in the (de Mel and others 2012). - developing world. There has been little rigorous evi An important channel through which training dence of the impacts of these programs; when these may improve business outcomes is better business evaluations have taken place they have encountered practices; almost all studies find a positive effect. serious methodological challenges. Seven out of 9 estimations find significant effects, Several issues arise in assessing the studies. First, ranging from 3 percent to 203 percent. Although the impact of training is likely to depend on who - some of these effects seem large, however, in abso receives the training. Second, the business training lute terms they are low, because business practices at - offered varies across studies substantially. McKen baseline are very weak (less than 30 percent of firms zie and Woodruff (2013) distinguish four strategies keep records in most cases). for participant selection among existing studies: Another relevant outcome is the increase in prof - classroom- based training offered by microfinance its after training. Only two of seven studies find sig - organizations or banks to their clients, training nificant effects on profits, with effects of 24 percent offered to firms in a particular industry or cluster, and 43 percent on female participants. There is also - individual application to training as part of a compe little evidence of employment creation, with just tition, and training offered to a random subsample 1 in 20 trained entrepreneurs hiring an additional of a representative population of microenterprises. worker. It is hard to draw general conclusions from exist - - Five issues need better answers before govern ing studies because of four fundamental challenges. ments start implementing large- scale interventions: First, the studies often lack statistical power: only 2 of the 15 studies have enough statistical power to Studies have not been able to say who benefits • safely yield conclusions. Second, most of the studies most from these programs. In theory, it would up interview and are very include only one follow- be optimal to target firms where management short run, looking at impacts after one year or less skills represent a constraint on growth, but after the training. Third, attrition rates range from identifying those firms is a complicated en- 6 percent to 28 percent. Their relation to business deavor. It is still unclear through which chan- failure, disappointment with training effects, and nels training affects business outcomes. location movements complicates inference. Fourth, • How do markets and the competition react to sales and profits reported may not be true indicators newly trained firms? of impact: training may simply reduce bookkeeping run scope of existing studies pre- The short- • mistakes rather than improve actual outcomes. run. Are vents extracting lessons in the long- Keeping these caveats in mind, a few tentative there any market constraints preventing firms conclusions can be drawn. On the one hand, there from accessing helpful training programs by is little evidence of a relationship between training themselves? and survival, with significant effects for three out What is the effect of attitudes and personalities • of seven estimations and estimated impacts ranging of business owners on performance? from 6 percent to 9 percent for men. On the other Can people be turned into entrepreneurs? • hand, the evidence suggests that business training up, with signifi generates short- run impacts on start- - characterizes the behavior of incumbent Eslava and Haltiwanger (2013) analyze business dynamics in the formal manufac - firms and their degree of entrepreneurship. turing sector of Colombia, contrasting them The next few paragraphs describe some of the most salient stylized facts of business when possible with similar data for the 19 dynamics in the region. United States. They find similar patterns 02_ENTinLAC_023-060.indd 43 11/21/13 5:42 PM

62 44 LATIN AMERICAN ENTREPRENEURS 21 53 percent. Once entry and exit are consid - in the two countries. Figure 2.11, panel a, ered, the fastest- growing establishments are reveals the importance of the size versus small and young. Compared with the United the age of the plant for the generation of 20 It separates plants into small, employment. States, younger Colombian firms appear medium, and large based on their average “healthier”: they exhibit stronger growth and employment levels in two consecutive peri - are less likely to die. This evidence suggests that selection dynamics are stronger in the ods and shows net employment creation for United States, where only the fittest firms are establishments of different ages. Growth clearly increases with size and able to survive. Even within relatively homogeneous size - declines with age. However, the differ and age classes there is tremendous heteroge - ences are much more marked along the age neity in growth rates across firms. Excluding dimension. On average, young firms are net employment generators for all size classes, entry and exit, it is always the case that the fastest- and average growth rates increase rapidly growing firms are among the young - - growing young estab with size. The fastest- est (figure 2.12). Employment by young firms at the 90th percentile of the lishments are the largest, a fact that appears gazelles— - can increase by almost to contradict the idea that most employ growth distribution— 50 percent in one year, even if they are already ment generation occurs among small firms. Moreover, and in line with evidence from large. Across age classes, there is much more variation among top performers than among the United States, small plants older than five years contract rather than grow. contracting firms (firms in the 10th percentile This evidence does not imply that small of the growth distribution). Smaller firms in the 10th percentile tend to decline faster than firms are not important for growth. When the contribution of all firms (including new larger ones, with very little differences across - firms and firms that die) is considered, the pic age classes. When the additional impact of exits on employment growth is considered, ture changes dramatically (figure 2.11, panel it is also true that youngest firms are more b). The average growth rate of small plants up to four years old jumps from 4 percent to likely to decline fastest. FIGURE 2.11 Employment growth in Colombia, by firm size and age cohort a. Continuers b. All establishments 0.6 0.10 0.4 0.05 0.2 Growth rate Growth rate 0 0 –0.2 –0.05 Small Small Large Large Medium Medium Size of rm Size of rm 5–9 years 15+ years 10–14 years 0–4 years All Age of rm: Source: Eslava and Haltiwanger 2013. Note: Small: fewer than 50 employees; medium: 51–200 employees; large: more than 200 employees. Growth rates are defined as in Davis, Haltiwanger, and Schuh (1996); they are the change in employment between two consecutive periods divided by the average employment between the two periods. 02_ENTinLAC_023-060.indd 44 11/21/13 5:42 PM

63 ENTREPRENEURShIP y, ANd ThE LIfE Cy CLE of fIRMS IN LATIN A MERICA ANd ThE C ARIbbEAN 45 , ENTR FIGURE 2.12 Net employment growth rates by firms in Young firms grow faster than mature firms 2009 Colombia, by establishment age and size, 1994– in Colombia, even among the small fraction of gazelles. However, young establishments tend to be smaller. Does the growth of young 0.40 establishments matter in terms of aggregate employment? The answer is a resounding 0.20 yes. Table 2.2 shows the dynamics of Colom - 90th bian manufacturing firms by birth cohort percentile 0 for 1994– 2009. Firms that were 10 years or 10th older in 1994 had shrunk in size by 2009. percentile DHS growth rates Indeed, if it were not for the creation of new –0.20 firms, the Colombian manufacturing sector would have contracted considerably during –0.40 the sample period. Small Medium Large In contrast to commonly held views, there Firm age (years) is substantial mobility across establishments 10–14 15+ 5–9 0–4 in the few LAC countries for which data 10–14 15+ 5–9 0–4 are available. Table 2.3 shows transition matrixes for five years in Chile and Colom - Source: Eslava and Haltiwanger 2013. Note: Small: fewer than 50 employees; medium: 51–200 employees; large: more than bia across three establishment size classes: 200 employees. Growth rates are defined as in Davis, Haltiwanger, and Schuh (1996); 249 small (10– 49 employees), medium (50– they are the change in employment between two consecutive periods divided by the average employment between the two periods. employees), and large (250 or more employ - ees). There is substantial upward mobility in both countries: about a third of the medium - in Colombia), but the analysis does not con and large firms in Chile (a fifth in Colombia) sider the death and birth of firms. Upward belonged to a smaller size class five years mobility is even greater if only young firms in earlier. Downward mobility is very small in the base year are considered. Restricting the Chile (somewhat greater, at about 7 percent sample to establishments that were less than TABLE 2.2 Dynamics of manufacturing firms in Colombia Plant’s initial Before 1970 1970 – 79 1980 – 8 4 1985 – 89 1990 – 94 1995 – 97 1998– year of operation 2001– 03 2004– 06 2007– 09 To t al 2000 Total employment 19 9 4 139, 428 80,396 73,248 26,377 — — — — — 636, 0 61 316 , 612 — 279,372 75,739 74 ,119 4 4 , 811 17,114 124, 205 — — — 615, 36 0 19 97 2000 222,464 102,478 63,371 64,540 43,868 20,669 8,297 — — — 525,687 2003 201, 227 64,491 6 7, 37 9 5 7, 6 6 9 26,381 18,559 4,423 — — 5 37, 6 41 9 7, 512 12 , 5 4 4 215,886 78,947 68,357 37, 0 7 3 25,226 69,771 3,182 — 617,14 9 2006 10 6,163 203,989 98,969 6 7, 4 8 4 73,960 72,750 39,525 33,305 23,703 17, 2 6 8 12 , 5 45 643,498 2009 – 112 , 6 2 3 – 40,459 – 12 ,912 712 46,373 39,525 33,305 23,703 17, 2 6 8 12 , 5 45 7, 4 37 19 9 4 –20 0 9 Number of establishments 19 9 4 1,931 1,50 0 1,4 8 4 593 1,756 — — — — 7, 2 6 4 — 19 97 1, 6 43 1, 891 1, 511 1,585 1,032 375 — — — — 8,037 2000 1, 374 1, 243 1, 329 975 426 19 6 — — — 7, 0 6 7 1,524 388 2003 1,10 4 1, 271 1,051 521 1, 375 13 8 — — 7, 0 6 0 1, 212 2006 1,112 1, 247 1,031 1, 228 1,110 594 493 315 86 — 7, 216 794 2009 968 1, 235 1, 28 6 74 0 1,114 693 596 373 8,828 1,029 19 9 4 – 20 0 9 – 727 – 817 – 532 – 249 693 74 0 794 693 596 373 1,56 4 Source: Eslava and Haltiwanger 2013. 02_ENTinLAC_023-060.indd 45 11/21/13 5:42 PM

64 46 LATIN AMERICAN ENTREPRENEURS Five- year changes in size categories for establishments of different ages in Chile and Colombia TABLE 2.3 Size in year + 4 t Establishments less than Establishment of all ages four years old in year t Country/size in year t Large Small Medium Large Small Medium Chile 96.0 2.0 28.0 1.0 Small 31.0 96.0 38.0 4.0 71.0 33.0 4.0 68.0 Medium 1.0 Large 0 65.0 0 1.0 61. 0 Colombia 38.5 0.6 Small 92.6 19. 3 6.4 94.8 7.1 Medium 5.1 58 .1 35.0 18. 8 74.4 Large 58.7 0.2 6.3 80.5 0.2 3.4 Sources: World Bank data for Chile; Eslava and Haltiwanger 2013 for Colombia. Note: Small: 10– 49 employees. Medium: 50– 249 employees. Large: More than 250 employees. firms that have formalized their businesses. four years old at baseline, some 38 percent of size establishments in Chile (35 per - medium- Moreover, the question regarding initial size - cent in Colombia) were large establishments is ambiguous. If the firm started as an infor - five years later. This evidence shows dyna mal establishment, some managers may refer mism across younger establishments in LAC, to the initial size as the size when the first full- time employee was hired, whereas others a feature that is consistent with the evidence may refer to the size of the firm when it was for the United States reviewed above. formally registered. However, administrative The detailed analysis presented so far data featuring long panels of firms yields sim leaves several questions open. How much - of the observed patterns of firm dynamics ilar results, providing some confirmation of the analysis of firm dynamics using this data can be generalized to the region? Ideally, set (box 2.3). one would like to trace firms in all countries The relationship between age cohort and over time to observe the contribution to total initial firm size is strong in LAC. Companies employment across birth cohorts. Unfortu - 39 years old in 2009 increased that were 30– nately, such long panels of firms in the region are not easily available. their initial size by a factor of eight over the to 40- Firm dynamics can be examined across 30- year period (figure 2.13). This different birth cohorts in a large number of performance is less impressive than that observed in high- income countries (where the countries using Enterprise Surveys, however (see box 2.1 for a description of this data set). multiplying factor exceeds 14) but better than in regions of similar levels of development. Although Enterprise Surveys are representa - section of firms at one point in tive of a cross- In EAP4, the relative size is close to seven; time, they contain a key question that makes in ECA it barely exceeds 4. Note, however, the analysis possible. Managers of the firms that in ECA the firms created in the 1970s are asked “how many permanent full- time and 1980s were state firms, which underwent massive transformation in the 1990s during employees did this establishment employ the transition to a market economy. But even when it started operations?” The question if only the youngest cohorts are examined, allows their current size to be compared with LAC has a relative advantage in firm growth the size at the time of setting up the business. with respect to initial size. - Enterprise Surveys poll only formally reg istered firms. This sample is thus highly selec - The impressive employment growth per - formance of LAC firms hides a fundamental tive, including only those relatively successful 02_ENTinLAC_023-060.indd 46 11/21/13 5:42 PM

65 47 ThE LIfE Cy CLE of fIRMS IN LATIN A MERICA ANd ThE C ARIbbEAN y, ANd , ENTR ENTREPRENEURShIP BOX 2.3 Comparing firm size across age cohorts in Colombia using Enterprise Surveys and administrative data 5. In contrast, Eslava and 15 or more than at age 1– In an attempt to provide some external validity to Haltiwanger find that the size of these firms barely the Enterprise Surveys, we compared the differences doubled. However, if the sample in the Enterprise in firm size across age cohorts in Colombia from the Surveys is restricted to eliminate firms with 5– 10 Enterprise Surveys with the differences Eslava and employees, a virtually identical picture of the size Haltiwanger (2013) document based on a universal structure across ages emerges from the two sources. establishment registry. The data in Eslava and Halti - The impact of eliminating very small firms from wanger cover only the manufacturing sector; refer to - the sample is clearly observed in panel b of fig plants, not firms; and have a different size threshold ure B2.3.1. The average firm size for age category from the Enterprise Surveys (more than 10 employees 1– 4 is below 20 when the smallest firms are included rather than more than 4 employees). The picture that in the sample; it more than doubles when firms in emerges from the Enterprise Surveys restricted to the 9 category are dropped. the 5– manufacturing sector is significantly different. Firms in the Enterprise Surveys are five times larger at age Employment in establishments in Colombia, by age of establishment FIGURE B2.3.1 b. Average number of employees per rm size a. Average of old and young rms 5 120 100 4 80 3 60 2 40 to rms 1–4 years old Number of employers Relative size with respect 20 1 15+ 1–4 1–4 5–9 10–14 15+ 5–9 10–14 Firm establishment age (years) Firm establishment age (years) Manufacturing Manufacturing Manufacturing (as measured by Eslava-Haltiwanger) (excluding micro rms) World Bank, based on Eslava and Haltiwanger 2013. Source: the typical LAC firm at the 90 percent percen weakness, however. At the time of creation - LAC firms are smaller than in any other tile barely reaches 25 employees, as opposed country group. The gap in initial firm size to 40 in ECA and high- income countries and is not obvious for the average firm; rather, almost 55 in EAP4 (panel b of figure 2.13). The imbalance in initial firm size is such LAC seems to be lacking top performers. The that LAC firms never catch up in size with median firm size at the start of operations in LAC is five employees, very much in line with firms from other regions. LAC firms that income countries. However, ECA and high- are 40 years old or older are on average half 02_ENTinLAC_023-060.indd 47 11/21/13 5:42 PM

66 48 LATIN AMERICAN ENTREPRENEURS 10 Firm size in Latin America and the Caribbean, by age of firm, 2006– FIGURE 2.13 b. Average initial size of rm a. Average size of rm relative to its initial size 16 60 14 50 12 40 10 30 8 6 20 4 Number of employees 10 2 Ratio between current and initial rm size 0 0 10–19 20–29 30–39 5–9 1–4 EAP4 High-income LAC ECA economies 10th percentile Average High-income EAP4 ECA LAC economies 50th percentile 90th percentile c. Average employment by rm age 300 250 200 150 100 Number of employees 50 0 1–4 20–29 10–19 40+ 5–9 30–39 LAC EAP4 High-income ECA economies World Bank, based on data from World Bank Enterprise Surveys. Source: Note: The last survey available for each country or economy was used. Each country or economy has the same weight in the regional average. Size at birth above 10,000 employees was replaced by “missing.” For countries and economies included in each group, see note 11. the size of firms in similar age cohorts from times the initial size after 40 years of opera - high- tion. Differences in sampling frames between income countries or countries in ECA the Enterprise Surveys and the Mexican data countries (panel b of figure 2.12). The size used by these authors are likely to be the main gap is also notable in comparison with EAP4. factor behind these differences. The Hsieh Even within the cohort of firms 10–19 years and Klenow data set includes all firms, for - old, firms in EAP4 are twice the size of LAC mal or informal, except street vendors. These firms, at 100 employees on average versus 50. - micro firms were included in Hsieh and Kle The finding of rapid growth of LAC firms now but excluded from the Enterprise Sur - may seem to contradict a recent study by veys. Most of them have no employees and Hsieh and Klenow (2012) for Mexico. They report an average firm size of merely two are very unlikely to grow. 02_ENTinLAC_023-060.indd 48 11/21/13 5:42 PM

67 y, ANd Cy CLE of fIRMS IN LATIN A MERICA ANd ThE C ARIbbEAN 49 ThE , ENTR ENTREPRENEURShIP LIfE Age distribution of top 100 firms in selected country FIGURE 2.14 The high selectivity of the Enterprise groups Surveys sample is clearly observed in the reported initial firm size of five employees. Top 100 rms in developing vs developed countries Analysis of the Gallup data suggest that even 0.025 among formal business owners, the median number of employees is 0. The implication 0.02 is that there is a subset of firms in LAC that - are highly dynamic. They start small in com 0.015 parison with similar firms in other parts of - the world but grow relatively quickly. How Density 0.01 ever, these firms represent a small subset of the economy. The vast majority of LAC firms 0.005 start small and never cross the size threshold of five employees to be considered in the sam - 0 pling frame of the Enterprise Survey. 50 0 150 100 A final piece of evidence supporting the rel - Age of rm (years) ative dynamism of good markets in the region is obtained by examining the age distributions LAC5 (developing) Other LAC (developing) - of firms in different parts of the world (fig United States EAP (developing) Continental Europe (developed) (developed) ure 2.14). The Orbis data (see box 2.1) were used to plot the size distribution of the 100 World Bank, based on data from Orbis. Source: largest firms in terms of revenue in different Note: The distribution includes all firms within a region for which data were available. EAP (East Asia and Pacific): Indonesia, Malaysia, the Philippines, and Thailand. Continental Europe: Belgium, France, regions, including LAC5, Other LAC, EAP4, Germany, Italy, the Netherlands, and Spain. For countries included in LAC5 and Other LAC, see note 11. Continental Europe, and the United States. If the largest firms in LAC are public sector is somewhat lower than expected, but the companies that later privatized but still benefit share of formal businesses is larger than in from a position of dominance in the market, other regions of similar levels of develop - one would expect to observe that the larg - ment. However, the share of informal busi - est firms are relatively old. In contrast, if the ness owners is also relatively large. These two privatization of the 1990s resulted in a cleans - set of facts mesh when one observes that for - - ing effect, killing unproductive firms and giv mal sector firms in LAC tend to be smaller ing birth to a new entrepreneurial class, the than firms in other parts of the world. Even age distribution should be tilted toward the - firms that manage to grow and generate sig relatively young. The problem is determining nificant numbers of jobs are substantially the right benchmark for comparison. Some smaller than in EAP4 or ECA. The last sec - top U.S. firms have had a remarkable ability tion examines whether this bias toward small to reinvent themselves: some companies date firms is dictated by the environment in which as far back as the early 1800s (Siegel 2007). LAC firms operate or is instead more deeply Something similar is likely to have happened rooted in cultural and historical factors. in Europe. Perhaps for this reason, the most interesting comparison is with EAP4. LAC firms are on average younger than firms in growth What is hindering high- EAP4. In particular, both Other LAC and entrepreneurship: Culture, LAC5 have relatively large numbers of large institutions, or the environment? firms that are very young (for example, less Is LAC missing truly innovative entrepre - - than 30 years old) and have a long tail, includ neurs? Firms in the region are small given the ing some firms that are 100 years old or older. level of development, limiting employment The analysis so far provides a mixed opportunities, creating too few good- paying picture. The formal sector in LAC is rela - jobs, and contributing to the flourishing tively dynamic. The rate of firm creation 02_ENTinLAC_023-060.indd 49 11/21/13 5:42 PM

68 50 LATIN AMERICAN ENTREPRENEURS FIGURE 2.15 Share of business establishments in growth firms and self- of low- employment. Argentina owned by foreigners, 1910 These facts may point to an environment that is not business friendly; they may also be signs of insufficient entrepreneurial zeal. Sugar rening The two hypotheses may be connected, as an Sugar mills environment that is less favorable to innova - Gas tion and high- growth entrepreneurship is Wool fabric likely to push potential employees into less Printing dynamic forms of entrepreneurship or even Flour mills outside the market (through migration, for Beer instance). Fruit vending One way to shed light on these questions Meat processing plant is to look back at history. At the beginning Electricity of the 20th century, insufficient entrepre - Sack cloth neurial spirit reflected the institutions and Tobacco attitudes toward entrepreneurship inherited Saddlery from Spain on the one hand, and the lack of Lumber mills techno- literacy and knowledge among the Glass native population on the other (Maloney 2012). Foreign- born entrepreneurs were in Foundries charge of the vast majority of businesses in Meat preserves the Americas. Indeed, census data for 1910 Brickmaking - in Argentina show that 7 out of 10 busi Tanneries nesses registered in Argentina were owned by All foreigners. Designers The influence of foreign- born ownership Mechanic shops in Argentina was heavily tilted toward sectors Dressmaking that were more technologically advanced, Carpentry including trolleys (100 percent foreign pres - Iron works - ence), carriages and other vehicles (79 per Baking cent), iron works (71 percent), mechanic Tin work shops (70 percent), and lumber mills (58 per - Footwear cent) (figure 2.15). Although foreign presence Shoe making was also very important in some sectors that Carriages/Vehicles are arguably less technologically advanced (for example, baking and cloth vending), in Tailoring general it was less important in some of the Clothes vending more traditional sectors, such as sugar mill - Espadrilles - ing (30 percent), wool production (39 per Furniture making cent), flour milling (43 percent), and beer Shirt making production (46 percent). Trolleys born The tremendous presence of foreign- Wool cleaning individuals in the productive network of 60 50 40 30 20 70 80 90 100 0 10 Argentina is naturally influenced by the large Foreign ownership (%) influx of migrants there. However, foreign- born residents own a large share of businesses Source: Maloney 2012. even in countries with smaller shares of migrants. In 1888 in Barranquilla, the major center of economic activity in Colombia at the time, some 64 percent of establishments 02_ENTinLAC_023-060.indd 50 11/21/13 5:42 PM

69 y, ANd Cy CLE of fIRMS IN LATIN A MERICA ANd ThE C ARIbbEAN 51 , ENTR LIfE ENTREPRENEURShIP ThE were owned by people born abroad (Maloney entrepreneurial drive among locals is behind 2012). In Mexico in 1935, the share of estab - innovative programs that try to attract for - eign entrepreneurs (box 2.4). lishments directed by people born abroad - Cross- country heterogeneity in local con was 35 percent, while some 90 percent of the ditions such as access to credit, barriers to workers in the same sectors were Mexican. born pres - entry, and attitudes of institutions toward Spaniards dominate the foreign- entrepreneurship make it difficult to draw - ence among the number of directors (16 per cent), followed by people born in the United causal relationships about why on average people from some countries are more likely States (3 percent) and in Germany, France, than people from other countries to become - Poland, and the Russian Federation (2 per entrepreneurs. It is almost impossible to iso cent each). - This evidence suggests that people from late the role of the environment from the role LAC were not particularly prone to entre - of innate entrepreneurial ability or predispo - country comparisons. One - preneurial activities at the turn of the cen sition from cross- tury. If this tendency reflected cultural possible albeit imperfect way to do so is to compare immigrants from different countries traits or deficits in human capital that were strongly persistent, it could explain the bias in a particular country. growth entrepreneurial firms in toward low- Messina, Özden, and Sarzosa (2013) study 22 The perception of insufficient differences across countries of origin in the the region. Up Chile BOX 2.4 Importing entrepreneurs: Start- hosted; more than $8 million had been raised from In August 2010, the Chilean economic development - investors in the United States, Argentina, and Mex agency, CORFO, launched an innovative initiative ico; and projects had achieved sales of $550,000 and - with the aim of enhancing the country’s competitive employed 228 people. The goal is to reach 1,000 ness through technology, innovation, and entrepre - projects by 2014. neurship. The program, Start- Up Chile, aims to cre - - The program also created a network of entrepre ate a new entrepreneurial environment by enhancing neurs. Through the online platform Meetups, Start- international connections and removing the barriers Up Chile entrepreneurs and local interested parties faced by entrepreneurs: limited access to credit, low can meet to share experiences and challenges. This adoption of new technologies, and the lack of inter - - part of the program is intended to promote entre national customers. preneurial activity and contribute to changing the stage, high- potential entrepreneurs received Early- culture in the local environment. seed capital of $40,000, which they had to match Critics of the program complain about the with at least $4,000 of their own resources. bureaucracy of the reimbursement process and the Entrepreneurs were approved in an admission lack of commitment of certain participants, high - process conducted by Silicon Valley experts and a lighting problems with the selection process. The Chilean innovation board. program needs to define its long- term goals and a The truly innovative aspect of the initiative is method for measuring results. Although it is too that the program targets foreign entrepreneurs or early to assess the impact on economic activity, this Chileans developing projects abroad. Entrepreneurs initiative reveals the increasing interest of govern - are required to spend at least six months in Chile, - ments in attracting the most promising entrepre year where a variety of facilities, including a one- neurs to their countries. - visa, social security, a bank account, and a work place with wireless Internet, are provided. Source: Applegate and others 2012. ups from The pilot launched a modest 22 start- ups had been 14 countries. By June 2012, 323 start- 02_ENTinLAC_023-060.indd 51 11/21/13 5:42 PM

70 52 LATIN AMERICAN ENTREPRENEURS the Current Population Survey (CPS), con - entrepreneurial experiences of migrants to the United States. The main advantage of looking ducted by the U.S. Bureau of Labor Statistics, at migrants in one country is that they share about 30 percent of self- employed people with incorporated businesses had firms with the same economic environment. Perhaps the more than 10 employees; in contrast, only most important limitation is that migration is not a random phenomenon. A combina 1 percent of unincorporated businesses did - so. Hence, the proxy for transformational tion of factors, including the socioeconomic entrepreneurship used in the analysis is the situation at home and expected prospects incorporation of the business. after migration, determines the decision to - Figure 2.16 shows differences across coun migrate. If such selection were similar across tries of origin in the self- employment rates of countries, one could compare differences in - - migrants in the United States after control entrepreneurship across migrants from dif ferent birth countries and draw conclusions ling for differences in education, age, and about differences in entrepreneurial drive. year of arrival. Results for men are exam - In fact, these factors differ across migrant ined, in order to avoid dealing with problems - groups. Indian migrants in the United States selection into participa associated with self- tend to be highly educated, even more so tion in the labor market. As expected, most migrants have a lower likelihood of being than natives, whereas migrants from Mexico self- employed than non- Hispanic U.S. and El Salvador have, on average, less educa - natives, but very interesting differences across tion than U.S. natives. The year of migration 24 region of origin emerge. also differs across groups, and the moment of arrival is likely to influence the entrepreneur With the exception of Spanish- speaking - ial experience. The costs of migration are Caribbeans, people from LAC appear to - likely to be different as well, with geographi be less entrepreneurial than migrants from other regions. The least entrepreneurial cal proximity reducing such costs. Some of these differences can be accounted for by among migrants are Mexicans, closely fol - lowed by migrants from Central America and controlling for observable characteristics of non-Spanish-speaking Caribbean islands. migrants and the year of migration. - - Migrants from South America do some Another complication is that the destina what better, about as well as migrants from tion of migrants within the recipient country East Asia and the Anglo- Saxon countries is not random. Migrants from different ori - (Australia, Ireland, New Zealand, and the gins tend to cluster in geographical enclaves, United Kingdom). The estimated effects are and the characteristics of each of these geo - graphical areas, including the entrepreneur large. Being of Mexican origin reduces the - likelihood of being self- employed by almost ial environment, are likely to differ. Indeed, 70 percent with respect to being a U.S. native in a pioneering study, Borjas (1986) finds (from 14 percent to 4 percent). that part of the migrant/native gap in self- 23 The gap between Latin American employment rates reflects “enclave” effects. The final challenge to studying entrepre - migrants and U.S. natives is much larger neurship among migrants in the United States employed people with incorpo among self- - is related to the difficulties in separating high- rated businesses, although differences by and low-growth-potential entrepreneurship. region of origin are stable across classifica - Messina, Özden, and Sarzosa (2013) employ tions. Among Mexican immigrants, the gap a fundamental dimension that distinguishes with respect to non- Hispanic U.S. natives is the two forms of entrepreneurship: their almost 4 percentage points, which suggests - capacity to generate employment. Trans the virtual nonexistence of Mexicans within formational entrepreneurs by and large run this type of entrepreneurial activity, as the growth entrepreneurs larger firms than low- share of white U.S. natives that have incorpo - and hence generate more jobs. According to rated businesses is about 4 percent. 02_ENTinLAC_023-060.indd 52 11/21/13 5:42 PM

71 ENTREPRENEURShIP y, ANd ThE LIfE Cy CLE of fIRMS IN LATIN A MERICA ANd ThE C ARIbbEAN 53 , ENTR FIGURE 2.16 Entrepreneurship among immigrants and natives in the United States, by type of business and country b. Not incorporated a. Self-employed Mexico Central America Mexico Central America Caribbean Caribbean South Asia South Asia East Asia East Asia Anglo-Saxon Anglo-Saxon South America South America Eastern Europe Eastern Europe Africa Africa Middle East and North Africa Spanish-speaking Caribbean Middle East and North Africa Spanish-speaking Caribbean Spanish-speaking United States Western Europe Spanish-speaking United States Western Europe –0.1 –0.04 –0.05 0 –0.02 0.05 –0.06 0 Marginal eect Marginal eect c. Incorporated Non-LAC countries LAC countries Mexico Caribbean Central America South Asia East Asia South America Africa Anglo-Saxon Eastern Europe Middle East and North Africa Spanish-speaking Caribbean Spanish-speaking United States Western Europe 0 –0.02 –0.02 0.04 –0.04 Marginal eect Adapted from Messina, Özden, and Sarzosa 2013. Source: Figure shows the marginal effects of country of origin grouped by region for a 35- year- old male migrant with secondary education who immigrated between 1992 and 1996 Note: 12 years after arrival in the United States). The baseline category is U.S. non- Hispanic natives. These estimates are obtained from and is observed in the period 2001– 04 (that is, 5– logit regressions (panel a) and multinomial logits (panels b and c) in specifications that control for age, age squared, educational attainment, the log of number of years since arrival in the United States, sector dummies, a citizenship dummy, and country of origin dummies. Points represent the marginal effect for each group. Bars represent the 95 confidence interval. Red points are migrants from Latin America and the Caribbean (LAC). The large gap among LAC migrants in the the gap to shrink as the immigrant spends time in the host country and assimilates. This share of incorporated businesses in the United hypothesis is examined by looking at the gap States may reflect difficulties in accessing - in businesses owned by immigrants from dif credit and other market imperfections that ferent regions over time. are more likely to affect migrants than U.S. natives (although such difficulties are likely Across most regions of origin, the gap to be similar across migrants of different ori in not incorporated self- - employment with gin). If this were the case, one would expect respect to non- Hispanic natives dissipates 02_ENTinLAC_023-060.indd 53 11/21/13 5:42 PM

72 54 LATIN AMERICAN ENTREPRENEURS Marginal effects of years in United States on entrepreneurship gap between migrant and nonmigrant white FIGURE 2.17 men, by cohort of arrival and region a. Mexico b. South Asia Incorporated rms Nonincorporated rms Incorporated rms Nonincorporated rms 0.02 0.1 0.02 0.1 0 0 0.05 0.05 –0.02 –0.02 0 0 –0.04 –0.04 Marginal eects –0.04 –0.06 –0.04 –0.06 3 17 15 13 11 9 7 5 19 3 17 15 13 11 9 7 5 19 3 17 15 13 11 9 7 5 19 17 15 13 11 3 9 7 5 19 Number of years in Number of years in Number of years in Number of years in United States United States United States United States d. Central America c. Caribbean Nonincorporated rms Incorporated rms Incorporated rms Nonincorporated rms 0.02 0.02 0.02 0.02 0 0 0 0 –0.02 –0.02 –0.02 –0.02 –0.04 –0.04 –0.04 –0.04 Marginal eects –0.06 –0.06 –0.06 –0.06 15 13 11 9 7 5 17 3 17 15 3 19 5 7 9 11 13 15 17 3 19 5 7 9 19 13 15 17 3 19 5 7 9 11 13 11 Number of years in Number of years in Number of years in Number of years in United States United States United States United States 1998–2001 cohort 1992–97 cohort Year of arrival in United States: 1987–91 cohort Source: Messina, Özden, and Sarzosa 2013. Note: Each line represents the marginal effects of years in the United States for each cohort of immigrants. Estimates are obtained from multinomial logits in specifications that con - trol for age, age squared, educational attainment, the log of number of years since arrival in the United States, sector dummy, a citizenship dummy, and countries-of-origin dummies. The marginal effects are obtained for a male migrant with secondary education. - after 15– 17 years in the United States (fig Notes ure 2.17). In contrast, the gap in incorporated These statistics are averages of household 1. businesses persists among migrants from surveys from Argentina, Chile, Colombia, - many regions, although there is some conver the Dominican Republic, Ecuador, El Salva- gence after 15 years for some regions outside dor, Mexico, Panama, Peru, and Paraguay LAC. Convergence occurs for migrants from 10. The samples were restricted to in 2009– South Asia (panel b) but not among Mexicans 60 who worked more than workers ages 25– speaking Caribbeans Spanish- (panel a), non- 30 hours in the reference week (SEDLAC). (panel c), or Central Americans (panel d). Some of the most successful entrepreneurs in 2. the region are probably not captured by the LAC migrants thus catch up with household surveys, which tend to underrepre- non- Hispanic natives in the type of self- sent the upper tail of the income distribution. employment they are used to at home— Poschke (2013a) argues that a firm’s produc- 3. namely, small- scale self- employment. But just tivity is an increasing and convex function of - like at home, they have a harder time engag the ability of the entrepreneur who runs it— ing in the dynamic activities that have high that is, both the level of productivity and the generation potential. employment- 02_ENTinLAC_023-060.indd 54 11/21/13 5:42 PM

73 y, ANd LIfE Cy CLE of fIRMS IN LATIN A MERICA ANd ThE C ARIbbEAN 55 , ENTR ENTREPRENEURShIP ThE Asia) includes Albania, Armenia, Azerbaijan, rate at which productivity increases are posi- Belarus, Bosnia and Herzegovina, Bulgaria, tively associated with ability. Georgia, Kazakhstan, Latvia, Lithuania, FYR See, for instance, Boeri and Jimeno (2005) for 4. Macedonia, Moldova, Romania, the Russian related employment protec- a rationale of size- Federation, Serbia, Turkey, Turkmenistan, tion in Italy and an analysis of its impact on Ukraine, and Uzbekistan. includes EAP4 the labor market. Indonesia, Malaysia, the Philippines, and Jovanovic (1994) provides a very rich treat- 5. include High-income economies Thailand. ment of the occupational choice between Australia; Canada; Hong Kong SAR, China; entrepreneurship and wage work. In this Israel; Japan; the Republic of Korea; Kuwait; model, entrepreneurs are concentrated among New Zealand; Oman; Saudi Arabia; Singa- ability individuals. In contrast, the simple high- pore; Switzerland; the United Arab Emirates; framework presented here highlights the coex- the United States; and all countries in the istence of two critical masses of entrepreneurs European Union not included in ECA. The set at the extremes of the ability distribution. of economies from each group used in figures - 6. For simplicity and comparability across sur throughout this chapter varies according to veys, and unless otherwise stated in the text, data availability. the self- employed are assumed not to have 12. A perhaps more obvious explanation would paid employees, although in the data some be that entrepreneurs are a more heteroge- employed run small firms. On average self- neous group than salaried workers. Repli- in Latin America and the Caribbean, about cation of the analysis with the residuals of 14 employed people had at least percent of self- a flexible Mincer regression that includes a one employee in 2009. second- order polynomial in age and educa- thirds of 7. These 73 countries represent two- tion, a gender dummy, and their interactions the population of the developing world. Data results in residual wage distributions that still sources vary by country. They are harmonized display substantially higher variance for both micro level household surveys collected by the groups of entrepreneurs. It is not possible to Development Economics Group (DEC) of the rule out the possibility that such higher vari- World Bank in the International Income Dis- ance in earnings is the result of greater het- tribution Database (I2D2). See Gindling and erogeneity in unobservable characteristics (for Newhouse (2012) for details. example, ability). Loayza and Rigolini (2011) provide a detailed 8. 13. Interviewers were instructed to ask if the treatment of the relationship between self- businesses were registered with the relevant employment and GDP per capita. authorities and had a license or certificate. 9. employment in For example, the share of self- 14. For an account in an endogenous growth the United States fell by half between 1910 framework, see Aghion and Howitt (1992). and 1990, from 16 percent to 8 percent of The procedures, time, and costs to start up 15. workers in the adult population (Fairlie and a business refer to the requirements to reg- Meyer 1999). ister formally a limited liability company of 10. In order to mitigate differences in the length of 50). Our entry data small to medium size (10– the schooling period across countries, we con- include all formal registrations. The costs to centrate on the population in the age bracket register smaller firms may be different from 25– 65. those captured by Doing Business. In addi- 11. Throughout this chapter we use the following tion, local authorities, such as authorities in groups of economies unless otherwise noted. charge of zoning laws and building permits, includes Argentina, Brazil, Chile, LAC5 impose some potentially important restric- Colombia, and Mexico. Other LAC includes tions on small entrepreneurs that the Doing Bolivia, Costa Rica, the Dominican Republic, Business indicators do not include. However, Ecuador, El Salvador, Guatemala, Honduras, the costs reported by Doing Business are likely Nicaragua, Paraguay, Peru, Uruguay, and to be correlated with the overall costs to set up Carib- República Bolivariana de Venezuela. a business. bean includes Antigua and Barbuda, Cuba, 16. Administrative barriers to entrepreneurship in Dominica, Grenada, Guyana, Haiti, Jamaica, OECD countries refer to the regulatory frame- St. Kitts and Nevis, St. Lucia, St. Vincent and work in 2008, whereas in LAC the indicator the Grenadines, Suriname, and Trinidad and was constructed in 2013. See Wölfl, Kozluk, Tobago. ECA (Eastern Europe and Central 02_ENTinLAC_023-060.indd 55 11/21/13 5:42 PM

74 56 LATIN AMERICAN ENTREPRENEURS Acs, Z. J., S. Desai, and L. F. Klapper. 2008. and Nicoletti (2009) for a description of the “What Does ‘Entrepreneurship’ Data Really methodology. Show?” Small Business Economics 31 (3): The standard deviation of the costs of red tape 17. 81. 265– from declined by a factor of more than four— Aghion, P., and P. Howitt. 1992. “A Model for the 151 coun- 218 in 2004 to 48 in 2013— of Growth through Creative Destruction.” tries for which data were available throughout 60 (2): 325– Econometrica 51. the period. Schi Alesina, A., S. Ardagna, G. Nicoletti, and F. - Results are very similar if the yearly observa- 18. - antarelli. 2005. “Regulation and Invest tions or period averages are used. ment.” Journal of the European Economic 19. The data set covers Colombian manufacturing 825. Association 3 (4): 791– firms with more than 10 employees or annual Almeida, R., and P. Carneiro. 2011. “Enforce - production of more than about $100,000. ment of Labor Regulation and Informality.” The 10- employee threshold has implications IZA Discussion Paper 5902, Institute for the for the study of business dynamics, as dis- Study of Labor, Bonn. cussed in box 3.3 in chapter 3. Applegate, L. M., R. K. William, J. Lerner, D. D. 20. Although all of the analysis is based on estab- Pomeranz, G. A. Herrero, and C. Scott. 2012. lishments, the main patterns remain when Up Chile: April 2012.” “Start- Harvard Busi - firms are considered (see Eslava and Halti- 158. ness School Case 812– wanger 2013 for details). - Ardagna, S., and A. M. Lusardi. 2010. “Explain Growth rates in this section are defined as the 21. - ing International Differences in Entrepreneur difference in firm size between two consecutive ship: The Role of Individual Characteristics periods divided by the average employment in International and Regulatory Constraints.” In - the two periods. These growth rates, popular edited by Differences in Entrepreneurship, ized by the work of Davis, Haltiwanger, and - J. Lerner and A. Schoar, 17– 62. Chicago: Uni Schuh (1996), present two main advantages. versity of Chicago Press. First, they are symmetric for expansions and Åstebro, T. 2003. “The Return to Independent contractions, ranging in the interval [– 2, +2]. Invention: Evidence of Unrealistic Optimism, Second, they allow the treatment of firm birth Risk Seeking or Skewness Loving?” Economic and death in the computation of the growth 39. Journal 113 (484): 226– rate. - Audretsch, D. B., and M. Keilbach. 2005. “Entre For an interesting discussion of the main per - 22. preneurship Capital: Determinants and sonality traits entrepreneurs typically have, Impact.” CEPR Discussion Paper 4905, Centre see CAF (2013). for Economic Policy Research, London. There is little we could do to tackle this 23. Bartelsman, E., J. Haltiwanger, and S. Scarpetta. problem with the data we have. Hence, the 2009. “Measuring and Analyzing Cross- results remain informative but present some Country Differences in Firm Dynamics.” In limitations. Producer Dynamics: New Evidence from 24. Migrants other than Mexicans were pooled by T. Dunne, J. B. Jensen, edited by Micro Data, region of origin because the number of entre- and M. J. Roberts, 15– 76. Chicago: University preneurial migrants in the American Commu- of Chicago Press for the National Bureau of nity Survey (U.S. Census) samples were not Economic Research. large enough for some countries in particular Blanchflower, D. G., and B. D. Meyer. 1994. cohorts of arrival. Mexicans constitute a suffi- “A Longitudinal Analysis of the Young ciently large group to be considered separately. Employed in Australia and the United Self- Small Business Economics 6 (1): 1– 19. States.” References Blanchflower, D. G., and A. J. Oswald. 1998. Journal of “What Makes an Entrepreneur?” Acs, Z. J. 2008. “Foundations of High Impact Labor Economics 60. 16 (1): 26– Foundations and Trends Entrepreneurship.” Boeri, T., and J. F. Jimeno. 2005. “The Effects in Entrepreneurship 4 (6): 535– 620. of Employment Protection: Learning from Acs, Z. J., and D. B. Audretsch. 1989a. “Small- Variable Enforcement.” European Economic Firm Entry in U.S. Manufacturing.” Econom - Review 49 (8): 2057– 77. 65. 56 (222): 255– ica Borjas, G. L. 1986. “The Self- Employment ———. 1989b. “Small Firms in U.S. Manufactur - Experience of Migrants.” Journal of Human ing: A First report.” 31 (4): Economics Letters Resources 21 (4): 485– 506. 399– 402. 02_ENTinLAC_023-060.indd 56 11/21/13 5:42 PM

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77 ThE Cy CLE of fIRMS IN LATIN A MERICA ANd ThE C ARIbbEAN 59 y, ANd , ENTR ENTREPRENEURShIP LIfE National University of La Plata, La Plata, - Industries.” Review of Economics and Statis Argentina, and World Bank, Washington, DC. 66. tics 56 (1): 58– Siegel, J. 2007. Stocks in the Long Run: The Oxenfeldt, A. R. 1943. “New Firms and Free Definitive Guide to Financial Market Returns War Aspects.” Enterprise: Pre- War and Post- New and Long Term Investment Strategies. - American Council on Public Affairs, Washing York: McGraw- Hill. ton, DC. Storey, D. J. 1991. “The Birth of New Firms: Parker, S. 2006. “A Selection- Based Theory of the Does Unemployment Matter? A Review of the - Transition from Employment to Entrepreneur 3 (3): Small Business Economics Evidence.” ship: The Role of Employer Size.” IZA Dis - 167– 78. cussion Paper 2071, Institute for the Study of ———. 1994. Understanding the Small Business Labor, Bonn. London: Routledge. Sector. Parker, S. C. 1997. “The Effects of Risk on Self- Storey, D. J., and A. M. Jones. 1987. “New Firm Employment.” Small Business Economics Formation: A Labour Market Approach to 22. 9 (4): 515– Industrial Entry.” Scottish Journal of Political Poschke, M. 2013a. “The Decision to Become an 51. Economy 34 (1): 37– Entrepreneur and the Firm Size Distribution: Vivarelli, M. 1991. “The Birth of New Enter - A Unifying Framework.” Background paper Small Business Economics 3 (3): prises.” for this report. 215– 23. ———. 2013b. “Entrepreneurs out of Necessity: ———. 2004. “Are All the Potential Entrepre - Applied Economics Letters A Snapshot.” Small Business Econom neurs So Good?” - 20 (7): 658– 63. ics 49. 23 (1): 41– ———. 2013c. “Who Becomes an Entrepreneur? ———. 2013. “Entrepreneurship in Advanced and Labor Market Prospects and Occupational - Developing Countries: A Microeconomic Per Choice.” Journal of Economic Dynamics and spective.” Background paper for this report. Control 37 (3): 693– 710. Wennekers, S., and A. R. Thurik. 1999. “Link - Reynolds, P. D., S. Michael Camp, W. D. Bygrave, ing Entrepreneurship and Economic Growth.” E. Autio, and M. Hay. 2001. Global Entre - 13 (1): 27– Small Business Economics 55. 2001 Summary Report, preneurship Monitor. Wennekers, S., A. J. van Stel, A.R. Thurik, and London Business School, London, and Babson P.D. Reynolds. 2005. “Nascent Entrepreneur - College, Babson Park, MA. ship and the Level of Economic Development.” Rissman, E. R. 2007. “Labor Market Transitions 24 (3): 293– Small Business Economics 309. Employment.” Federal Reserve Bank and Self- Wölfl, I., T. Kozluk, and G. Nicoletti. 2009. “Ten of Chicago Working Paper 2007– 14, Chicago. Years of Product Market Reform in OECD Santarelli, E., M. Carree, and I. Verheul. 2009. - Countries: Insights from a Revised PMR Indi “Unemployment and Firm Entry and Exit: - cator.” OECD Economic Department Work An Update on a Controversial Relationship.” ing Paper 695, Organisation for Economic Co- 43 (8): 1061– Regional Studies 73. operation and Development, Paris. Schoar, A. 2010. “The Divide between Subsis - Washington, Doing Business. World Bank. 2011. tence and Transformational Entrepreneur - DC: World Bank. ship.” In Innovation Policy and the Economy, - World Bank Entrepreneurship Database. Wash 81. vol. 10, edited by J. Lerner and S. Stern, 57– ington, DC. http://www.doingbusiness.org Chicago: University of Chicago Press. /data/exploretopics/entrepreneurship. Schumpeter, J. A. 1934. The Theory of Economic World Development Indicators (database). World Development. Cambridge, MA: Harvard Uni - Bank, Washington, DC. http://data.worldbank versity Press. catalog/world- .org/data- development ———. 1939. Business Cycles: A Theoretical, - indicators. Historical and Statistical Analysis of the Worldwide Governance Indicators (database). Hill. Capitalist Process. New York: McGraw- World Bank, Washington, DC. http://info - Capitalism, Socialism and Democ ———. 1943. .worldbank.org/governance/wgi/index.asp. racy. London: Allen and Unwin (originally Zacharakis, A. L., W. D. Bygrave, and D. A. Shep - published in the United States in 1942; - herd. 2000. Global Entrepreneurship Moni reprinted by Routledge, London in 1994). - tor 2012 United States Report. Babson Col Economic Database for Latin SEDLAC (Socio- lege, Babson Park, MA. America and the Caribbean). Center for Distributive, Labor and Social (CEDLAS), 02_ENTinLAC_023-060.indd 59 11/21/13 5:42 PM

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79 Entrepreneurship by Incumbent 3 Firms: What Explains the Innovation Gap? Latin America and the Caribbean suffers from an innovation gap. On average, its entrepre- neurs introduce new products less frequently, invest less in research and development, and hold fewer patents than entrepreneurs in other regions; moreover, their management practices are far from global best practices. A deficit in human capital for innovation, lack of competi- tion, and inadequate intellectual property rights may explain the region’s underperformance. high- - tech sectors (although it briefly reviews ntry is only one dimension of entre this area as well). It shows that, with the preneurship. To survive, firms must - performing firms exception of a few top- E innovate. Incumbent firms can inno vate by bringing new products into the mar - (examined in chapters 4 and 5), the types of innovations that drive productivity growth ket or by exploring new markets at home and middle- in low- ). They can income countries differ and abroad ( product innovation also improve their internal processes and from those that drive growth in high- income management practices ( process innovation economies. Most firms in emerging markets ). engage in activities that lie far from the tech - These innovations are usually invisible to nological frontier; they innovate by adopt the final consumer but may be even more - ing and adapting products and production important for surviving the test of the mar - processes that have already been tested in ket than other innovations. Innovations by incumbent firms are likely countries that are at the technology frontier (Grossman and Helpman 1991; Segerstrom to be at least as important as entry rates for term economic growth and employment long- 1991; Dutz 2007; Ayyagari, Demirgüc- generation. This chapter reviews the innova - Kunt, and Maksimovic 2011). Cutting- edge tive performance of firms in Latin Ameri - innovation tends to gradually become more can and the Caribbean (LAC) in terms of important when firms in a country approach the world technology frontier (Acemoglu, their propensity to introduce new products, change their internal processes in search of Aghion, and Zilibotti 2006). Overall, the evidence suggests that LAC efficiency, invest in research and development firms tend to score toward the bottom end (R&D), and receive patents. - The chapter moves away from tradi of the spectrum in product innovation. tional analyses of cutting- edge innovation in Firms in East Asia and Eastern Europe tend 61 03_ENTinLAC_061-094.indd 61 11/21/13 5:14 PM

80 LATIN AMERICAN ENTREPRENEURS 62 to introduce new products more frequently, addressing to some extent the vulnerability concern caused by inflexible labor markets. conduct more R&D, and obtain patents in This progress notwithstanding, LAC the United States more often than do firms countries still underperform their peers in in LAC. some aspects, and regulation may still ham - Assessing process innovation across coun - per firms’ ability to innovate. Nevertheless, tries is difficult because of data constraints. although some benefits may still be extracted Fortunately, thanks to the emergence of a wave of management surveys that are com from improving the regulatory framework, - regulation may no longer be the most severe parable across countries, it is now possible to compare the quality of management prac obstacle to unleashing the private sector’s - innovative potential. - tices across countries and assess their rela The toughest challenge ahead may be to tionship with firm productivity. The picture address other aspects of the regulatory envi - that emerges suggests that much remains to - ronment, such as governance and uncom be done in LAC on the process front as well. petitive practices. To be sure, the relationship With a few exceptions, management pro - cesses (even by the relatively large firms that between competition and innovation is com - are included in the surveys) remain weak and plex. In sectors with increasing returns to are comparable to those of firms in China or scale, for instance, there is a strong rationale regulated) monop - India. Weak processes may not be the sole for allowing a single (well- olist to operate. And new research indicates determinant of long- term firm productivity, - that even in sectors with low returns to scale, but given LAC’s labor costs, which are signif icantly higher than Asia’s, poor management “excess” competition can, at times, reduce processes can hamper productivity. firms’ incentives to innovate (Aghion, Bloom, and others 2005). LAC is far from the tipping After comparing innovation performance point at which excess competition may hurt across regions, the chapter reviews factors that can potentially affect firms’ innovative innovation, however. Although there are seri - potential. The focus is on four factors that ous technical challenges in measuring de facto have been shown to affect innovation: regu - competition, LAC shows a pattern consistent with a few actors grabbing a large share of the lations, competition, access to finance, and entrepreneurial skills. It also briefly reviews market and having little incentive to innovate. Overall, as discussed in chapter 6, the region the extent to which policy makers can affect - entrepreneurship and innovation by exploit exhibits high concentration both across and ing agglomerations and spatial spillovers. within markets: production remains less Designing regulations requires balancing diversified than in other countries, and within the protection of workers and consumers sectors, especially in nontradable industries, a against the ability of firms to operate without few firms dominate the market. unnecessary obstacles. The consensus on the An important stream of research has historical evolution of the region’s regulatory documented the channels through which environment is that in the 1980s, policy dis - - underdeveloped financial markets and insuf tortions were excessively tilted against firms ficient or inefficient financial intermediation may hurt productivity and innovation (see and protecting only a minority of formal de la Torre, Ize, and Schmukler 2012). This workers. Some have argued that the regula - tory environment was so onerous for private chapter focuses on early- stage financing, an sector firms that ultimately workers and con - aspect of financial intermediation supposedly designed for young, innovative firms. Using sumers were negatively affected rather than protected (de Soto 1989). Over the past 20 a new database that surveys the region’s pri - vate equity deals, it shows that most deals are years, however, the region made regulatory - - large and involve mature firms. Venture capi reforms that improved the business envi tal targets large firms in traditional sectors, ronment substantially. It also substantially expanded social assistance for the poor, and angel investors are missing in action. 03_ENTinLAC_061-094.indd 62 11/21/13 5:14 PM

81 ? ExPLAINS ThE INNov ATIoN GAP : WhAT 63 by INCUMbENT ENTREPRENEURShIP FIRMS for policy action, which would one choose? Enterprise Survey data indicate that for both Overall, the competition and skills fronts seem young and old firms, the region is probably most important in LAC. Greater competition not lagging other emerging markets in terms generates pressure to innovate, but without of firms’ access to credit, however. the human capital to do so, the momentum Regarding the human capital aspect of - will probably be lost. There is therefore a entrepreneurship, often referred to as “entre need to produce skilled managers and tech preneurial skills,” entrepreneurs’ technical - nicians who, by promoting innovation, may and managerial background has been found increase competition. By acting on these two to increase firms’ chances of success (Viva - fronts, governments may be able to sustain a relli 2012). Historical studies also find a - virtuous cycle of innovation and competition. positive association between densities of engi These issues are revisited in chapter 6. neers at the beginning of the 20th century Finally, we would like to make a pitch and long- term economic growth (Maloney for more rigorous evaluations of entrepre and Valencia- - Caicedo 2012). Our analysis suggests that the region is still lagging along neurship and innovation programs. These country com - programs are plentiful in the region, as this dimension. Although cross- comprehensively reviewed by recent studies parisons remain a challenge in this field, most American Development Bank by the Inter- LAC countries have smaller percentages of (Pagés-Serra 2010) and the Corporación science and engineering graduates than do countries in Eastern Europe or East Asia. To Andina de Fomento (CAF 2013). Despite the substantial resources invested in these some extent, many Latin American countries programs, there is a sense that few deliver seeking societies,” in the words remain “rent- economic benefits. This failure can be a of Murphy, Shleifer, and Vishny (1991). The region also appears to have surpris - consequence of an environment that may be hindering innovation, but it may also reflect managed modern firms, as ingly few well- poor program design. In addition to working reflected by the poor quality of management on the broader constraints reviewed in this practices in relatively large formal sector firms. The correlation between how good chapter, there is a need to better understand which programs work and which do not. managers are, and how good they think they Few rigorous evaluations of entrepreneur are, is also very weak. To the extent that - ship and innovation programs have been management practices can be taught— and conducted in the region. Only by improving these find - evidence suggests that they can— ings leave room for public action. the understanding of which programs are The chapter ends by discussing an aspect effective through more rigorous evaluations - of innovation policies that has always fasci will it be possible to act effectively on both nated policy makers: the (alleged) ability to economic fronts. and macro the micro- sustaining innovation clusters by foster self- exploiting geographic spillovers. Geographic What drives innovation? spillovers do indeed substantially affect A conceptual framework firms’ incentives and ability to innovate. - Multiple factors drive innovation, often inter However, it is extremely difficult to generate acting in a complex manner. The fictional self- sustaining innovation clusters ex novo. In story of Javier, the winemaker introduced in experimenting with these risky (and costly) chapter 1, can shed some light on the process. strategies, it is therefore extremely important His story illustrates a conceptual framework to build on natural advantages, partner with about the difficult choices faced by entrepre - - the private sector, and ensure that exit strat neurs around the world— namely, whether egies are well defined to avoid subsidizing and how much to invest in innovation. failed attempts. Javier’s dreams have no boundaries. All these factors, and many others, affect He wants to take advantage of Mendoza’s innovation. But if one were to pick priorities 03_ENTinLAC_061-094.indd 63 11/21/13 5:14 PM

82 64 LATIN AMERICAN ENTREPRENEURS high- altitude Malbec grape varietal and they are the main source of innovations that improve existing products (Bartelsman and growing wine export his product to the ever- market in New York. He knows, however, Doms 2000; Foster, Haltiwanger, and Krizan that in order to indulge the refined palates 2001; Akcigit and Kerr 2010). of New York’s wine connoisseurs he needs The first lesson from Javier’s story is that to improve the quality of the wine from his - there are two parts of the decision to inno vate: whether to invest in innovation (the vineyards. His first wines were good for the extensive margin of innovation) and, if so, price, but many competitors produce similar how much (the intensive margin). Javier can wines. If he wants to conquer the competitive continue to produce at the local scale or he U.S. market, he knows he needs to go one step further. can improve his production processes in order to export. Panel a of figure 3.1 analyzes After talking to some of his friends in the - this type of decision. The entrepreneur com - wine business, Javier realizes that achiev quality wine pares preinnovation profits with the value of ing his goal of producing a top- requires investments. The first is a fixed innovating— expected profits less any initial investment that will be spent regardless of fixed costs of engaging in innovation activi - whether the business plan works. Javier - ties. Any factor influencing either preinnova tion profits or the value of innovation may needs to conduct a detailed analysis of the vineyard’s soil, the genetic characteristics of affect an entrepreneur’s decisions to innovate. the fruit, and the blending process in order For instance, if the United States imposed to have a better sense of the scope for quality import quotas on Argentine wines, the value of innovation would drop, and Javier might improvements. Before producing a single bot - tle of his longed- choose not to innovate. for wine, Javier has to invest a significant sum of money. - The second aspect of the innovation deci - Once he determines the feasibility of pro sion—how much to spend on innovation— ducing a higher- captures the amount of resources spent by quality wine, his next step a firm to improve its internal processes or is to hire an experienced winemaker. Javier products. The amount of the investment is understands that hiring an internationally likely associated with the probability of suc - renowned expert would increase his chances of reaching his goal but would also signifi cess. Panel b of figure 3.1 summarizes this - choice. It illustrates that the entrepreneur has cantly increase his costs. And there is a risk incentives to invest in innovation up to the that he fails to achieve the desired quality point at which a small additional investment of wine, which would mean not only that in innovation (that is, the marginal cost) the wine will not be good enough to export but that the local market may also be lost, equals the small additional gains that result because of the increased costs of production. from it (that is, the marginal benefit). Any factor affecting the marginal costs or benefits Failure would also mean that Javier loses his sunk- costs investment without a payoff. from innovation may change firms’ innova - tion investments. - After evaluating these options, Javier pon Thus far we have discussed the forces driv ders his options. Should he settle for the quiet - ing firms’ innovation decisions without delv - life of a small local wine producer, or should he incur the costs and run the risks required ing into the factors affecting these forces. to pursue his dreams of becoming an interna - What affects firms’ profitability? How does tional winemaker? a country’s legal framework affect firms’ incentives to innovate? Many factors affect Javier’s story illustrates the decision to the joint choices of whether to invest in inno - innovate of almost any incumbent firm. Such vation and how much to invest. The rest of firms are a major force behind the growth this chapter focuses on a few of them, such as and innovation processes. In the United - States, for instance, incumbent establish regulation, competition, or access to finance. - ments account for almost 75 percent of aver Box 3.1 discusses others like risk, laws, or age total factor productivity growth, and macroeconomic stability. 03_ENTinLAC_061-094.indd 64 11/21/13 5:14 PM

83 : WhAT ExPLAINS ThE INNov ATIoN GAP ? FIRMS 65 by INCUMbENT ENTREPRENEURShIP F I G U R E 3.1 Extensive and intensive margins of innovation b. Intensive margin: Whether to innovate a. Extensive margin: Whether to innovate Optimal Preinnovation prots innovation intensity Equality of preinnovation prots and value of Marginal costs Do not innovating of innovating innovate Prots Marginal benets Value of innovating: of innovating Innovate Expected prots minus any xed costs of Marginal costs and benets innovating Investment in innovation Preinnovation prots Adapted from Pienknagura 2013. Source: Risk, laws, macroeconomics, and the innovation B O X 3.1 gap in Latin America and the Caribbean the literature. One of the few theoretical papers to Our framework appears to be silent on the role of argue that badly designed bankruptcy laws could - risk as an important constraint for innovative entre hurt the intensive margin of innovation is Manso preneurship, because it assumes that firms are risk (2011). Bankruptcy laws can have two opposing neutral. However, uncertainty does play a role; it is effects on the intensive margin. On the one hand, hidden behind expected profits, which depend on lenient bankruptcy laws that limit the losses of a - the probability of being successful in the R&D pro failed innovation could decrease incentives to invest cess. To the extent that firms and entrepreneurs fear in innovation, as the “punishment” factor is reduced losses more than they value gains, risk can play an (a downward shift of the marginal benefits curve in even larger role in driving the decision to innovate, figure 3.1). On the other hand, limited liability may as it reduces the value of innovation directly. reduce the marginal cost of innovation, providing Risk is so embedded in everyday business prac - firms with an incentive to increase investments (this tices that it is difficult to measure the full extent to could be the case, for instance, if firms take loans - which it affects innovation (chapter 6 briefly exam to finance innovation, which will be repaid only if ines the risk of contracts being broken and the role they are successful). The net effect therefore remains - of intellectual property rights). A few studies look ambiguous a priori, which emphasizes the need to - ing at the impacts of bankruptcy laws on innova conduct empirical analyses. tion provide a glimpse into the ways in which risk - The contractual environment in which entrepre can affect innovation. These studies tend to point neurs operate also affects the incentives to invest in toward a negative impact of harsh bankruptcy laws innovation. Intellectual property rights, for instance, on the extensive margin of innovation (Armour and - increase the expected profits from innovation invest Cumming 2008; Acharya and Subramanian 2009; ments. Risk caused by unexpected macroeconomic Primo and Green 2011). Lenient bankruptcy laws - fluctuations can also hamper private sector invest are associated with lower penalties if investments in ment (Servén 1998). LAC, however, enjoyed a period innovation fail to bear fruit; they therefore reduce of relative macroeconomic calm during the years the expected fixed costs of innovation under the sce - covered by the analyses in this chapter. It is therefore - nario in which the profits associated with an innova unlikely that the innovation gap documented in this tion do not materialize. chapter reflects macroeconomic volatility. The relation between bankruptcy laws and inno - vation intensity has received much less attention in 03_ENTinLAC_061-094.indd 65 11/21/13 5:14 PM

84 66 LATIN AMERICAN ENTREPRENEURS Several studies have challenged this idea, Regulations - providing evidence of a positive correla Chapter 2 documented how poorly designed tion between innovation and competition regulations may affect the entry of private (Nickell 1996; Blundell, Griffith, and van - sector firms into the marketplace. Regula Reenen 1999). The logic is that innovation tions can also affect both the intensive and - may serve as a vehicle for escaping competi extensive margins of innovation investments. tion by providing the innovator with an edge Regulations that increase the fixed costs of over competitors (Aghion, Harris, and oth - innovation, for instance, reduce the value of ers 2001; Aghion, Bloom, and others 2005). innovation, limiting the number of innova - In the example of Javier, an increase in the tors and an economy’s aggregate investments number of wine producers serving Mendoza’s in innovation. Similarly, regulations that local market would reduce preinnovation increase the cost of either capital or labor used profits, possibly putting pressure on Javier to for R&D, such as laboratory equipment or improve the quality of his wine in order to - researchers, affect the marginal costs of inno export to New York or compete in a higher- - vation and thus the size of the optimal invest quality niche market in Argentina. ment in innovation. This is not to say that These two views represent the extreme all regulations are bad; regulation is needed cases. Reality is probably more complex. - to solve market failures, prevent unfair prac Whether competition is good or bad for inno - tices, and protect workers and consumers. But vation needs to be assessed empirically, as regulations may have impacts on innovation done below. that need to be taken into account. How regulation is implemented and 1 Access to finance Risk- averse firms enforced also matters. may be better off knowing the rules with The empirical literature has uncovered a than fac - even if they are costly— certainty— - strong association between financial develop ing uncertainty. Higher uncertainty in the ment and growth (see King and Levine 1993; returns from innovation reduces the value Beck, Levine, and Loayza 2000; and Rajan of innovation, discouraging some firms from and Zingales 1998, to mention a few studies). innovating. From a theoretical standpoint, this positive correlation is consistent with the role played by financial intermediation in allowing firms Competition enhancing activities such to invest in growth- Innovation decisions are tightly linked to as R&D (Aghion, Angeletos, and others profits, which depend crucially on the level of 2010). competition. The link between competition Financial development can positively and innovation (or more generally produc - affect innovation by decreasing the fixed tivity) has been central in the policy debate - and variable costs of innovation by reduc in developing countries for many decades. ing financing costs. Financial development There are two opposing views regarding can thus have a positive effect on innovation. this relation. Less competition can provide In particular, deepening financial develop - - incentives for entrepreneurs to invest in inno ment may have large effects on innovation if vation. This view has led many to argue in it expands available credit to firms that were favor of stronger patent protection as a way previously financially constrained. to boost incentives to innovate (see, for exam - ple, Romer 1990; Aghion and Bolton 1992). Entrepreneurial skills Such protection is equivalent to an increase in the value of innovation relative to the value Entrepreneurial skills can affect both the of the status quo, which leads more firms to number of innovations and the intensity of innovate. investment in innovation. To the extent that 03_ENTinLAC_061-094.indd 66 11/21/13 5:14 PM

85 ? : WhAT ExPLAINS ThE INNov ATIoN GAP FIRMS 67 by INCUMbENT ENTREPRENEURShIP FIGURE 3.2 Percentage of firms in selected entrepreneurial skills increase the ability to countries that introduced a new product in the introduce new products or improve existing past year - technologies, they raise the value of innova tion and thus the likelihood of engaging in innovation activities. St. Lucia Dominica Jamaica Antigua and Barbuda Agglomeration and spatial spillovers Nicaragua Venezuela, RB It is theoretically plausible that firms could Mexico Guyana upgrade their product mix and manage - Trinidad and Tobago ment practices without investing much of St. Kitts and Nevis Ecuador their own resources in innovation. Such St. Vincent and the Grenadines an outcome could be possible if there are Malaysia Dominican Republic strong knowledge spillovers across firms, El Salvador both within countries (through, for instance, Uzbekistan Uruguay agglomeration effects) and across countries Guatemala (through international knowledge spillovers). Romania Spain The last section of this chapter briefly studies Bolivia Honduras the potential of exploiting both domestic and Costa Rica international knowledge spillovers. Chile Paraguay Colombia Greece How innovative are firms in Latin Peru America and the Caribbean? Turkey Argentina Suriname LAC underwent substantial regulatory Bulgaria reforms in the past decade. These reforms Korea, Rep. Azerbaijan improved firms’ investment and employ - Grenada ment decisions. As the next chapters docu - Kazakhstan Germany ment, the most successful firms managed to Croatia grow beyond their national boundaries to Ireland Ukraine compete on the world scene. Nevertheless, Hungary although the success of companies such as Georgia Poland Vale, Embraer, and CEMEX has been her - Moldova alded, going beyond these top performers the Slovak Republic Macedonia, FYR picture is more nuanced. In fact, even some Russian Federation of these LAC giants may be underperforming Thailand Serbia relative to their peers (see chapters 4 and 5). Czech Republic Many formal firms in the region are engaged Albania Latvia in some form of innovation, but in many Armenia cases the intensity and type of innovation Bosnia and Herzegovina Slovenia may not increase much productivity. Lithuania Figure 3.2 shows the percentage of firms Belarus that developed or introduced a product that 100 80 20 0 60 40 is new to the market (product innovation). Percent With a few exceptions, Latin American firms LAC countries Other countries tend to engage less in innovation than firms 10 Enter World Bank, based on data from Seker 2013 and 2006– - Source: in other parts of the world. On average, firms prise Surveys. in the region are 20 percent less likely to have Note: LAC = Latin America and the Caribbean. - introduced a new product than their coun terparts in Eastern Europe and Central Asia 03_ENTinLAC_061-094.indd 67 11/21/13 5:14 PM

86 68 LATIN AMERICAN ENTREPRENEURS 2 FIGURE 3.3 Average investment in research and And the income countries. (ECA) or in high- 10 development, by region and level of GDP, 2008– picture is even grimmer in the Caribbean, where the likelihood of introducing a new a. R&D by region product is half that observed in ECA or high- income countries. Other LAC These raw numbers indicate the percent - age of firms involved in innovation activities ECA each year; they are uninformative about the quality and intensity of innovation, two fac - LAC5 tors strongly associated with firms’ growth and productivity. Datasets exploring these China fundamental factors at the level of the firm High-income that are comparable across countries are of countries - poor quality, but the few indicators avail 4 12 10 2 14 6 16 8 0 able suggest that the quality of innovation in R&D/manufacturing value added (%) LAC may be as much of an obstacle to firms’ Business enterprise Government growth and productivity as the quantity. Private nonprot Higher education Figure 3.3 shows aggregate investment in Foreign R&D. Panel a compares average R&D as a percentage of value added in manufactur - b. R&D by level of GDP ing (the sector where most R&D takes place) 5 Israel across regions. Panel b benchmarks R&D in - LAC against the average of countries at simi 4 3 lar stages of development. On average, R&D Finland Korea, investment in the five largest Latin American Rep. 3 economies other than República Bolivariana thirds the level of China de Venezuela is two- 2 - when expressed as a percentage of manu R&D (% of GDP) China Brazil facturing value added, and one- third when Costa 1 Rica expressed as a percentage of gross domestic India Uruguay 4 Argentina Colombia For the remaining LAC coun - product (GDP). Mexico 0 Guatemala tries, R&D investment is about one-third the 10,000 1,000 100,000 100 Chinese level when expressed as a percentage GDP per capita (PPP) of manufacturing value added and one-tenth when expressed as a percentage of GDP. Panel a: World Bank, based on data from World Development Sources: A second feature that distinguishes LAC Indicators and UIS. Panel b: Adapted from Lederman and Maloney 2003. Note: For countries and economies included in each group, see note 2. income countries is the from China and high- GDP = gross domestic product. LAC = Latin America and the Caribbean. preponderant role played by the public sec - PPP = purchasing power parity. R&D = research and development. 5 (This fea - Serra 2010). tor in R&D (Pagés- ture is also observed in Eastern Europe.) This that economies that experienced periods of is not to say that the public sector invests sustained growth often had levels of R&D excessively in R&D: as a percentage of GDP, investments well above their peers. The low public sector R&D is lower than in China or levels of R&D in LAC, and the fact that little high- income countries. Instead, it reflects the R&D is conducted by the private sector, may low level of private investment in innovation. represent a drag on productivity and growth Many factors influence the extent to which in the medium term. - lower levels of R&D are likely to trans A similar picture emerges by looking late into lower productivity and economic at patents granted by the U.S. Patent and growth. But panel b of figure 3.3 shows 03_ENTinLAC_061-094.indd 68 11/21/13 5:14 PM

87 GAP ExPLAINS ThE INNov ATIoN : WhAT ? 69 FIRMS by INCUMbENT ENTREPRENEURShIP FIGURE 3.4 Number of patents per capita granted by U.S. Patent Trademark Office (USPTO). Figure 3.4 and Trademark Office, actual and benchmarked, by inventor’s shows the number of patents per million country or place of residence people that inventors from each country received from the USPTO between 2006 and LAC countries Uzbekistan Haiti - 2010. It also displays the results of a multi Other countries Bolivia variate regression analysis that shows where Paraguay or economies Albania each country stands with respect to countries El Salvador Benchmark Indonesia with similar levels of GDP, population, and Honduras 6 Kazakhstan - Both compari exports to the United States. Bosnia and Herzegovina Guatemala sons suggest that patenting activity of most Peru Azerbaijan LAC countries remains low: no LAC country Colombia Ecuador exhibits a level of patenting that equals that Macedonia, FYR Dominican Republic of a high- income country, and most coun - Philippines tries have lower levels than their peers. Bra - Ukraine Turkey zil, for instance, registered just 5 patents per Venezuela, RB Serbia million people between 2006 and 2010, half Belarus Georgia the number per capita of China (10) and only Oman India slightly less than a quarter the number per Thailand Armenia capita of Bulgaria (22). Mexico Jamaica Part of these differences can be explained Brazil Uruguay by lower levels of income per capita and United Arab Emirates lower intensities of exports to the United Argentina Saudi Arabia States (which implies fewer incentives to Latvia Poland apply for patents with the USPTO). As the Chile Russian Federation benchmarking exercise shows, however, China Trinidad and Tobago these structural factors do not fully account Portugal Slovak Republic for the low patenting intensity of LAC firms. Lithuania St. Kitts and Nevis With very few exceptions, patenting intensity Greece Croatia in most LAC countries falls well below the Costa Rica benchmark numbers. For example, given its Bulgaria Kuwait GDP, population, and level of exports to the Antigua and Barbuda Czech Republic United States, Brazil is expected to register Malaysia Hungary 1.5 times as many patents as were granted Spain Slovenia during 2006– 10. For many countries in the Italy New Zealand region, the difference is even larger. Ireland France R&D and patenting are indicators of the Norway Belgium intensity and quality of innovation, but they United Kingdom indicate only indirectly how firms perform in Australia Austria terms of process innovation. Until recently, Hong Kong SAR, China Singapore comparable data across countries were Netherlands Denmark scarce, which is unfortunate given the strong Canada Germany - link between process innovation and pro Sweden Finland ductivity. In 2007, however, Bloom and van Korea, Rep. Switzerland Reenen published a methodology that has Israel Japan since been applied to a large number of devel - oped and developing countries. It assesses 10,000 1,000 100 10 1 Patents per 1 million people the quality of management practices, which are both an input and an outcome of process Source: World Bank, based on data from USPTO 2012 and World Development Indicators. innovation (box 3.2). Note: Dots represent predictions from a multivariate regression analysis that includes the log of patents per million people on the log of gross domestic product (GDP) adjusted for purchasing power parity, the log of population, and the log of merchandise exports to the United States. They indicate where each country stands with respect to countries with similar levels of GDP, population, and merchandise exports to the United States. The regression used all countries and economies for which data were available; the figure presents only comparator countries. Data are averages for 2006–10. LAC = Latin America and the Caribbean. 03_ENTinLAC_061-094.indd 69 11/21/13 5:14 PM

88 70 LATIN AMERICAN ENTREPRENEURS BOX 3.2 Management matters: How better practices could increase productivity in Latin America and the Caribbean Until recently, few studies focused on low- or About half of per capita income and productivity middle- income countries. One reason for the dearth differences across countries cannot be explained of work on management as a development issue by the accumulation of factors of production such is the absence of comparable cross- country data. as labor and capital. How effectively these factors - Bloom and van Reenen (2007) surveyed manufac are combined accounts in part for the gap: the uti - turing firms about management practices in the lization and combination of factors of production United States and Europe, a methodology that has requires a particular type of organizational capital been extended to four Latin American countries: management quality— something the literature has Argentina, Brazil, Chile, and Mexico. overlooked until recently. As expected, management quality appears sig - - Historically, the literature stressed the impor nificantly correlated with (average) labor produc - tance of management practices. Chandler (1990) tivity across countries (figure B3.2.1). But even - and Lazonic (1990), for instance, argue that differ within countries, management scores are correlated ences in management and organizational practices level productivity, growth, and survival. with firm- account for the United States overtaking the United Although causality cannot be confidently assigned, Kingdom by the turn of the 20th century. Wom - the extreme heterogeneity of management quality ack, Jones, and Roos (1990) see the organization of suggests that significant gains in efficiency could Japanese firms as critical to their growth miracle. - result from increasing managerial quality, a dimen Bertrand and Schoar (2003) focus on the impact of sion of human capital formation and firm behavior changing chief executive officers and chief financial that should not be ignored. officers in very large publicly traded U.S. firms (see also Bloom and van Reenen 2007). Correlation between management quality and productivity in selected countries and economies FIGURE B3.2.1 6 Sweden Japan Republic of Ireland Italy Germany Northern Ireland France Greece United Kingdom United States Portugal Canada 5 Argentina Chile Poland Australia Brazil 4 Mexico India China Log of sales per employee 3 New Zealand 2 3.2 3.4 2.8 2.6 3 Overall management score LAC countries Other countries and economies Source: Maloney and Sarrias 2012, based on Bloom and van Reenen 2007. Note: Samples are drawn from manufacturing firms with 100– 5,000 employees. LAC = Latin America and the Caribbean. 03_ENTinLAC_061-094.indd 70 11/21/13 5:14 PM

89 ? : WhAT ExPLAINS ThE INNov ATIoN GAP FIRMS 71 by INCUMbENT ENTREPRENEURShIP - Figure 3.5 compares management prac which management surveys were conducted). With the exception of Mexico, Latin Ameri - tices of manufacturing firms across dif - can countries score toward the bottom of the ferent dimensions in LAC, high- income countries, China, and India (countries in distribution: management practices remain Management practices in selected countries or economies FIGURE 3.5 a. Overall management practices c. Performance monitoring b. Operation management Sweden United States United States United States Germany Japan Germany Germany Sweden Canada Sweden Japan Japan Canada Canada France Australia United Kingdom United Kingdom Italy New Zealand Mexico Italy France Italy Australia France Australia United Kingdom Mexico Portugal Greece Poland Poland Northern Ireland Argentina New Zealand Portugal New Zealand Argentina Mexico Portugal Chile Republic of Ireland Northern Ireland Brazil Chile Argentina Northern Ireland Republic of Ireland Chile Republic of Ireland Greece China Greece Poland China China Brazil Brazil India India India 3.0 2.5 2.0 3.0 3.5 3.0 2.5 3.5 2.0 2.0 2.5 3.5 Mean score Mean score Mean score e. Talent management d. Target management Japan United States Canada Germany Japan United States Germany Sweden United Kingdom Italy Poland Canada France Sweden Australia Northern Ireland United Kingdom Italy Poland Mexico Australia Mexico Republic of Ireland New Zealand Northern Ireland China France Portugal Chile Republic of Ireland New Zealand Argentina Brazil Greece Greece Argentina Portugal China India Chile Brazil India 2.0 2.5 3.0 2.0 2.5 3.0 3.5 3.5 Other countries LAC countries or economies Mean score Mean score Source: Maloney and Sarrias 2012. Note: Samples are drawn from manufacturing firms with 100– 5,000 employees. LAC = Latin America and the Caribbean. 03_ENTinLAC_061-094.indd 71 11/21/13 5:14 PM

90 72 LATIN AMERICAN ENTREPRENEURS Distribution of overall management FIGURE 3.6 closer to the practices of Chinese and Indian scores in Brazil and the United States firms than to firms in Germany, Japan, or the United States. Given that Latin American firms have higher labor costs than firms in 0.6 China and India, management practices may - pose a more severe constraint for labor pro ductivity for them. 0.4 Maloney and Sarrias (2012) investigate - the factors associated with the poor manage ment practices of Latin American firms. Low Density 0.2 average scores could be driven by a long, fat tail of underperforming firms that conceals good practices by top firms, but this does not appear to be the case. Figure 3.6 presents 0 the distribution of management scores for 1 4 3 2 5 Brazilian and U.S. firms. It shows that the Management score whole distribution of Brazilian firms tends to United States Brazil underperform the distribution of their U.S. Maloney and Sarrias 2012. Source: counterparts at all levels; very few Brazilian 5,000 employees. Samples are drawn from manufacturing firms with 100– Note: firms reach the management scores of top U.S. firms. Moreover, the actual distribution firms (which, on average, tend to be less well of management practices in Latin America is managed than publicly traded companies) is likely to be even weaker than the survey data almost twice as large in Latin America (about indicate, because the survey covers firms with 5,000 employees, which should be bet - 100– 20 percent) as in the United States (about 10 percent). Furthermore, a large proportion ter managed than the average firm. of firms in Latin America are run by their Part of the “management gap” between the United States and Latin America can founder (up to a third in Brazil). be explained by firm characteristics. In the These differences in firm characteristics United States, midsized firms have a larger account for a share of the management gap share of employees with a college degree, are but not all of it. A decomposition exercise - Mata (2005) meth larger, and are more likely to be multinational following the Machado- corporations than firms in Latin America - odology shows that median firm charac teristics can explain at most a third of the 3.1). The proportion of family- (table owned TABLE 3.1 Firm characteristics in Latin America, the United States, and China (percent, except where indicated otherwise) Brazil Firm characteristic Chile Mexico United States China Argentina 518 Number of employees 487 594 1, 254 960 581 8 12 15 15 4 Employees with college degree 5 Output exported 14 30 38 17 48 22 Multinational 36 21 38 39 48 52 Family firms 21 23 19 19 12 5 29 32 19 21 Run by founder 8 14 Share of management gap with respect to United States 15 explained by firm characteristics 28 37 13 3 n.a. Share of management gap left unexplained 72 63 87 97 n.a. 85 Source: Maloney and Sarrias 2012. 5,000 employees. n.a. = Not applicable. Note: Samples are drawn from manufacturing firms with 100– 03_ENTinLAC_061-094.indd 72 11/21/13 5:14 PM

91 FIRMS INNov ATIoN GAP ? 73 : WhAT ThE by INCUMbENT ENTREPRENEURShIP ExPLAINS development, entrepreneurial skills, and management gap between median firms in agglomerations/externalities have repeatedly Latin America and the United States (bottom been shown to affect innovation. LAC is not two rows of table 3.1). Moreover, in Mexico, likely to boost innovation without addressing where firm characteristics and the quality of these factors. management are closer to the United States’, characteristics of the median firm do not appear to account at all for the management Regulation still matters— gap. To be sure, the survey probably missed but less than in past decades important firm characteristics associated Early analyses— such as the work of de with the quality of management, increasing Soto (1989), Rauch (1991), Loayza (1996), - the unexplained component of the manage and Johnson, Kaufmann, and Shleifer ment gap. But given the results, it is unlikely (1997)— spurred an important stream of - that firm characteristics fully account for dif research that aimed to understand and ferences in the quality of management. document the many ways in which poorly designed regulations affect entrepreneurial What explains the innovation gap? activity. Overall, most of these studies find Many factors affect innovation, both directly a positive association between the quality of and through their interaction with one regulation, innovation, and economic growth (examples include Bassanini and Ernst 2002 another. There is probably no universal recipe for enhancing innovation, just as there is no and Djankov, McLiesh, and Ramalho 2006). single recipe for growth. But certain factors Figure 3.7 shows the association between including regulations, competition, financial the strength of investor protection and the Relationship between investor protection and time required to register property FIGURE 3.7 and innovation in Latin America and the Caribbean b. Registering property a. Protecting investors: Strength (time in days) of investor protection index (1–10) New or signicantly New or signicantly improved product improved product New or signicantly New or signicantly improved process improved process Invested in R&D Invested in R&D Cooperates on Cooperates on innovation with others innovation with others Adopted foreign Adopted foreign technology technology Filed for a patent Filed for a patent 0.04 –0.04 0 –0.06 0 0.02 –0.02 –0.02 Additional likelihood to innovate Additional likelihood to innovate Not signicant Signicant at 10% World Bank, based on data from 2006– 10 Enterprise Surveys. Source: Note: Bars show the impact on the dependent variable of one standard deviation of the explanatory variable. The regression includes other country- level Doing Business indicators; sectoral concentration (Herfindahl) indexes; the number of competitors; size; age; the number of establishments; legal organization; the manager’s years of experience; the percentage of workers with complete university education; and whether the firm was registered at start- up, has a foreign owner, is an exporter, and has taken a loan. Robust standard errors are clustered at the country level. Countries include Argentina, Chile, Colombia, Costa Rica, the Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, Jamaica, Mexico, Nicaragua, Paraguay, Peru, Trinidad and Tobago, and Uruguay. R&D = research and development. 03_ENTinLAC_061-094.indd 73 11/21/13 5:14 PM

92 74 LATIN AMERICAN ENTREPRENEURS time required to register a property (from the aspect of the regulatory environment seems particularly weak in Caribbean countries, World Bank’s Doing Business indicators) on - where the number of days required to regis the one hand, and the propensity of firms to ter property is four times the number in East engage in innovative activities on the other. Asia. Caribbean countries also score poorly The underlying econometric analysis controls for firms’ characteristics, other Doing Busi on the cost of registering property, which - averages almost 10 percent of the property ness indicators, the number of competitors, - - value, against an average of less than 4 per and sectoral concentration. Even after con cent for other LAC countries. Interestingly, trolling for competition, regulation appears as in the rest of the world except some East to matter: a one standard deviation improve - ment in either investor protection or the Asian economies, export costs (imposed by time required to register property is associ - government regulations, excluding trade 4 percent more firms engaging ated with 2– taxes) have soared in LAC and remain second 7 in innovative activities, such as cooperating only to Eastern European countries. These numbers should be taken with a on innovation with others, adopting foreign grain of salt, as they focus on very selective technologies, filing for patents, and investing aspects of the regulatory environment. But in R&D. they suggest that there is room for further The significance of these correlations improvement of the regulatory environment, should be interpreted with caution. Some which could stimulate firms’ propensity to could stem from unobserved characteristics of the regulatory environment that are also - innovate. How much they would boost inno vation remains an open question, however: correlated with Doing Business indicators. thanks to recent waves of regulatory reforms But taken as a whole, they remain sugges - in the region, regulation may no longer be the tive of the role that the quality of regulation main bottleneck to innovation. As discussed plays in promoting or preventing innovation. Although the magnitudes of the association below, new challenges are emerging. may at first sight seem small, one should not forget that the regressions consider only Competition: An unfinished agenda variation within LAC, a fairly homogeneous group of countries in which innovation is rel The ability to foster innovation through com - - atively low to start with. petition is of particular relevance for low- and income countries, as governments may The good news is that, just as in the middle- find it easier and more effective to level the case of the entry regulations described in - chapter 2, many LAC countries have made playing field than to use more intervention ist policies with strong governance challenges substantial regulatory reforms. However, because these reforms are part of a global (Allen and Gale 2000; Ayyagari, Demirgüc- Kunt, and Maksimovic 2011). However, the deregulation process taking place in a broad empirical association between competition, international context, LAC countries still lag productivity, and innovation is complex. their peers along important dimensions. In Although there is little doubt that in many cir addition, although the largest countries in - - cumstances competition can have a positive the region (Argentina, Brazil, Chile, Colom bia, and Mexico [LAC5]) have for the most impact on growth and innovation (Blundell, Griffith, and van Reenen 1995; Nickell 1996; part improved investor protection, many of Galdon- - Sanchez and Schmitz 2002; Ayya the smaller countries have not made much Kunt, and Maksimovic 2011), progress (figure 3.8). The number of days gari, Demirgüc- there are many instances in which its impact required to register property, for instance, may be limited or even negative. remains high throughout the region (on aver - age, at the same level as in India), well above In sectors with strong returns to scale, Eastern European and East Asian peers. This for instance, well- regulated monopolies may 03_ENTinLAC_061-094.indd 74 11/21/13 5:14 PM

93 GAP FIRMS : WhAT ExPLAINS ThE INNov ATIoN by INCUMbENT ? 75 ENTREPRENEURShIP Doing Business in selected country groups and countries, circa 2004 versus 2013 FIGURE 3.8 b. Cost to export a. Investor protection 2,000 10 1,800 1,600 8 1,400 1,200 6 1,000 800 4 600 US$ per container 400 2 200 Strength of investor protection index 0 0 ECA ECA India India LAC5 LAC5 EAP4 EAP4 China China Other LAC Other LAC Caribbean Caribbean economies economies High-income High-income c. Registering property d. Costs to register property 12 140 120 10 100 8 80 6 60 Time (days) 4 Property value (%) 40 2 20 0 0 ECA ECA India India LAC5 LAC5 EAP4 EAP4 China China Other LAC Other LAC Caribbean Caribbean economies economies High-income High-income Other country groups, LAC countries, 2013 LAC countries, 2004 Other country groups, countries, and economies , 2004 countries, and economies, 2013 Authors, based on Doing Business indicators. Source: Note: For countries and economies in each group, see note 2. be the way to go. In some financial services, analysis, low levels of competition lead to a - excessive competition can also be harmful, as few oligopolistic firms sharing similar pro duction costs and laggard technologies. In it may prevent the building of sound reserves, such an environment, competition is good, raising the overall vulnerability of the system. as it drives rents down; firms react to higher - And recent studies have uncovered that com - petition may hurt innovation (and productiv competition by “escaping” it through innova - tion (along both the products and the process ity) even in more traditional sectors, such as - dimensions). In contrast, in highly com manufacturing. A seminal study by Aghion, petitive sectors, a (short- Bloom, and others (2005) suggests that the lived) technological relationship between competition and inno - leader captures the market. In these settings, further increases in competition may reduce - U vation may have an inverted shape. In their 03_ENTinLAC_061-094.indd 75 11/21/13 5:14 PM

94 76 LATIN AMERICAN ENTREPRENEURS innovative plants and minor products and firms’ incentives to innovate, as competition 8 increased sales of larger plants and main reduces any rent from innovation. Competition may also generate short- term increase term products. Although the long- distributional effects that have to be taken in productivity may well compensate for the level data from the short- term losses associated with the exit of into account. Using firm- the least productive firms, any competition - United Kingdom, Aghion, Blundell, and oth reform should include measures to protect ers (2009) find that the intensity of compe - workers who may suffer from a potential tition, measured by entry into an industry, term surge in plant closures. fosters innovation and productivity growth short- among the more technologically advanced These caveats notwithstanding, LAC may not have reached the tipping point at which incumbents but slows it among less efficient incumbents. Iacovone, Rauch, and Win - an increase in competition hurts innovation. On the contrary, lack of competition may ters (2013) find similar results for Mexico, inhibit firms’ incentives to innovate. where a surge in Chinese exports from 1994 to 2004 reduced sales of smaller and less Figure 3.9 shows the association between various dimensions of innovation and the number of competitors. The regressions con - Relationship between competition and various FIGURE 3.9 trol for other firm- level characteristics and aspects of innovation in Latin America and the Caribbean country- level Doing Business indicators. Although there seems to be little association - between competition and the generic ques New or signicantly tion about whether firms have developed new improved product products or processes, competition seems to be associated with the quality of innovation New or signicantly activities that firms claim to conduct: a more improved process competitive environment is associated with a higher likelihood of firms collaborating with Invested in R&D others on innovation, adopting foreign tech - 9 nologies, and filing patent applications. Cooperates on The magnitude of the correlations is at innovation with others times substantial: all else being equal, having more than one competitor is associated with a Adopted foreign 4 percent increase in the likelihood of cooper - technology ating on innovation and an 8 percent increase in the likelihood of applying for a patent. To Filed for a patent be sure, unobserved factors (such as higher profit opportunities driving both entry and 0.04 0.08 0.12 0.16 0.20 0 innovation) may be behind these associations. Additional likelihood to innovate But these findings and the causal impact of >5 competitors, 2–5 competitors, competition found in most of the literature signicant at 10% signicant at 10% suggest that in many sectors, gains from >5 competitors, 2–5 competitors, increased competition could be substantial. not signicant at 10% not signicant at 10% How could LAC governments foster a more competitive environment? Until now, Source: 10 Enterprise Surveys. World Bank, based on data from 2006– level Doing Business indicators; sectoral concentration Note: The regression includes other country- efforts have focused on improving the regula - - (Herfindahl) indexes; number of competitors; size; age; number of establishments; legal organiza tory environment. However, many countries tion; manager’s years of experience; percentage of workers with complete university education; and up, has a foreign owner, is an exporter, and has taken a loan. whether firm was registered at start- have made substantial progress along the Robust standard errors are clustered at the country level. Countries include Argentina, Chile, Colom - regulatory front. Although there may still be bia, Costa Rica, the Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, Jamaica, Mexico, Nicaragua, Paraguay, Peru, Trinidad and Tobago, and Uruguay. R&D = research and development. room for improvement, additional regulatory 03_ENTinLAC_061-094.indd 76 11/21/13 5:14 PM

95 ENTREPRENEURShIP : WhAT ExPLAINS ThE INNov ATIoN GAP ? 77 by INCUMbENT FIRMS reform is not likely to bring countries in the ministry, and is responsible directly to the parliament or legislature for its budget is region to the competitive frontier. structurally independent. Operational inde LAC countries are in a situation in which - more active aspects of competition policies pendency refers to the freedom to use the - start to matter. These initiatives are mul budget, organize the agency, and carry out - enforcement activities and advocacy func tifaceted and fall under the umbrella of the governance structure and the effectiveness of tions, without having a ministry supersede decisions (Clark 2005). - competition and consumer protection poli Data collected by the CRC suggest that in cies and authorities. only about half of the surveyed agencies is the Many countries in the region enacted - head appointed or cleared by Congress (fig competition laws in recent years (Honduras ure 3.10). Mexico and Brazil have the stron in 2005, Nicaragua in 2006, the Domini - - gest checks and balances to avoid political can Republic in 2008, and Ecuador in 2011) interference; their agencies are structurally or saw major legislative reforms (Mexico in and operationally independent, and there is a 2011, Brazil in 2012). These countries based low risk that their decisions will be overruled their legal frameworks on international best practices. Many of their competition laws by the executive branch. Although in Chile, the head of the Fiscalía Nacional Económica grant significant power to competition agen - cies to carry out investigations and impose is not cleared by Congress, strong check and 10 balances are in place. The institutional design Many countries also included sanctions. of the competition agencies in the Domini - provisions in their laws shielding competition agencies from political interferences to guar - can Republic, Ecuador, and Honduras also favors, at least de jure, the independency of antee their independence. the president of the regulatory agency and its The challenges, however, lie in imple - commissioners (who are appointed by Con - menting these policies and laws. To varying extents, and with a few exceptions, countries gress, or jointly by Congress and the govern - in the region are characterized by limited cul - ment, for a relatively long period of time), and only a court can overrule the agencies’ tures of competition, concentrated markets, vested interests, scarce human and economic decisions. In contrast, Argentina, Colombia, - Costa Rica, and Uruguay may potentially resources, lack of cooperation among regula tors, opposition from large corporations, and judiciary systems with little or no experience F I G U R E 3.10 Appointment of head of regulatory in competition matters. All these elements agency in Latin America and the Caribbean may reduce the capabilities of the competition agencies to enforce the law (Ortiz 2013). The One minister - extent to which they will be successful in pro or more moting competition will depend on whether - they have the means, independence, and pow Government ers to operate effectively. New data collected by the Centro Regional de Competencia para Congress América Latina (CRC) allow some of these aspects to be explored in greater detail. Government and Congress Independence of competition agencies 5 4 3 2 1 0 6 The Organisation for Economic Co- Number of agencies - operation and Development (OECD) consid ers two aspects of independence: operational Centro Regional de Competencia para América Latina 2013. Source: and structural. An agency that is created as Note: Covered countries are Argentina, Brazil, Chile, Colombia, Costa Rica, the Dominican Republic, Ecuador, El Salvador, Honduras, Mexico, and Uruguay. a separate entity, rather than as part of a 03_ENTinLAC_061-094.indd 77 11/21/13 5:14 PM

96 78 LATIN AMERICAN ENTREPRENEURS criminal sanctions, affect their effectiveness. be more exposed to interference: their legal frameworks allow the government to inter Much heterogeneity is evident along these - two dimensions. Competition agencies in vene in the agencies by selecting its president and commissioners (including participating Brazil, Chile, and Mexico appear to be well in their reelection), giving instructions to endowed, operating with budgets ranging the agencies about current investigations, or from $9 million to almost $20 million. At determining the internal organization of the the other end of the spectrum, some agencies, agency. such as the ones in in Costa Rica, Honduras, Another source of vulnerability may - and Uruguay, operate with much more lim 11 ited budgets. stem from the ability of the government to interfere in the agencies’ decisions: agencies The scope of action also varies across in only half of the surveyed countries are agencies. Although all agencies are entitled - site investiga shielded from explicit government interven - to conduct “dawn raids” (on- tions (figure 3.11). In the other half, the gov - - tions) at the premises of the companies inves tigated, only 6 out of 11 did so between 2010 ernment can overrule the agencies’ decisions or interfere in an ongoing investigation. and 2013 (figure 3.12). All agencies can also request information from the companies - Given their limited experience in enforce investigated, but only 5 out of 11 can record ment, it is too early to assess whether some of these recently created agencies are not only de or ask the police to record conversations jure but also de facto independent. To date, - between employees to collect evidence. Fur thermore, in some countries, such as Brazil, none of the agencies has seen its decision Costa Rica, and Mexico, some sectors are overruled, and none reports having received exempt from competition law enforcement. - instructions from the executive branch. Nev ertheless, lack of legislation makes agencies more vulnerable to potential interference. Scope of action of regulatory F I G U R E 3.12 agencies in Latin America and the Caribbean Budget and scope of action The budget of competition agencies, as well as the legal means they have been given to Sanctions to individuals conduct investigations and impose fines and Recording conversations Interim F I G U R E 3 .11 Level of allowed government measures intervention in regulatory decisions Leniency programs Request No intervention information Overrule the Settlements agency’s decision Dawn raids Instructions in an Dawn raids ongoing investigation (eectively conducted) Appointment of head 6 8 10 12 0 2 4 commissioners Legal actions available 1 2 3 4 0 5 7 6 (from antitrust agencies) Number of agencies Centro Regional de Competencia para América Latina 2013. Source: Source: Centro Regional de Competencia para América Latina 2013. Note: Covered countries are Argentina, Brazil, Chile, Colombia, Costa Rica, Note: Covered countries are Argentina, Brazil, Chile, Colombia, Costa Rica, the Dominican Republic, Ecuador, El Salvador, Honduras, Mexico, and the Dominican Republic, Ecuador, El Salvador, Honduras, Mexico, and Uruguay. Effectively conducted dawn raids cover 2010– 13. Uruguay. 03_ENTinLAC_061-094.indd 78 11/21/13 5:14 PM

97 ? ExPLAINS ThE INNov ATIoN GAP : WhAT 79 by INCUMbENT ENTREPRENEURShIP FIRMS Transparency mergers. The remaining nine agencies do Good transparency practices include publish - not have guidelines in some of these areas, - ing decisions, disclosing the facts and theo - although some are in the process of draft ries of harm under consideration, providing ing them. Although the absence of guidelines access to evidence, providing opportunities need not reduce transparency, it is desirable to - to meet with the agency, responding to con make available to the public the methodology cerns, and guaranteeing the confidentiality of used by the agency when assessing conduct. third parties. Most agencies display a relatively high Anticompetitive conduct and fines standard of transparency (figure 3.13). All The data on anticompetitive conduct and 11 agencies publish their decisions and the fines are far from exhaustive. The surveys col - underlying legal and economic reasoning, lected information only about the existence of and all 11 provide access to the file once certain anticompetitive conduct and the pos - the decision has been made (sometimes this sibility of investigating and sanctioning it. information is publicly available, but some - All agencies share similar capacities to times it is necessary to formally request it). investigate horizontal agreements, vertical All 11 agencies also release annual reports agreements, abuse of dominant positions, and other types of reports to inform the and mergers. There are, however, important public about their activities, and all of them differences in various dimensions, reflecting - guarantee confidentiality when parties sub the different roles agencies play in each coun - mit information. try. Countries differ in how anticompetitive An area where there is still room for conducts are assessed. Brazil, Chile, Colom - improvement is the adoption of guidelines - bia, and Ecuador, for instance, do not con for how specific anticompetitive practices sider all cartels as anticompetitive per se. are treated. Brazil and Mexico are the only The maximum fines that have been countries that have published guidelines imposed also differ substantially across coun - explaining horizontal agreements, vertical tries (figure 3.14). The toughest agencies are agreements, abuse of dominant position, and Maximum fines imposed by regulatory agencies in F I G U R E 3.14 Transparency practices of F I G U R E 3.13 selected countries in Latin America and the Caribbean regulatory agencies in Latin America and the Caribbean Ecuador Dominican Publish Republic guidelines Costa Rica Uruguay Oral hearings Colombia El Salvador Access to les Honduras Accounts reviewed by Chile third party Argentina Publish Mexico decisions 8 2 4 0 10 6 12 Brazil Number of agencies 1,000,000 1,000 100,000 10,000 1 100 10 Source: Centro Regional de Competencia para América Latina 2013. US$ (thousands) Covered countries are Argentina, Brazil, Chile, Colombia, Costa Rica, Note: the Dominican Republic, Ecuador, El Salvador, Honduras, Mexico, and Uruguay. Centro Regional de Competencia para América Latina 2013. Source: 03_ENTinLAC_061-094.indd 79 11/21/13 5:14 PM

98 80 LATIN AMERICAN ENTREPRENEURS CADE (Brazil), which imposed a fine of $1.1 Colombia and Mexico are the only two - - countries in the region that conduct a “com billion on White Martins, and CFC (Mex - petition impact assessment” of new pro ico), which fined Telcel $1 billion. The lowest posed regulation, implement sector studies, maximum fines were imposed by Uruguay - and carry out ex post evaluations of their ($10,000) and Costa Rica ($4,600). Agen cies in the Dominican Republic and Ecuador activities— and the competition agency in have not yet imposed fines. Of course, not Mexico is the only one entitled to issue bind - ing opinions under certain circumstances. In all of this heterogeneity can be attributed all countries, the competition agency can issue to the agencies’ effectiveness: many of these (nonbinding) opinions to prevent the adoption agencies were established or reformed only recently and are in the process of defining of regulation with negative effects in the mar - ket and publish market and sector studies. their scope and scaling up operations. - Training and advocacy need to be custom Mergers ized to the local context. Instruments used in one country (conferences, training courses, Good merger evaluation practices should opinions, market studies, media appear - include a comprehensive framework to - ances) may not be effective in another. Lim - address mergers that are likely to harm com petition significantly. Factors other than mar ited economic resources and a still nascent - competition culture make training and advo - ket share or increase in market share, such as cacy costly and challenging. Nonetheless, it entry barriers, should also be evaluated. is important to keep investing in this area, Mergers represent the area with possi - - because it affects the likelihood of enforce bly the greatest divergence across agencies. ment of competition policies. Agencies in four countries (Brazil Colombia, Costa Rica, and El Salvador) have to approve all mergers and acquisitions before the par - Does financial underdevelopment ties can close the deal. Agencies in three explain the innovation gap? countries (Ecuador, Honduras, and Mexico) have to approve only some operations before Innovation is a risky activity; if markets fail the parties can proceed. In Chile, there is no to share some of these risks, entrepreneurs need to approve a merger or acquisition. The - may find it difficult to innovate. The asso ciation between financial intermediation and Dominican Republic and Uruguay do not yet growth and innovation has been documented have a merger notification system in place. extensively in the literature. Early works by Disparities can also be found in the analy - King and Levine (1993) and Beck, Levine, sis of mergers. Argentina, Chile, Honduras, and Loayza (2000) find a positive association and Mexico take into account only criteria between financial development and growth based on competition grounds (that is, effi - ciencies) in determining whether to approve a (see Levine 2005 for a review). merger. In contrast, Brazil, Colombia, Ecua - In addition to the depth of financial mar - dor, and El Salvador also take into consider kets, it also appears that regulations and the - - type of financial intermediation tools avail ation other issues, such as public interest or able to firms affect economic performance. impacts on the labor market. According to Bekaert, Harvey, and Lundblad Training and advocacy (2005), for example, liberalization of the Training and advocacy should be central equity market led to an average increase in annual real economic growth of 1 percent. activities of any competition agency. The Most of these studies suffer from reverse - more judges, policy makers, and the pri vate sector are trained on the benefits of - causality biases, as better- performing econo good competitive practices and regulation, mies may foster the development of finan - the easier it will be to sustain a competitive cial markets. In an attempt to draw causal environment. relationships, Rajan and Zingales (1998) 03_ENTinLAC_061-094.indd 80 11/21/13 5:14 PM

99 ENTREPRENEURShIP ThE INNov ATIoN GAP ? 81 FIRMS by INCUMbENT : WhAT ExPLAINS Credit, investment, and innovation in Latin America F I G U R E 3.15 construct a measure of “financial depen - and the Caribbean dency” of each sector. They show that indus - trial sectors that need more external finance grow faster in countries with more developed New or signicantly financial markets. improved product Financial development, in terms of both New or signicantly the depth and the diversification of financing improved process instruments, appears to exert a dispropor - tionately positive effect on small firms, which Invested in R&D tend to find it more difficult to raise funds Cooperates on (Guiso, Sapienza, and Zingales 2004; Beck innovation with others and others 2008). Because small firms tend to operate locally, local financial development Filed for patent, trademark, or copyright has also been found to be an important deter - Invested to improve minant of the economic success of an area quality control or obtain (Guiso, Sapienza, and Zingales 2004). certication Ayyagari, Demirgüc- - Kunt, and Maksi 0.12 –0.04 0 0.04 0.08 0.16 Marginal eect movic (2011) explore the association between financial development and innovation in Loan, signicant at 10% emerging markets. They define innovation to Loan, not signicant at 10% Purchased xed assets, signicant at 10% include the introduction of new products and Purchased xed assets, not signicant at 10% technologies, knowledge transfers, and new production processes. They find that access to World Bank, based on data from 2006– Source: 10 Enterprise Surveys. external financing is associated with greater - Robust standard errors are clustered at the country level. As additional controls, the regres Note: sions include firm size, age, legal organization, the number of establishments, whether the firm firm innovation. Although data constraints was registered at start- up, whether it is foreign owned, the percentage of full- time workers with - limit the causal interpretation of the associa university degrees, and country and sector fixed effects. Countries include Antigua and Barbuda, Argentina, the Bahamas, Barbados, Belize, Chile, Colombia, Costa Rica, Dominica, the Dominican tion, the study highlights an important chan - Republic, Ecuador, El Salvador, Grenada, Guatemala, Guyana, Honduras, Jamaica, Mexico, Nicaragua, nel through which financial development can Panama, Paraguay, Peru, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Trinidad and Tobago, and Uruguay. R&D = Research and development. affect productivity. These analyses are not specific to LAC, but figure 3.15 shows that the region is no exception. Based on a multivariate regression level characteris - that controls for other firm- a 9 percent higher probability of investing in tics, sector, and country effects, it shows the quality control and certification. association between having taken a loan and Investment in fixed assets also appears various forms of innovation. It also shows the to be an important channel through which association between investment in fixed assets innovation takes place. The fact that the fixed and innovation (controlling for taking a loan), assets indicator remains significant even after - as these types of investments are an impor controlling for borrowing suggests that many tant avenue through which firms innovate. firms invest using other means, such as self- The results show that at least one of the financing and (for large firms) equity financ - two variables is significantly associated with ing. For some firms, however, these types of - any form of innovation captured in Enter best choices dictated financing may be second- prise Surveys. The magnitudes of these effects by the lack of good financial intermediation. are also relatively large: everything else being - LAC financial markets developed substan equal, having taken a loan is associated with tially in the last two decades, as de la Torre, a 9 percent higher probability of introduc - Ize, and Schmukler (2012) document. Bond - ing a new product, a 5 percent higher prob and equity markets have gained ground, ability of improving processes, an 11 percent institutional investors now play a central role, higher probability of conducting R&D, and new markets and instruments have sprung 03_ENTinLAC_061-094.indd 81 11/21/13 5:14 PM

100 82 LATIN AMERICAN ENTREPRENEURS F I G U R E 3.16 Depth of financial systems in selected up, maturities have lengthened, and dollar - country groups and countries, 1995 and 2005 ization has been reduced. However, many of these gains are benefitting only larger firms; significant gaps remain in the financing of 1995 China smaller ones, as manifested by the depth 2005 and efficiency (as measured by interest rate 1995 margins) of banking intermediation and the EAP4 liquidity of domestic equity markets. 2005 These gaps are of concern because they 1995 coincide with some of the financial indicators Turkey 2005 that have been shown to be the best predictors of future output growth and because, except 1995 High-income for bank margins, there is little evidence of economies 2005 convergence toward benchmark levels con - 1995 sistent with the economic development of the India region and its basic structural characteristics 2005 (figure 3.16). The lack of depth of the banking 1995 sector, an important financing avenue of small LAC5 2005 firms, may in particular hurt the innovation potential of emerging firms. Another area of 1995 Other concern is the limited capacity of institutional LAC 2005 investors to expand their portfolios beyond 3.0 0 2.0 3.5 0.5 1.0 2.5 1.5 the safest and most liquid investments. Percentage of GDP These features are not identical across Banks, LAC countries Banks, other countries countries. There is substantial heterogeneity and economies Bonds, LAC countries in financial development within the region, Bonds, other countries Equities, LAC countries and economies - income countries gener with smaller, lower- Equities, other countries ally lagging behind. and economies The innovation potential of firms in in particular small ones— LAC— may also be Source: Adapted from Didier and Schmukler 2011. For countries and economies included in each group, see note 2. Note: hindered by the dearth of private equity and venture capital financing options. Mondragón (2012) benchmarks the private equity and - were minimal in all emerging economies). It venture capital (PEVC) industry in LAC rela tive to other low- and middle- income regions dramatically picked up in Asia but remains using a new dataset that merges various relatively modest in LAC and Eastern Europe sources of information on PEVC financing. and Central Asia. Although the dataset may miss smaller deals, In addition to being in its infancy, the it is one of the most comprehensive efforts to PEVC industry in the region focuses on large deals, in mature industries, in a few coun measure PEVC intensity at the regional level. - tries (figure 3.18). More than 90 percent of Despite unprecedented growth since activity takes place in Mexico or the major 2000s, PEVC investments in LAC the mid- economies of South America, with Bra - remains relatively low, below the region’s zil accounting for half of reported deals in - share of world GDP and capital inflows (fig 11 and two- ure 3.17). In 2011, PEVC investments in LAC 2008– thirds of investments. The totaled $3.2 billion. This figure was close larger number of deals in Brazil suggests that to the figure in Eastern Europe and Central market size and liquidity may be important Asia ($3.6 billion) but well below PEVC factors driving the expansion of the PEVC investments in emerging Asia ($18.7 billion). industry; without liquidity and a constant The industry is quite new in middle- income stream of potential deals, it may be difficult for the industry to expand. countries (before 2005, PEVC investments 03_ENTinLAC_061-094.indd 82 11/21/13 5:14 PM

101 ATIoN : WhAT ExPLAINS ThE INNov FIRMS GAP ? 83 ENTREPRENEURShIP by INCUMbENT F I G U R E 3.17 Private equity and venture capital investments, It may thus not come as a surprise that in by region, 2002– 11 the smaller countries, very few PEVC deals have been reported. More surprising is the 40 size of the deals and the type of company the PEVC industry is targeting. Only 20 percent - of deals are smaller than $5 million (see fig 30 ure 3.18), and the average deal is $30 mil - lion. Moreover, companies that benefit from 20 PEVC financing do not appear to be young, ups: the average company innovative start- US$ billions is about 18 years old. After controlling for 10 other company characteristics, each addi - tional year in operation implies $0.9 million of additional PEVC investments. Investments 0 2011 2005 2009 2010 2008 2007 2004 2006 2003 2002 also have a strong bias toward energy and natural resources, which account for about a Emerging Asia Eastern Europe and Central Asia third of PEVC investments. Latin America and the Caribbean Middle East and North Africa - up financing remains a chal Overall, start- Sub-Saharan Africa lenge in the region: venture capital accounts - for less than 10 percent of total PEVC invest Source: Mondragón 2012, based on data from the Emerging Markets Private Equity Association (EMPEA). Note: Emerging Asia: All countries; excludes funds whose primary mandate is investments in Japan, ments. Moreover, venture capital typically Australia, or New Zealand. Eastern Europe and Central Asia: Countries in Central and Eastern Europe, does not finance young, innovative firms. the Commonwealth of Independent States, the Baltics, and the Balkans; the European Union acces - sion countries; and Turkey. Latin America and the Caribbean: countries in Central America, South The dearth of financing opportunities for - America, and the Caribbean excluding Puerto Rico; Middle East and North Africa: Afghanistan, Alge young, innovative firms may be hindering ria, the Arab Republic of Egypt, the Gulf Cooperation Council countries, the Islamic Republic of Iran, Iraq, Libya, Jordan, Lebanon, Morocco, Pakistan, the Palestinian Territories, Sudan, Syria, Tunisia, and the region’s entrepreneurial potential. But the Republic of Yemen. Sub- Saharan Africa: All countries; excludes funds whose primary mandate is the problem may not necessarily be solved by investments in Algeria, Egypt, Libya, Morocco, Sudan, or Tunisia. F I G U R E 3.18 Number and size of private equity and venture capital deals in Latin America and the Caribbean, by country, 2008– 11 b. Deal size distribution a. Number of deals, 2008–11 Belize 0–1 Cayman Islands Nicaragua 1–5 Guyana Jamaica 5–10 Panama Paraguay 10–20 Dominican Republic Honduras Trinidad and Tobago 20–50 Guatemala US$ (millions) Uruguay 50–100 Costa Rica Peru 100–250 Colombia Chile 250–500 Argentina Mexico >500 Brazil 25 15 0 5 20 10 200 0 100 150 50 250 % of total deals Deals Mondragón 2012. Source: Information on the size of the investment was not available on all deals. Note: 03_ENTinLAC_061-094.indd 83 11/21/13 5:14 PM

102 84 LATIN AMERICAN ENTREPRENEURS F I G U R E 3.19 Access to credit, by region and age simple supply-side interventions. The region of firm may be trapped in a vicious cycle of low innovation leading to too little demand for a healthy PEVC industry to flourish. It may be 70 possible to break such a cycle with govern - ment-led supply side interventions—but with - 60 out a larger mass of young, innovative firms, only interventions are likely to fail. supply- 50 In addition, the facts that LAC has under - developed capital markets and that venture 40 Firms (%) - capital appears to chase big deals in tradi tional industries do not by themselves imply 30 that the region’s innovation gap is caused by lack of access to finance. Young rather than 20 small firms drive growth and employment 5–9 10–1 9 20–29 30–39 1–4 generation in the long run (see chapter 2). Age of rm (years) LAC High-income countries Hence, it is worthwhile to explore the link EAP4 ECA between firm age and access to finance. Figure 3.19 shows the share of firms Source: World Bank, based on data from 2006– 10 Enterprise Surveys. across regions and age groups covered by the Note: The last survey available is used for each country. Each country has Enterprise Survey database that report hav - the same weight in the regional average. Initial size of more than 10,000 was replaced by missing. Data do not take into account the initial year for ing access to credit. LAC appears not to have firms more than 39 years old. High income: Croatia, the Czech Republic, a meaningful gap. Consequently, it seems dif - Hungary, Poland, the Slovak Republic, Slovenia and Spain. For countries included in other groups, see note 2. ficult to conclude that lack of finance is the main explanation for the region’s innovation tech start- ups, where particularly for high- gap. Much remains to be done to continue the founder’s human capital is a key driver of transforming the region’s capital markets growth (Colombo and Grilli 2010; Arvanitis into engines of growth without hampering and Stucki 2012). recently achieved stability. Yet lack of finance Education in technical or scientific fields is unlikely to be the main driver of the inno - - and work experience in technical and com vation gap. Chapter 6 revisits this issue. mercial functions within the same industry also matter for success, especially for new Entrepreneurial skills: based firms (Almus and Ner - technology– A key missing link? - linger 1999; Colombo and Grilli 2005; Bal coni and Fontana 2011; Ganotakis 2012). Entrepreneurial skills are personal traits, Entrepreneurs who are well endowed in a experience, and human capital that favor of- all trades”— “jacks- variety of fields— may experimentation, risk taking, and ultimately also have higher probabilities of success, the growth of incumbent firms. For the pur - because entrepreneurs have to manage dif - poses of this section, entrepreneurs include ferent people and tasks and be well versed all individuals in a position to make impor - in a variety of management skills (Lazear tant strategic decisions in a firm, including section analyses, 2004, 2005). Using cross- managers, chief executive officers, founders, Lazear (2005) and Wagner (2003) find that and engineers. accumulation of a balanced skills mix (that Some personal traits have been associated is, general human capital) is associated with with entrepreneurial success. Education, for above- average postentry performance (see instance, increases the likelihood of survival also Vivarelli 2012). of new firms and subsequent economic per - These aspects of entrepreneurship appear formance (Bates 1990; Gimeno and others to be relevant in LAC. In Brazil, for instance, 1997; Acs, Armington, and Zhang 2007), 03_ENTinLAC_061-094.indd 84 11/21/13 5:14 PM

103 ENTREPRENEURShIP : WhAT ExPLAINS ThE INNov ATIoN GAP ? 85 by INCUMbENT FIRMS offs from existing enterprises spin- employee spin- offs have a lower likelihood of exit (fig - sixth to one- third of new account for one- ure 3.20): employee spin- offs, for instance, are 6 percent more likely than ordinary new formal sector firms, and these firms exhibit a higher likelihood of survival. Muendler, firms to survive. These results point to the importance of - Rauch, and Tocoian (2012) analyze post knowing the sector and the country con - entry performance of new firms using a unique employee- employer database from text for the success of new firms, but they Brazil that offers comprehensive individ remain silent about the particular skills - that are needed. Lessons from high- income ual employee information on occupations, derived largely from analyses of countries— demographic characteristics, and earnings. - - may be of limited rele Exploiting these data, they compare differ tech sectors— high- ences in likelihood of exit after five years vance for most countries in LAC, where firms between “ordinary” new firms and spin- do not necessarily operate at the technology offs, distinguishing between spin- offs by frontier. offs generated by the firms New studies of LAC show that people with employees, spin- themselves out of diversification purposes, good technical and managerial skills may and “divestitures,” where a new firm absorbs improve a firm’s innovative potential and, plants from an existing firm. They also break - ultimately, productivity. Drawing on gradu - level man offs that included high- out spin- ation records, membership in professional agers from the mother firm from spin- societies, and historical census data, Maloney offs and Valencia- Caicedo (2012) generated new that included only employees. Their results data on the stock of engineers at the end of suggest that the founders’ profile influences the 19th century at the subnational level for postentry performance: in almost all cases, a panel of five countries (the United States, Argentina, Chile, Mexico, and the República off firm after five FIGURE 3.20 Likelihood of spin- Bolivariana de Venezuela). Two findings years, by type of entrant stand out from these data. First, Argentina, Chile, and Mexico had lower densities of 4 engineers in 1900 than Spain and Portugal, despite higher income per capita (figure 3.21). 0 FIGURE 3.21 Engineering density and GDP of selected countries, 1900 –4 180 –8 United States, north 150 Additional likelihood of exit (%) –12 120 Director/manager Five or more employees United States 90 Employee spino, signicant at 5% Divestiture, signicant at 5% 60 United States, south Diversication venture, signicant at 5% Venezuela, RB Spain Portugal 30 Diversication venture, not signicant Chile Brazil Engineers per 100,000 male workers Colombia Argentina Mexico Peru Muendler, Rauch, and Tocoian 2012. Source: 0 6.0 8.5 8.0 7.5 7.0 6.5 9.0 Note: Bars show coefficients of a multivariate regression on the likelihood of exit. “Director/manager” means that a director or manager from the Log of GDP per capita (US$ in 1900) - former company was involved in the new company; “five or more employ ees” means that five or more employees of the former company joined Source: Maloney and Valencia-Caicedo 2012. the new company. The omitted category is all other new formal sector Note: GDP = gross domestic product. firms. Regressions include cohort and sector fixed effects. 03_ENTinLAC_061-094.indd 85 11/21/13 5:14 PM

104 86 LATIN AMERICAN ENTREPRENEURS This gap in the number of engineers per cap - with efforts to improve management perfor - mance itself, could potentially be an effective ita appears to have persisted over the course avenue for policy action. of history. Second, at both the national and subnational levels, there is a significant asso - ciation between engineering density in the Agglomerations and spillovers: 1900s and per capita income in the 2000s. Can policy makers affect them? A low prevalence of people with good techni - cal skills in LAC may thus have hurt firms’ The holy grail of entrepreneurship policies - innovative potential and affected long- is scale effects: once a critical mass of entre term preneurial firms is achieved, the ball may growth prospects. keep rolling almost by itself. Scale effects - Why do engineers matter? The roman can be driven by technological factors, such tech tic vision of engineers conducting high- - as increasing returns to scale in production, research and pushing the technology fron as well as by factors beyond technology that tier may represent only part of the story, can, in principle, be steered through policy income countries. Most especially in middle- actions. Such factors include positive exter engineers play a less fashionable but equally - - nalities generated by geographic agglomera important role in continuously improving basis products and production processes tions of similar industries. and adapting foreign products and technolo - The idea of designing policies that promote gies to local conditions. There is no need agglomeration is tempting, and the evidence for a degree from Harvard or MIT to equip supporting the presence of externality effects is strong. Natural advantages can explain only engineers to perform such functions: a solid curriculum that combines good analytical about 20 percent of geographic concentration; although correcting for omitted geographic thinking with practice— and teaches what the industry is demanding— may suffice. characteristics might raise the share they account for slightly, agglomeration effects Chapter 6 provides further evidence on the - association between the region’s innovation would not exist without localized intraindus gap and its low density of engineers. try spillovers (Ellison and Glaeser 1999). But technology is only one part of the In the United States, for instance, employ - equation. How people and technologies are ment growth is strongly predicted by the managed also matters: a potentially great presence of small establishments, across both new product may never see the light of day - cities and industries within cities. The pres ence of entrepreneurs may thus attract more if engineering efforts are poorly coordi - nated. And, as discussed, the region’s larg - entrepreneurs, by lowering the cost of entry - est firms seem to have subpar management through the growth of suppliers, venture cap practices. - italists, and by developing an entrepreneur - An additional finding is that few manag ial culture (Chinitz 1961; Glaeser and Kerr 2009; Glaeser, Kerr, and Ponzetto 2010). ers may be aware of how they are running their company. Maloney and Sarrias (2012) Greenstone, Hornbeck, and Moretti (2010) also find that five years after the opening of present survey evidence on managers’ rat - a large plant, the total factor productivity of ings of how well they think they are running incumbent plants is 12 percent higher than in the company (figure 3.22) The correlation - - counties without large plant openings. More between how good managers are (as mea sured by the management score) and how over, this productivity spillover is larger for plants that share similar labor and technol good they think they are is very low (about - 0.2). This low correlation is also evident in ogy pools with the new plant. other countries, even high- income countries. - Human capital spillovers can also be sig nificant. Moretti (2004) finds that the produc - But given the lower average management per - - formance of LAC firms, it suggests that inter tivity of plants in cities that experienced large ventions aimed at improving awareness of the increases in the share of college graduates rises importance of management practices, along more than the productivity of similar plants 03_ENTinLAC_061-094.indd 86 11/21/13 5:14 PM

105 ENTREPRENEURShIP : WhAT ExPLAINS ThE INNov ATIoN GAP ? 87 by INCUMbENT FIRMS FIGURE 3.22 Actual versus perceived management quality in Argentina, Mexico, Chile, and Brazil b. Mexico a. Argentina 10 8 6 4 Self-perception, index 2 4 3 4 1 2 5 3 2 1 5 Average of all management questions d. Brazil c. Chile 10 8 6 4 Self-perception, index 2 5 4 2 4 2 3 1 3 5 1 Average of all management questions Maloney and Sarrias 2012. Source: Given the large impacts of externalities, it in cities that experienced small increases. For human capital, too, “technological proxim is tempting for policy makers to invest large - ity” seems to matter: within a city, spillovers - sums to attract firms and promote agglomer ations. And indeed, when there is competition between industries that are economically - close are larger than spillovers between indus to attract investments, providing (reasonable) financial incentives to make the balance tilt tries that are economically distant. in a region’s favor may be money well spent - Local multipliers also play a role in fos tering agglomerations. Moretti and Thulin (Moretti 2010). But there is very little evi - (2012), for instance, distinguish between dence that it is possible to artificially gener - locally tradable and nontradable jobs. They ate self- sustaining agglomerations. Successful - find that every time a local economy gener industrial parks that were promoted by the ates a new job by attracting a new business government are hard to find, and there is lit - in the traded sector, a significant number of tle evidence that large tax incentives aimed at additional jobs is created in the nontraded attracting foreign firms and investments have systematically provided good returns. sector. The type of job generated matters: the Success stories often result out of the com - local multiplier varies from a third to three. bination of natural advantages (including tech indus It is particularly large for high- - “first- tries and other jobs that require high levels of mover” advantages), luck, and good human capital. policies that nudged incentives in already 03_ENTinLAC_061-094.indd 87 11/21/13 5:14 PM

106 88 LATIN AMERICAN ENTREPRENEURS favorable local conditions. Silicon Valley, the international spillovers (mostly generated - by the transfer of knowledge) affect innova gold standard of entrepreneurship ecosys - tion. The policy implications may change tems, was never “founded.” It evolved from a dramatically depending on the source of the unique set of circumstances: Stanford Univer - - spillovers. If spillovers are domestic, there sity’s interest in hooking up with the indus may be space for government intervention try, a strong aerospace industry, a handful of industries making breakthrough progresses to solve free- riding problems (the so- called in the semiconductor industry, a liberal immi - “appropriability problem”): because firms do gration policy toward doctoral students, and not internalize the positive impacts of their production of knowledge on other firms, they - pure luck, among others (Isenberg 2010). Sili con Valley also benefitted from a first- may underinvest in knowledge production. If, mover - in contrast, knowledge spillovers are gener advantage. It is not clear that if the same con - by technology transfers ated internationally— ditions appeared today they would lead to the through trade, for example— then the appro same success. - faire and priate policy may be one of laissez- Overall, there is not enough evidence to trade liberalization, especially for small open say with certainty what works and what - - does not. But some do’s and don’ts are start economies that do not affect prices in inter national markets. 3.3). And one fact seems ing to emerge (box Ortega, Causalito, and Leder Bravo- to be repeatedly confirmed: it is very hard to - get it right. man (2013) attempt to identify the origins of spillovers. Using a cross- country panel Geography is only one channel through of investment in R&D and USPTO patents, which spillovers may affect firms’ productiv - ity and innovative behavior. Another is trade. they look at the extent to which domestic patenting activity is influenced by domes - There have been few attempts to understand tic investments in R&D, the domestic stock the extent to which domestic as opposed to Do’s and don’ts of entrepreneurship ecosystems BOX 3.3 cultural factors in fostering entrepreneurship In a 2010 article in the Harvard Business Review, has been understudied. But there is a growing Daniel Isenberg, a business school professor, sum - sense that culture matters significantly. marizes years of experience in analyzing conditions Experiment holistically, but do not overengi- • under which entrepreneurs thrive (“entrepreneurship neer. For ecosystems to thrive, several elements ecosystems”). His list of dos and don’ts includes the must work well together— hence the need to following: experiment holistically along several fronts. • Shape the ecosystem around local conditions. Overengineering, however, may also lead to Natural advantages cannot fully account for failure. The more there is a need to intervene, the higher productivity of agglomerations, but the less likely it is that ecosystems will eventu- they can give a good head start. The less natural ally thrive alone. advantage there is a, the more difficult it will be Not all experi- Think about an exit strategy. • sustaining agglomeration. to foster a self- mentation will deliver the desired results— if it Profit- Engage the private sector from the start. • did it would not be an experiment. But there is driven motives may lead firms to miss the ben- a danger, often for political economy reasons, eficial effect of spillovers, but they provide the to keep subsidizing pilots that do not work. All best perspective to judge whether a venture will experiments should have clearly defined time work. horizons and exit strategies. on. Because cul- Tackle cultural change head- • ture is at times intangible, the importance of Adapted from Isenberg 2010. Source: 03_ENTinLAC_061-094.indd 88 11/21/13 5:14 PM

107 ATIoN : WhAT ExPLAINS ThE INNov FIRMS GAP ? 89 ENTREPRENEURShIP by INCUMbENT technology leaders is large and they prefer to of patents, the stock of patents from other countries in the same region, and the stock import technology. The ambiguous interpretations about the of patents in the rest of the world. The results role of international movements of goods, - suggest some scope for government interven services, and capital on domestic innovation tion (figure 3.23). Net of R&D expenditures, the domestic stock of USPTO patents does highlights the need to understand the roles that trade and multinational activity play in affect the number (that is, flow) of patents by a country, a result that is consistent with fostering innovation and entrepreneurship. - The following chapters examine the perfor the presence of domestic knowledge spill - - overs. The elasticity is less than one, how mance of some of the top entrepreneurs in LAC and the firms that enter and survive in ever, suggesting that “big push” interventions sustaining virtuous cycle of to generate a self- highly competitive export markets and seek out foreign markets by investing abroad. innovation may be difficult to achieve. These firms are led by the highest end of the On the international front, the stock of region’s entrepreneurs. But how innovative are patents of countries in the same region does seem to positively affect domestic patenting they? Chapters 4 and 5 examine these issues. activity, suggesting the presence of positive regional knowledge spillovers. In contrast, Notes the stock of patents from the rest of the world Some observers argue that it may be optimal 1. appears to negatively affect domestic patent - not to enforce some poorly conceived regu- ing activity. This negative coefficient can be lations that may hurt firms or people exces- interpreted in two ways. It could simply be best sively, but weak enforcement is a second- an outcome of “patent races” between high- option that often creates more complications and low- income countries, where low- income than it solves. countries do not see a need to patent innova - Throughout this chapter we use the following 2. tions because of lower engagement at a global groups of economies unless otherwise noted. - scale or because of lower returns from pat LAC5 includes Argentina, Brazil, Chile, enting in sectors where firms in high- income Colombia, and Mexico. includes Other LAC countries are also active. It could also be a Bolivia, Costa Rica, the Dominican Republic, Ecuador, El Salvador, Guatemala, Honduras, genuine negative externality, where firms Nicaragua, Paraguay, Peru, Uruguay, and in low- income countries do not see a need República Bolivariana de Venezuela. Carib- to innovate because their distance from the bean includes Antigua and Barbuda, Cuba, Dominica, Grenada, Guyana, Haiti, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent and Domestic versus international FIGURE 3.23 the Grenadines, Suriname, and Trinidad and spillovers in patenting activity ECA (Eastern Europe and Central Tobago. Asia) includes Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, R&D expenditures Georgia, Kazakhstan, Latvia, Lithuania, FYR Macedonia, Moldova, Romania, the Russian Domestic stock Federation, Serbia, Turkey, Turkmenistan, of patents Ukraine, and Uzbekistan. includes EAP4 Regional stock Indonesia, Malaysia, the Philippines, and of patents Thailand. High-income economies include Stock of patents Australia; Canada; Hong Kong SAR, China; in the rest Israel; Japan; the Republic of Korea; Kuwait; of the world New Zealand; Oman; Saudi Arabia, Singa- 0 0.2 0.4 0.6 0.8 –0.4 –0.2 pore; Switzerland; the United Arab Emirates; Elasticity of patenting activity the United States; and all countries in the European Union not included in ECA. The set Ortega, Cusolito, and Lederman 2013. Source: Bravo- R&D = research and development. Note: of economies from each group used in figures 03_ENTinLAC_061-094.indd 89 11/21/13 5:14 PM

108 90 LATIN AMERICAN ENTREPRENEURS Budget information is not provided because of 11. throughout this chapter varies according to the challenges in obtaining comparative data. data availability. Some agencies are incorporated into minis- 3. The OECD (2002) on R&D Frascati Manual tries, making it difficult to estimate the budget statistics, which is used around the world, available to the agency. excludes investments in soil analysis and min- eral exploration from R&D activities. Conse- quently investments in innovation in agriculture References and mining tend to be underreported. 4. It is likely that multinational corporations Acemoglu, D., P. Aghion, and F. Zilibotti. 2006. rather than domestic firms conduct a large “Distance to Frontier, Selection, and Economic share of R&D in China. A similar bias in Grow t h.” Journal of the European Economic reported R&D statistics may affect some LAC 74. 4 (1): 37– Association economies, such as Mexico. It is unlikely that Acharya, V. V., and K. V. Subramanian. 2009. LAC economies would overcome China’s “Bankruptcy Codes and Innovation.” Review measured R&D effort even if the data were 22 (12): 4949– of Financial Studies 88. corrected for this bias, however. (The authors Acs, Z. J., C. Armington, and T. Zhang. 2007. would like to thank William F. Maloney for Firm Survival “The Determinants of New- pointing this out.) across Regional Economies: The Role of R&D data are classified as “productive- 5. Human Capital Stock and Knowledge Spill - sector” R&D when the source of the financ- Papers in Regional Science over.” 86 (3): ing comes from a company that participates 367– 91. in the market. However, these companies can M. Angeletos, A. Banerjee, and Aghion, P., G.- be publicly owned, thus blurring the distinc- K. Manova. 2010. “Volatility and Growth: tion between private and public R&D. In Credit Constraints and the Composition of Serra this report, as in others such as Pagés- Journal of Monetary Economics I nvest ment.” (2010), the term is used to character private - 57 (3): 246– 65. sector R&D. ize productive- Aghion, P., N. Bloom, R. Blundell, R. Griffith, 6. Specifically, the log of patents per million peo- - and P. Howitt. 2005. “Competition and Inno ple was regressed on the log of GDP (expressed Quar vation: An Inverted U Relationsh ip.” - in purchasing power parity terms), the log 120 (2): 701– terly Journal of Economics 28. of population, and the log of merchandise Aghion, P., R. Blundell, R. Griffith, P. Howitt, exports to the United States. The dots in fig- and S. Prantl. 2009. “The Effects of Entry ure 3.4 represent the estimated intensity of pat- on Incumbent Innovation and Productivity.” enting in the United States given each country’s Review of Economics and Statistics 91 (1): characteristics along these three dimensions. 32. 20 – 7. Official export costs include costs for docu- Aghion, P., and P. Bolton. 1992. “An Incomplete ments, administrative fees for customs clear - Contracts Approach to Financial Contracting.” ance and technical control, customs broker Review of Economic Studies 59 (3): 473– 94. fees, terminal handling charges, and inland Aghion, P., C. Harris, P. Howitt, and J. Vickers. transport. The cost measure does not include 2001. “Competition, Imitation and Growth tariffs or trade taxes. Review of Step Innovation.” by- with Step- 8. In the aggregate, productivity may still Economic Studies 92. 68 (3): 467– increase, because more firms innovating raises Akcigit, U., and W. R. Kerr. 2010. “Growth the chances of a technological breakthrough through Heterogeneous Innovations.” NBER (Bento, forthcoming). Working Paper 16443, National Bureau of 9. The measured effects are in addition to the Economic Research, Cambridge, MA. impact of regulation on innovation as mea- - Allen, F., and D. Gale. 2000. “Corporate Gov sured by the Doing Business indicators (see ernance and Competition.” In Corporate figure 3.7), which, by affecting competition Governance: The Theoretical and Empirical themselves, also capture part of the effects of Perspectives, edited by X. Vives, 23– - 94. Cam working though competition. bridge, U.K.: Cambridge University Press. 10. This section benefitted immensely from dis- Almus, M., and E. A. Nerlinger. 1999. “Growth cussions with Paolo Benedetti and Aitor Ortiz, Based Firms: Which Fac of New Technology- - of the Centro Regional de Competencia para tors Matter?” Small Business Economics América Latina (CRC), as well as from infor - 13 (2): 141– 54. mation provided by the CRC. 03_ENTinLAC_061-094.indd 90 11/21/13 5:14 PM

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113 Export Entrepreneurship 4 Exporting is difficult: only highly successful firms ever try to do so, and most of them exit exporting within a year. Export entrepreneurship by the small number of superstar firms that term export growth. New evidence indicates that the economies of Latin survive drives long- America and the Caribbean underperform poorer economies in terms of export entry rates. However, companies in the region proved resilient in the face of the contraction of foreign demand in 2008– 09, experimenting with new export products and attempting to penetrate new markets. These findings suggest that competitive pressures can spur innovation by high- end entrepreneurs. If the costs of entry into export markets partly reflect the need to gather information about the characteristics of foreign markets, export promotion policies that pro- vide such information could increase export entry and enhance the likelihood of survival in global markets. Preliminary evidence suggests that export promotion policies in the region are having these effects, although even the region’s superstars enter exporting at lower rates than comparators in other regions. his chapter focuses on one type of Export entrepreneurship has several high- end innovative entrepreneur - dimensions. This chapter studies the rate of - T ship: the act of entering and surviv - entry and exit of exporting firms, the likeli 1 ing in global markets. Like the forms of hood of survival of firms in export markets innovation discussed in chapter 3, exporting after entry, and the size of their exports at is costly. Firms thus carefully analyze the entry. (Chapter 6 revisits the issue of whether potential costs and benefits of entering new LAC is lagging similar economies in its level markets. of openness to international trade.) The chapter begins with an assessment of Partly because of LAC’s comparative the contribution of export entrepreneurship advantage in mining and agriculture com - to overall export growth in Latin America modities, observers have long been pessimistic and the Caribbean (LAC) in the medium - about the region’s growth and entrepreneur term. It benchmarks LAC countries relative ial potential (see, for example, the literature to other developing economies in terms of reviewed by Lederman and Maloney 2007). export entrepreneurship. However, the literature has remained silent 95 04_ENTinLAC_095-120.indd 95 11/21/13 5:34 PM

114 96 LATIN AMERICAN ENTREPRENEURS 2 enter and thrive in export markets. with respect to the role of entrepreneurship firms— In an influential review of the literature on as a driver of export growth in developing - firms in international trade, Bernard and oth countries with diverse trade structures. This ers (2007) document that in 2000 only about chapter therefore benchmarks broad sectors 4 percent of the 5.5 million firms operating of economic activity in terms of their poten - in the United States were exporters. Among tial for export entrepreneurship and discusses the role of comparative advantage as a deter - manufacturing and agricultural firms, only minant of export entrepreneurship. - about 15 percent were exporters. Eaton, Kor - tum, and Kramarz (2011) show that only The chapter presents results from comple about 15 percent of French manufacturing mentary benchmarking exercises. The first firms with more than 20 employees were set is descriptive; it presents the basic statis - exporters in 1986. tics for groups of countries in LAC and other Although census data on enterprises are regions classified by their structural charac - teristics. The analysis does not identify the scarce in developing countries, it is safe to - portion of each export entrepreneurship indi speculate that exporting firms are also rare cator that is strictly associated with country in LAC and elsewhere. Lederman (2010) features or industry characteristics. reports that about 36 percent of a developing country sample of more than 25,000 manu The second set of exercises highlights - facturing firms surveyed between 2000 and “conditional” international comparisons. This approach relies on econometric analy 2006 reported exporting (these data are from - the World Bank’s Enterprise Surveys, which sis to decompose the sources of the observed - are not censuses and are probably upwardly international differences in export entrepre neurship indicators into country, industry, - biased in terms of the number of export 3 period effects. and time- - Lederman (2013) reports that the aver ers). The evidence presented suggests that age export intensity (the ratio of exports to export entrepreneurship in most LAC coun - total sales) ranges from less than 1 percent tries has significantly contributed to national (in the 2006 enterprise survey of Burundi) to 29 percent (in the 2007 enterprise survey export growth, even over short time periods. The picture that emerges is one of a seemingly of Bangladesh). The samples of firms from dynamic export sector, characterized by vig - LAC countries had average export intensi - ties ranging from less than 1 percent (in the orous entry and exit, with relatively healthy República Bolivariana de Venezuela survey survival rates. Unfortunately, the region’s of 2010) to slightly less than 15 percent (in export entry and survival rates appear to be lower than those of poorer countries after - the Peru survey of 2010). Moreover, in Leder controlling for industry characteristics and man’s global sample of more than 55,000 firms, the correlation between export inten GDP per capita. - sity and size (measured by the number of There is, however, good news on the policy front. Export promotion policies focused on employees) is high: average export intensity among developing country firms with less solving informational market failures seem than 15 employees was about 13 percent, to stimulate the entry of new LAC firms into - exporting activities as well as enhance their whereas firms with more than 1,000 employ likelihood of survival in export markets. ees reported average exports over total sales of about 40 percent. In sum, the vast major - ity of private sector enterprises do not export, Exporting as a transformative partly because export intensity tends to rise entrepreneurial act with the size of firms and developing econo - Exporting is difficult and thus rare among mies tend to have small firms. private enterprises. Only the best firms— The literature analyzes the export decision the largest, most productive, “superstar” as a function of both variable and fixed costs. 04_ENTinLAC_095-120.indd 96 11/21/13 5:34 PM

115 ENTREPRENEURShIP 97 ExPoRT Variable costs are associated with transport A large body of literature suggests that - more globalized economies (usually mea and trade barriers (such as import or export sured by the share of international trade taxes). The magnitude of such costs presum - over gross domestic product [GDP] or by ably varies with the quantity exported. Fixed costs (which do not vary with the quantity indicators related to trade policies) tend to of exports) include investments necessary to grow more rapidly than countries with less - globalized economies (see Sachs and War establish foreign business partners and clients, learn about product standards (both policy- ner 1995; Frankel and Romer 1999; Alcala and Ciccone 2004; Wacziarg and Welch induced via regulations and consumer prefer - 2008; Feyrer 2009; Arkolakis, Costinot, and ences), market products, and conduct market feasibility studies and other business due dili Rodriguez- - Clare 2012; and Brückner and - Lederman 2012, among others). This litera gence particular to each foreign market. ture has its skeptics (such as Rodriguez and - Fixed costs can be large. Using Colom Rodrik 2001), and openness to international level data, Das, Roberts, and bian plant- Tybout (2007) estimate that the fixed costs trade need not cause economic growth. Bald - of exporting were more than $400,000 in win and Robert- Nicoud (2008), for instance, argue that the impact of international inte 1986 (large firms tended to have fixed costs - 10 percent lower than small firms). When gration depends on the relative magnitude of two opposing effects. On the one hand, - entrepreneurs decide to export their prod international competition may wipe out low- ucts or services abroad, they are taking a bet productivity firms that must compete with that export revenues will be large enough to imports in the domestic market. Although this cover the fixed costs of exporting as well as one- time effect raises an economy’s aggregate the variable costs. The expected profits from exporting have to be higher than the profits productivity productivity (by eliminating low- - from selling domestically. firms) and increases domestic consumer wel Private sector enterprises that decide to fare (by making goods in the domestic market less expensive) the long- term growth rate can export are thus taking an entrepreneurial leap. They are exceptional entrepreneurs decline because of domestic firms’ perceptions who incur upfront costs in the expectation that they are less likely to “win” new varieties - of goods. Such firms may reduce their invest that their foreign sales will be more profit - able than their domestic sales. It is widely - ments in both physical and knowledge capi believed that only the most productive firms tal (for innovation). This analysis is similar to the discussion in chapter 3 on the impacts are able to cover the costs of exporting and grow in foreign markets. As discussed below, of competition on innovation. If investment most governments rely on export promotion by the typical domestic firm declines, then an economy’s aggregate growth is expected agencies and policies that focus on providing to decline as well. But trade liberalization (or information on foreign markets to domestic - entrepreneurs with the objective of increas any reduction in fixed or variable trade costs) ing national exports or diversifying the set of can reduce the marginal cost of investments in research and development (R&D) or knowl exported products. - - Rephrasing the question about the fic - edge capital by reducing the price of “knowl edge capital.” As capital becomes cheaper, tional entrepreneur introduced in chapter 1: Why should policy makers care whether private sector investment can rise, boosting Javier, a well- the economy’s aggregate income growth rate. educated wine entrepreneur Similarly, international integration can from South America, succeeds in exporting quality wine to the United States? The high- affect the incentives of the private sector concern for policy makers is not who exports and households to invest in human capi - but rather the size of the population of firms tal. Another strand of the trade literature, that are globalized. for example, links exports to the returns to 04_ENTinLAC_095-120.indd 97 11/21/13 5:34 PM

116 98 LATIN AMERICAN ENTREPRENEURS skills or education. It shows that under most from a global survey of EPAs conducted by the World Bank (in 2010) suggest that plausible scenarios for developing countries, increases in exports are associated with in all regions of the world the promotion of exports dominates other policy objec - increases in the relative demand for skilled tives (figure 4.1). In fact, 60 percent of the or highly educated workers, thus raising the 94 agencies that responded reported that returns to schooling and potentially stimu - stimulating export growth was the top pri - lating investments in human capital (see, for - ority, 20 percent reported that the top pri - example, Brambilla and others 2012; Leder man and Maloney 2012; and Brambilla, ority was the promotion of nontraditional Lederman, and Porto 2012 and the literature exports, and another 20 percent stated that their top priority was the promotion of spe cited therein). - cific sectors. In a nutshell, international integration can LAC agencies differ from agencies in other raise the prospects for quickening the pace of regions: their most important objective is the growth in the long term by raising the rate promotion of nontraditional exports; overall of accumulation of various forms of capi - export growth is their second most important tal (including human capital) and enhanc - objective. Both are part and parcel of export ing technological upgrading. Such effects are not preordained, however; they depend entrepreneurship, however, as will become clear through this chapter. on domestic firms’ capabilities to innovate Policy makers around the world tend to and introduce new varieties. Indeed, it can be argued that for international integration focus on export growth as an important pol - - icy objective. Hence, assessing the contribu to be a source of inclusive growth, domes - tic firms have to have the capacity to adapt tion of entrepreneurship to national export growth seems important on both analytical to competition by shifting their product and and policy grounds. service varieties to sectors with higher rela - tive domestic prices (Lederman 2013). As dis - The key issue is the contribution of export entrepreneurs to export growth in the long cussed in chapter 3, such innovation requires - investing before (potentially) reaping the ben run rather than their contribution in a single efits of uncertain future profits. year. On a yearly basis, the contribution of - Smart public interventions in the con new exporters is expected to be low, for two text of open, outward- reasons. First, the number of new exporters oriented trade policy - regimes can help reduce the fixed and vari - is expected to be small relative to the num ber of incumbent exporting firms; entrepre able costs of exporting for the benefit of all - domestic entrepreneurs by diffusing informa neurs are a rare breed. Second, the average - value of exports of new entrants is expected tion about the idiosyncrasies of foreign mar - to be lower than the average for established kets. Policy makers should thus care about exporters. The combination of these two Javier’s success in foreign markets because - his enterprise can become a conduit for other run contribu factors dictates that the short- firms to obtain knowledge about the nature tion of new exporters will be small from an and magnitude of the fixed and variable costs accounting perspective. of exporting to the United States at a lower To the extent that export entrepreneurs cost than if Javier had not shown the way. can survive and attain relatively high export growth rates, their contribution to national exports tends to grow over time. Perhaps the Contribution of export easiest way to visualize the long- run contri - entrepreneurship bution of new exporters is to recognize that in the medium term today’s exporters were probably not in busi - From a policy viewpoint, increasing exports ness a century ago. In this extreme example, is usually the mandate of publicly funded the contribution of export entrepreneurs to export promotion agencies (EPAs). Data national exports approaches 100 percent 04_ENTinLAC_095-120.indd 98 11/21/13 5:34 PM

117 ExPoRT 99 ENTREPRENEURShIP FIGURE 4.1 Strategic objectives of export promotion agencies, by region a. Europe and Central Asia c. Middle East and North Africa b. Latin America and the Caribbean 100 100 100 50 50 50 Country responses (%) 0 0 0 1 2 4 3 3 1 2 3 2 4 4 1 Strategy Strategy Strategy e. Sub-Saharan Africa d. OECD countries 100 100 50 50 Country responses (%) 0 0 2 1 4 2 3 3 1 4 Strategy Strategy Source: Lederman, Olarreaga, and Zavala 2013. 1 = promote overall exports; 2 = promote nontraditional exports only; 3 = promote specific sectors; 4 = promote industrial clusters and other objectives. Survey covered Note: 96 countries, but only 94 responded to this set of questions. OECD = Organisation for Economic Co-operation and Development. not exporting in 2004 but were exporting over time as older firms exit. Hence, the issue 5 is how quickly this process of renewal of in 2005. We define a subset of the 2005 exporting firms occurs; the speed of renewal exporter entrant cohort that includes only is associated with entry and exit rates, as well firms that continued to export continuously as the probability of survival of new entrants through 2009. We define as incumbents and their growth rates. firms that were already exporting in 2004 run export Given our interest in long- and continued to export through 2009. growth, we focus first on the contribution For each of these three groups of firms, we of entrepreneurs to exports over the period examine the changes in their contribution of time that is the longest possible period for to total exports and in the average size of which data are available for a large sample firms (measured by their exports). The 2005 of countries: 2004– 09. These data come cohort of new exporters includes both firms from the Exporter Dynamics Database, a that began exporting in 2005 but did not new database assembled by the World Bank’s continue to export through 2009 and firms Development Research Group (Cebeci and that entered in 2005 and survived through 4 others 2012). 2009. The sample of incumbents covers In each LAC country, we define as the firms that exported every year between 2004 2005 exporter entrant cohort firms that were and 20 09. 04_ENTinLAC_095-120.indd 99 11/21/13 5:34 PM

118 100 LATIN AMERICAN ENTREPRENEURS TABLE 4.1 Number of new and incumbent exporters in seven countries in Latin America and the Caribbean, 09 2005– Dominican Brazil Guatemala Year Republic Peru El Salvador Chile Costa Rica Number of firms in 2005 exporter entrant cohort 4,209 2,269 884 976 74 6 1,176 2005 2,375 2006 856 488 309 303 473 1,115 2,272 1,919 261 392 310 2007 420 844 693 2008 619 340 271 237 383 689 1, 6 62 2009 575 318 216 248 291 530 1, 36 4 Number of firms in 2005 exporter entrant cohort surviving until 2009 984 314 210 10 4 128 221 392 Number of continuous exporters in 2004–09 8,472 2,345 985 586 942 1,56 6 1,713 Total number of exporters 3,980 2,356 6,420 19, 8 6 8 2005 5,701 2,375 2,381 2,043 2,824 6,535 19,102 2006 2,360 4,022 6,147 2,862 2007 19, 624 7, 4 0 2 2,951 2,499 4 ,174 6,351 2, 515 4,424 2,558 2,778 7, 6 7 7 19, 0 87 2008 6,833 7, 0 2 6 18 ,17 7 6,934 2,697 2009 2,501 4,309 2,754 Source: Calculations based on data from the World Bank Exporter Dynamics Database. FIGURE 4.2 Share of total exports accounted for by new export Table 4.1 shows that the number of entrants in seven countries in Latin America and the Caribbean, exporter entrants in 2005 is large for most 2005– 09 LAC countries relative to the total number of exporters (this finding is consistent with 15 the high rates of exporter entry documented in the following section). Across countries, the number of new exporters in 2005 that remain in export markets continuously 10 through 2009 is substantially smaller, rang - ing from 10 percent of the 2005 exporter entrants cohort in the Dominican Republic to 5 almost a quarter in Brazil. The share of national exports contributed Share of total exports (%) by new entrants rose over time in six of the seven countries (figure 4.2). Only in Peru 0 2005 2009 2008 2007 2006 was the share of total exports from the new 2005 cohort lower in 2009 than in 2005. El Salvador Peru Perhaps more important, in all seven coun - Costa Rica Guatemala tries the share of total exports contributed by Brazil Chile the incumbent exporters that continuously Dominican Republic exported during 2000– 09 declined over 6 - The decline in all coun time (figure 4.3). Source: Calculations based on data from the World Bank Exporter Dynamics Database. tries except Costa Rica was 4– 5 percent - age points in just four years. The decline in Costa Rica was about 2 percentage points, but it occurred in 2008. Continued declines of these magnitudes would imply that a 04_ENTinLAC_095-120.indd 100 11/21/13 5:34 PM

119 ENTREPRENEURShIP 101 ExPoRT FIGURE 4.3 Share of total exports accounted for by continuous - country’s export base of firms would be com exporters in seven countries in Latin America and the Caribbean, pletely renewed in about 80– 100 years. 09 2004– Complementary evidence from other research indicates that the renewal of the 100 pool of firms that sustains national exports can occur more quickly than implied by the exporter dynamics portrayed in figures 4.2 90 and 4.3. Eaton and others (2007) show that in a sample of Colombian firms from 1996 to 2005, new exporters accounted for almost 80 half of exporting firms in any given year but contributed little to annual export growth. 70 The few firms that survived as exporters for Share of total exports (%) more than a year, however, grew rapidly and accounted for about half of the country’s total 60 2009 2005 2006 2007 2008 merchandise export growth after a decade. Clare, and Xu (2011) Lederman, Rodriguez- Guatemala Dominican Republic Chile report that the 1999 cohort of entrants into Peru Costa Rica exporting accounted for almost 40 percent El Salvador Brazil of Costa Rica’s total merchandise exports by 2005, albeit with significant turnover. This Calculations based on data from the World Bank Exporter Dynamics Database. Source: evidence suggests that firm entry into export activities and survival are as important as exports from incumbent firms for aggregate chapter 2, table 4.2 shows annual growth 7 export growth in the medium term. rates of the dollar value of exports of the Mimicking the analyses of firm dynam - 2005 cohort of new exporters and the growth ics and employment generation discussed in rates of continuous exporters. Export growth by new entrants and incumbents in seven countries in Latin America and the TABLE 4.2 09 Caribbean, 2004– (percent) Dominican Year Brazil Republic El Salvador Costa Rica Peru Guatemala Chile Growth in total exports of 2005 exporter entrant cohort 55.4 175 . 8 17 7. 5 14 4.6 18 .1 2005/06 84.9 58.7 2006/07 5.7 17. 5 18. 2 47. 2 –0.3 49.5 32.0 13 . 8 1.3 31.5 19. 8 43.8 20.6 15. 5 2 0 07/0 8 –33.2 2008/09 –14.9 –6.2 –6.5 –1.4 –30.2 11. 7 Growth in total exports of 2005 exporter entrant cohort surviving until 2009 133 .9 12 7.1 399.3 262.0 320.4 135.7 2005/06 165.5 15. 8 53.2 34.2 60.8 1.6 81.3 63.7 2006/07 2 7. 6 12 . 8 23.4 23.3 21.4 44.6 36.5 2 0 07/0 8 13 . 3 2008/09 –3.9 –30.4 –20.0 –30.1 2.0 –6.5 Growth in total exports of continuous exporters in 2004–09 2005/06 42.7 17. 0 8 .1 0.1 46.4 8.4 18. 2 9.2 16.6 – 0.1 14.0 14.5 16.7 2006/07 14.6 1.7 2 0 07/0 8 2.1 12 . 3 23.5 9.4 6.7 20.3 –28.8 –9.4 –20.2 –22.0 –10.0 –14. 3 2008/09 –28.7 Calculations based on data from the World Bank Exporter Dynamics Database. Source: 04_ENTinLAC_095-120.indd 101 11/21/13 5:34 PM

120 102 LATIN AMERICAN ENTREPRENEURS year export growth rates for the has the potential to sustain high growth rates The first- of national exports. The data in table 4.1 on cohort of 2005 entrants are striking. They - range from 18 percent to more than 177 per the number of new exporters in 2005 implies that the rate of export entrepreneurship cent between 2005 and 2006. Growth rates for the group of entrants that continuously (defined as the ratio of new exporters to the - exported after 2005 range from 135 per total number of exporters) could be high in cent to almost 400 percent. These growth LAC. What is a “normal” export entry rate? rates are upwardly biased, because they Where do LAC countries stand relative to other countries? To answer these questions, underestimate first- year exports (in 2005), the analyses in this section rely on the World because firms enter into exporting activities 9 throughout the calendar year— that is, the Bank’s Exporter Dynamics Database. To facilitate the descriptive international value of exports reported by new entrants in comparisons with LAC countries, Fer - 2005 was accumulated over several months, Rocha nandes, Lederman, and Gutierrez- whereas their annual exports reported in (2013) selected comparators for three types - 2006 cover all 12 months of the year. Ber of economies: natural resource economies nard and others (2007) label this bias the year effect.” To account for this bias, (including Chile, Colombia, Peru, and Costa “partial- it is prudent to adjust the observed growth Rica); simple processing or assembly econo - rates of the 2005 entrant cohorts by subtract mies (including Guatemala, the Dominican - Republic, El Salvador, and Nicaragua); and ing 30 percent from the reported growth rates 8 - economies with a broad export manufac for 2005– 06. Even after this adjustment, in 10 06 growth rates of turing base (including Brazil and Mexico). every country, the 2005– The natural resource countries were chosen the entrants cohort that survived until 2009 based on net exports of natural resources are much higher than the growth rates of the incumbent exporters. during 1980– - 2005 (see Lederman and Malo 11 Growth rates of the surviving 2005 cohort The simple processing countries ney 2012). tend to be higher than those of incumbents in have large shares of exports of apparel and subsequent years as well, although not for all textiles in their total exports, according to - countries. In Brazil, incumbents’ exports out the database of the World Integrated Trade - paced exports by the 2005 cohort in 2006/07 Solution (WITS)/United Nations Commod 12 and 2007/08 but not during the global ity Trade Statistics (COMTRADE). Coun - financial crisis of 2008/09. In El Salvador tries with a broad manufacturing export base had large shares of manufacturing exports in and Peru, incumbents’ exports grew more rapidly than exports by the 2005 cohort - 2010, accord merchandise exports in 1990– ing to the World Development Indicators. In in some years. Only in these two countries addition to comparator countries in each of did exports of incumbents decline less than these groups, the figures in the next section exports of the 2005 cohort during 2008/09. - We return to the role played by export entre - include data for “LAC countries” (the aver preneurship of incumbent exporters in the age across the region), “World higher” (the income countries in the following section, which provides evidence average across higher- that incumbents tried to cushion the blow of Exporter Dynamics Database), and “World lower” (the average across lower- income the decline in foreign demand in 2008/09 by introducing new products and attempting to countries in the database). export to new foreign market destinations. Entrepreneurship and export growth during good times and bad Descriptive benchmarking of export entrepreneurship Figure 4.4 shows the average annual growth rate of total exports for each country in The evidence from the literature and from 07 (the steady growth period) and the new data compiled for this report sug - 2005– gest that export entrepreneurship is rare but 2008– 09 (the global crisis). It presents the 04_ENTinLAC_095-120.indd 102 11/21/13 5:34 PM

121 103 ExPoRT ENTREPRENEURShIP 09 07 and 2008– Export growth and its components in selected countries, 2005– FIGURE 4.4 b. Export growth, 2008–09 a. Export growth, 2005–07 Ecuador Chile Costa Rica Peru Peru Ecuador Colombia South Africa Natural Natural resources resources Chile Costa Rica South Africa Nicaragua Cambodia Bangladesh Bangladesh Cambodia Nicaragua Guatemala Guatemala Dominican Republic Dominican Republic El Salvador Simple processing El Salvador Simple processing Egypt, Arab Rep. Egypt, Arab Rep. Brazil Brazil Mexico Manufacturing Mexico Manufacturing LAC countries LAC countries of LAC Average countries of LAC Average countries 0 0.2 0.4 0.1 0.3 0.1 –0.2 0.2 0 0.3 –0.1 Export growth rate Export growth rate Other countries LAC countries d. Decomposition, 2008–09 c. Decomposition, 2005–07 Ecuador Chile Costa Rica Peru Peru Ecuador Natural Colombia South Africa resources Natural resources Chile Costa Rica South Africa Nicaragua Bangladesh Cambodia Cambodia Bangladesh Guatemala Nicaragua Dominican Republic Guatemala El Salvador Dominican Republic Simple processing El Salvador Simple processing Egypt, Arab Rep. Brazil Egypt, Arab Rep. Mexico Brazil Mexico Manufacturing Manufacturing LAC countries LAC countries of LAC Average countries of LAC Average countries 0 –0.1 0.3 0.1 –0.2 0.3 0.2 0.4 0.2 0.1 0 –0.1 Export growth rate Export growth rate Entrants Exiters Incumbents Fernandes, Lederman, and Gutierrez-Rocha 2013, based on data from the World Bank Exporter Dynamics Database. Source: Data for Ecuador in panel a are for 2006– 07. Colombia is not included in panels a and c because data were not available. LAC = Latin America and the Note: Caribbean. average contribution of the three terms in the - explaining export growth in all LAC coun tries as well as comparator countries in export growth decomposition (new, incum - bent, and exiting exporters). natural resources, processing, and broad man - ufacturing export base countries. This find During the steady growth period, incum - - bent exporters played the dominant role in ing confirms the evidence from high- income 04_ENTinLAC_095-120.indd 103 11/21/13 5:34 PM

122 104 LATIN AMERICAN ENTREPRENEURS in practice relative to the uncertainty about countries (such as the United States) reported by Bernard and others (2007). New export - the sales gains from export success. ers contributed very little to export growth in Chile, Peru, and Costa Rica; they played a Exports of new products nonnegligible role in the Dominican Repub - Export entrepreneurship is present when lic and, to a lesser extent, in Brazil, Ecuador, incumbent exporters export new products; Guatemala, and Nicaragua in LAC as well as - in Bangladesh and Cambodia (the compara - it is similar to the innovation of introduc - tors for processing countries). Exiting export ing new products discussed in chapter 3. To - ers reduced total export growth in Costa Rica examine this dimension of innovative entre and Ecuador, as well as in the Arab Republic - preneurship, we focus on incumbent export ers in each country and consider products of Egypt (the comparator for broad manufac - defined at the six- digit level of the Harmo - turing export base countries). Across country 13 types, the contribution of new exporters was nized System (HS) of trade classification. more important in LAC countries experienc Figure 4.5 presents product entry rates for - incumbent exporters in each country during ing moderate export growth (Costa Rica, the 14 Incumbent export 2005– 07 and 2008– 09. Dominican Republic) than in LAC countries - ers displayed a tremendous degree of experi experiencing fast export growth (Chile, Peru) - between 2005 and 2007. mentation along the product dimension during the steady growth period: on average Average export growth rates were lower more than a third of the products exported by during the global recession of 2008– 09. incumbents in a given year were not exported They were negative for the most developed Brazil, Chile, Colombia, the previous year. Within LAC, the rates LAC countries— Costa Rica, Mexico, and Peru. Incum of new product introduction by incumbent - - bent exporters played a dominant role in exporters were somewhat higher in process ing countries, with the Dominican Repub explaining the export decline in those coun - - lic exhibiting the highest rate (42 percent). tries (except Costa Rica) and in increasing - Within the group of natural resource coun exports in Ecuador and Nicaragua. Exiting tries, incumbent exporters in LAC exhibited exporters contributed significantly to the export decline in Brazil and Costa Rica and product entry rates that were more than 20 percentage points lower than the rates for to reduced export growth in the Dominican Republic, Guatemala, and Nicaragua during incumbent exporters in South Africa. The global recession did the crisis. - reduce export entre not This evidence on LAC countries can be preneurship by incumbent exporters along the product dimension in the LAC region as a interpreted in the light of the literature’s focus on the fixed costs of exporting. High whole, actually increasing in a few countries entry rates are expected when either fixed (Costa Rica, the Dominican Republic, and costs are low or uncertainty is high. Because Guatemala). we know from other sources that entry costs To contrast with the patterns based on product entry rates, we present product exit can be high, the high exit rates offer another piece of the puzzle. Exit rates are likely to be rates for incumbent exporters in each coun - try (panels c and d of figure 4.5). During the high because weaker (possibly less produc - steady growth period, product exit rates were tive) firms enter when entry costs are low or - high in all LAC countries: on average 29 per when the probability of a large payoff is high. - cent of the products exported by incumbents What the evidence for the LAC region sug gests is that the sunk costs of entering export in a given year were dropped by the following which play such a crucial role in markets— year. Within LAC, product exit rates were similar across groups of countries. Among the models of heterogeneous firms and trade pioneered by Eaton and Kortum (2002) and natural resource countries, product exit Melitz (2003)— do not seem to be very large rates of incumbent exporters were more than 04_ENTinLAC_095-120.indd 104 11/21/13 5:34 PM

123 105 ExPoRT ENTREPRENEURShIP Product entry, exit, and first- year survival rates of incumbent exporters in selected countries, 2005– 07 and FIGURE 4.5 2008– 09 e. Survival averages, 2005–07 c. Exit averages, 2005–07 a. Entry averages, 2005–07 South Africa Chile South Africa Peru Peru Peru Costa Rica Costa Rica Ecuador Natural Chile Costa Rica Chile resources Ecuador South Africa Ecuador Dominican Republic Guatemala Cambodia El Salvador El Salvador Bangladesh Bangladesh Cambodia Nicaragua Nicaragua El Salvador Dominican Republic Nicaragua Bangladesh Dominican Republic Cambodia Guatemala Guatemala Simple processing Mexico Mexico Mexico Manufacturing LAC countries LAC countries LAC countries of LAC Average countries 0.5 0.4 0.6 0.2 0 0.1 0 0.3 0.2 0 0.1 0.2 0.3 0.4 Product entry rate Product exit rate Survival rate of new products b. Entry averages, 2008–09 d. Exit averages, 2008–09 f. Survival averages, 2008–09 Colombia South Africa South Africa Costa Rica Costa Rica Peru Ecuador Peru Peru Natural Ecuador Chile Chile resources Chile Ecuador Costa Rica Colombia South Africa Colombia Dominican Republic Cambodia Cambodia Guatemala Dominican Republic Bangladesh El Salvador Bangladesh Cambodia Bangladesh Nicaragua El Salvador Nicaragua Nicaragua El Salvador Guatemala Dominican Republic Guatemala Simple processing Mexico Mexico Mexico Manufacturing LAC countries LAC countries LAC countries of LAC Average countries 0 0.1 0.2 0.3 0 0.2 0.4 0.6 0.3 0.4 0.2 0.1 0 0.5 Product exit rate Product entry rate Survival rate of new products LAC countries Other countries Source: Fernandes, Lederman, and Gutierrez- Rocha 2013, based on data from the World Bank Exporter Dynamics Database. Note: Data for Ecuador in panels a, c, and e are for 2006– 07. Colombia is not included in panels a, c, and e because data were not available. Brazil is not included because of lack of exporter- level customs data. LAC = Latin America and the Caribbean. 04_ENTinLAC_095-120.indd 105 11/21/13 5:34 PM

124 106 LATIN AMERICAN ENTREPRENEURS 4.6 shows the average export value Figure 20 percentage points lower in LAC than in - - of new products relative to incumbent prod South Africa. The crisis increased the prod ucts for incumbent exporters. Exports of new uct exit rates of incumbent exporters sub - stantially only in the Dominican Republic; products were very small, ranging from less it caused a moderate increase in Costa Rica, than 2 percent of incumbent product exports Mexico, and Nicaragua. in Chile and Peru to 7.3 percent in Guatemala during the steady growth period. These differ The average survival rate during the - steady growth period indicates tremendous ences may be linked to the level of maturity attrition: more than 70 percent of the new and experience as an exporting country, which products incumbent exporters started to is much higher in Chile than in Guatemala. export in a given year were not exported the The value of new products relative to incum - following year. Incumbent exporters in LAC bent products increased in the crisis period in Chile, Costa Rica, El Salvador, Mexico, and natural resource countries exhibited substan - Peru. In these countries, incumbent exporters tially higher new product survival rates than incumbent exporters in comparator South started to export new products at a relatively larger scale during the global recession. Africa, however. Among processing coun - tries, Guatemala exhibited the highest new Figure 4.7 shows the average annual product survival rate. The global recession growth rate in total exports of incumbent exporters. It shows the average contribution reduced the survival rates of new products of incumbent exporters substantially in the of the three terms in the incumbent export - ers’ export growth decomposition (new, Dominican Republic and moderately in other LAC countries. incumbent, and exiting products). FIGURE 4.6 Size of new product exports relative to incumbent products in selected countries, 2005– 07 and 2008– 09 b. Averages, 2008–09 a. Averages, 2005–07 Ecuador Colombia Ecuador South Africa South Africa Costa Rica Natural Peru Costa Rica resources Natural resources Chile Peru Chile Bangladesh Cambodia Bangladesh Guatemala El Salvador Nicaragua Nicaragua El Salvador Guatemala Dominican Republic Cambodia Simple processing Dominican Republic Simple processing Mexico Mexico Manufacturing Manufacturing LAC countries LAC countries of LAC Average countries of LAC Average countries 0.15 0.2 0 0.05 0.1 0.04 0.08 0.06 0.1 0 0.02 Size of new product exports Size of new product exports relative to incumbent products relative to incumbent products LAC countries Other countries Rocha 2013, based on data from the World Bank Exporter Dynamics Database. Source: Fernandes, Lederman, and Gutierrez- 07. Colombia is not included in panel a because data were not available. Brazil is not included because Note: Data for Ecuador in panel a are for 2006– level customs data were not available. LAC = Latin America and the Caribbean. exporter- 04_ENTinLAC_095-120.indd 106 11/21/13 5:34 PM

125 107 ExPoRT ENTREPRENEURShIP Export growth of incumbent exporters in selected countries and its decomposition along FIGURE 4.7 the product dimension, 2005– 09 07 and 2008– a. Export growth, 2005–07 b. Export growth, 2008–09 Peru Ecuador Chile Costa Rica Ecuador Peru Natural South Africa Colombia resources Natural resources Costa Rica Chile South Africa Nicaragua Bangladesh Bangladesh Guatemala Cambodia Cambodia Nicaragua Dominican Republic Dominican Republic El Salvador Guatemala Simple processing El Salvador Simple processing Mexico Mexico Manufacturing Manufacturing LAC countries LAC countries of LAC Average countries of LAC Average countries 0.1 0 –0.1 0.2 –0.2 0.2 0.1 0.3 0 Export growth rate Export growth rate LAC countries Other countries c. Decomposition, 2005–07 d. Decomposition, 2008–09 Ecuador Peru Costa Rica Chile Peru Ecuador Natural South Africa Colombia resources Natural resources Costa Rica Chile South Africa Nicaragua Bangladesh Bangladesh Guatemala Cambodia Cambodia Nicaragua Dominican Republic Dominican Republic El Salvador Guatemala Simple processing El Salvador Simple processing Mexico Mexico Manufacturing Manufacturing LAC countries LAC countries of LAC Average countries of LAC Average countries –0.1 0 0.1 0.3 0.2 –0.1 0 0.1 0.3 0.2 –0.2 Export growth rate Export growth rate Exiting destinations New destinations Incumbent destinations Source: Fernandes, Lederman, and Gutierrez- Rocha 2013, based on data from the World Bank Exporter Dynamics Database. Note: Data for Ecuador in panel a are for 2006– 07. Colombia is not included in panels a and c because data were not available. LAC = Latin America and the Caribbean. 04_ENTinLAC_095-120.indd 107 11/21/13 5:34 PM

126 108 LATIN AMERICAN ENTREPRENEURS destination dimension during the steady - During the steady growth period, incum bent products contributed the largest share to growth period: on average a quarter of the the growth of incumbent exporters in every destinations served by incumbents in a given LAC country. New products represented a year were not served the previous year (fig - 15 Mexico exhibited the lowest des - - 4.8). ure significant share of export growth of incum bent exporters only in the Dominican Repub tination entry rate by incumbent exporters; - entry rates did not differ much across natural lic, El Salvador, Guatemala, and Nicaragua. resource and processing countries in LAC. One possible explanation for the importance However, among both natural resource and of new products in these countries is the entry into force of the Central America Free processing countries, incumbent exporters Trade Agreement (CAFTA) with the United in LAC exhibited much lower destination entry rates than incumbent exporters in the States, which granted incumbent exporters access to a very large market. In El Salvador, comparator countries. The global recession did not the reduction in exports because of products reduce export entrepreneurship by dropped by incumbent exporters more than incumbent exporters along the destination compensated for the increase in exports of - dimension in LAC; in the case of the Domini can Republic, it increased it substantially. new products. The importance of new prod - - ucts in explaining export growth of incum - During the steady growth period, 17 per cent of the destinations served by incumbents bent exporters was smaller in LAC than in its in LAC in a given year were dropped by the comparators in natural resource and process - following year. Because product exit rates ing countries. - During the global recession, exports from were lower than entry rates, there was posi incumbent firms declined in the most devel tive net entry into new destinations between - Chile, Colombia, oped LAC countries— 2005 and 2007. As was the case for entry Costa Rica, Mexico, and Peru— rates, Mexico exhibited the lowest destina - as well as in tion exit rate. Within natural resource and South Africa; exports of incumbents grew in the LAC processing countries (as well as their - processing countries, exit rates were simi comparators) and in Ecuador. Incumbent lar across LAC countries. However, among products explained most of the export decline both natural resource and processing coun - tries, incumbent exporters in LAC countries for incumbent exporters in Chile, Colombia, Mexico, and Peru and most of the export exhibited much lower destination exit rates than did incumbent exporters in comparator growth for incumbent exporters in Ecuador and Nicaragua. During the crisis, new prod countries. The crisis did not alter destination - exit rates by incumbent exporters in LAC, ucts became the major contributor to export growth of incumbent exporters in the Domin - except in the Dominican Republic, where ican Republic, El Salvador, and Guatemala, exit rates increased substantially. The average survival rate during the - and they accounted for a large share in Nica steady growth period indicated a high degree ragua and Ecuador. Participation in CAFTA - may have partially insulated the LAC process of attrition. More than 60 percent of the new destinations served by incumbent export - ing countries’ incumbent exporters from the ers in a given year were no longer served the crisis (despite the decline in U.S. demand) by next year. Within LAC, natural resource fostering entrepreneurship through the intro - duction of new products. This pattern of the countries exhibited slightly higher survival rates than other countries. Among natural - crisis fostering entrepreneurship was also evi resource countries, incumbent exporters in dent in Ecuador. LAC exhibited substantially higher survival rates than incumbent exporters in South Exports to new destinations Africa. Among processing countries, all LAC Incumbent exporters in LAC engaged in a countries exhibited lower survival rates than high degree of experimentation along the Bangladesh but higher survival rates than 04_ENTinLAC_095-120.indd 108 11/21/13 5:34 PM

127 109 ExPoRT ENTREPRENEURShIP Destination entry, exit, and first- year survival rates of incumbent exporters in selected countries, 2005– 07 FIGURE 4.8 09 and 2008– a. Entry averages, 2005–07 e. Survival averages, 2005–07 c. Exit averages, 2005–07 South Africa South Africa Chile Chile Costa Rica Chile Peru Peru Peru Natural Ecuador Ecuador Costa Rica resources Costa Rica South Africa Ecuador Bangladesh Cambodia Cambodia Bangladesh Bangladesh Guatemala El Salvador Dominican Republic Dominican Republic El Salvador Nicaragua Nicaragua Dominican Republic Nicaragua El Salvador Guatemala Cambodia Guatemala Simple processing Egypt, Arab Rep. Mexico Egypt, Arab Rep. Mexico Mexico Egypt, Arab Rep. Manufacturing LAC countries LAC countries LAC countries of LAC Average countries 0.3 0.2 0.1 0 0.4 0.4 0.1 0 0.2 0.1 0 0.2 0.3 0.3 Destination entry rate Survival rate of new Destination exit rate destinations d. Exit averages, 2008–09 b. Entry averages, 2008–09 f. Survival averages, 2008–09 South Africa South Africa Colombia Costa Rica Chile Costa Rica Ecuador Chile Chile Natural Peru Ecuador Costa Rica resources Peru Peru Ecuador Colombia South Africa Colombia Cambodia Dominican Republic Bangladesh Bangladesh Cambodia Cambodia Dominican Republic Guatemala Bangladesh Guatemala El Salvador El Salvador El Salvador Nicaragua Nicaragua Dominican Republic Nicaragua Guatemala Simple processing Egypt, Arab Rep. Mexico Egypt, Arab Rep. Mexico Mexico Egypt, Arab Rep. Manufacturing LAC countries LAC countries LAC countries of LAC Average countries 0.2 0.1 0.3 0.4 0 0.2 0.1 0.3 0.4 0 0.2 0.1 0.3 0 Destination entry rate Destination exit rate Survival rate of new destinations LAC countries Other countries Fernandes, Lederman, and Gutierrez- Rocha 2013, based on data from the World Bank Exporter Dynamics Database. Source: Note: level customs 07. Colombia is not included in panels a, c, and e because data were not available. Brazil is not included because exporter- Data for Ecuador in panel a are for 2006– data were not available. LAC = Latin America and the Caribbean. 04_ENTinLAC_095-120.indd 109 11/21/13 5:34 PM

128 110 LATIN AMERICAN ENTREPRENEURS - export growth decomposition (new, incum Cambodia. The global recession was associ - ated with a slight reduction in first- bent, and exiting destinations). During the - year sur vival rates of new destinations of incumbent steady growth period, incumbent destina - exporters across LAC. tions accounted for the largest share of the Exports to new destinations were gener growth of incumbent exporters in every LAC - - country. New destinations contributed a sig ally small, ranging from less than 5 percent of exports to incumbent destinations in Chile nificant share to export growth of incumbent to 12 percent in Ecuador (figure 4.9). As in - exporters in the Dominican Republic, Ecua dor, El Salvador, Guatemala, and Nicaragua. the case of exports of new products, we can only speculate that the differences between New destinations contributed minimally to annual export growth in the LAC countries Chile and Ecuador reflect Chile’s longer time whose incumbent exporters experienced the under an open trade regime, which may have - fastest growth (Chile and Peru). In Costa fostered outward- oriented firms with lon ger exporting experience. During the crisis, Rica, El Salvador, and Peru the reduction the value of exports to new destinations by in exports due to destinations dropped by incumbent exporters almost compensated incumbent exporters to exports to incumbent destinations increased in LAC as a whole and for the increase in exports due to their new in most individual countries. destinations. Among incumbent exporters in LAC, new destinations were less important Figure 4.10 shows the average contribution of the three terms in the incumbent exporters determinants of export growth in processing FIGURE 4.9 Exports to new destinations as a share of total exports by incumbent exporters in selected countries, 2005– 07 and 2008– 09 a. Averages, 2005–07 b. Averages, 2008–09 Ecuador Ecuador Peru Peru South Africa South Africa Natural Colombia Costa Rica resources Natural resources Chile Costa Rica Chile Bangladesh Nicaragua Guatemala Guatemala Bangladesh El Salvador Nicaragua Dominican Republic El Salvador Cambodia Dominican Republic Simple processing Cambodia Simple processing Egypt, Arab Rep. Egypt, Arab Rep. Mexico Mexico Manufacturing Manufacturing LAC countries LAC countries of LAC Average countries of LAC Average countries 0.10 0 0.05 0.15 0.2 0.3 0 0.1 Size of exports to new destinations Size of exports to new destinations relative to incumbent destinations relative to incumbent destinations LAC countries Other countries Fernandes, Lederman, and Gutierrez- Source: Rocha 2013, based on data from the World Bank Exporter Dynamics Database. 07. Colombia is not included in panel a because data were not available. Brazil is not included because Data for Ecuador in panel a are for 2006– Note: level customs data were not available. LAC = Latin America and the Caribbean. exporter- 04_ENTinLAC_095-120.indd 110 11/21/13 5:34 PM

129 111 ENTREPRENEURShIP ExPoRT Export growth of incumbent exporters in selected countries and its decomposition along FIGURE 4.10 07 and 2008– 09 the destination dimension, 2005– b. Export growth, 2008–09 a. Export growth, 2005–07 Ecuador Peru Chile Costa Rica Peru Ecuador Natural South Africa Colombia resources Natural resources Chile Costa Rica South Africa Nicaragua Bangladesh Bangladesh Guatemala Cambodia Cambodia Nicaragua Dominican Republic Dominican Republic El Salvador Guatemala Simple processing El Salvador Simple processing Egypt, Arab Rep. Egypt, Arab Rep. Mexico Mexico Manufacturing Manufacturing LAC countries LAC countries of LAC Average countries of LAC Average countries 0.1 0.1 0.2 0 0.3 0 0.2 –0.1 –0.2 Export growth rate Export growth rate LAC countries Other countries c. Decomposition, 2005–07 d. Decomposition, 2008–09 Ecuador Peru Chile Costa Rica Peru Ecuador Natural Colombia South Africa resources Natural resources Costa Rica Chile South Africa Nicaragua Bangladesh Bangladesh Guatemala Cambodia Cambodia Nicaragua Dominican Republic Dominican Republic El Salvador Guatemala Simple processing El Salvador Simple processing Egypt, Arab Rep. Egypt, Arab Rep. Mexico Mexico Manufacturing Manufacturing LAC countries LAC countries of LAC Average countries of LAC Average countries 0.2 0.4 0.3 0.1 0 –0.1 0.1 03 0 0.2 –0.2 –0.1 Export growth rate Export growth rate Exiting destinations New destinations Incumbent destinations Source: Fernandes, Lederman, and Gutierrez- Rocha 2013, based on data from the World Bank Exporter Dynamics Database. Note: Data for Ecuador in panel a are for 2006– 07. Colombia is not included in panels a, c, and d because data were not available. LAC = Latin America and the Caribbean. 04_ENTinLAC_095-120.indd 111 11/21/13 5:34 PM

130 112 LATIN AMERICAN ENTREPRENEURS countries than in comparator Bangladesh, Export entrepreneurship and they were less important to countries across industries with broad manufacturing export bases than Figure 4.11 presents annual export entry rates in comparator Egypt. for 15 industries. Minerals and base metals During the global recession, exports of appear in the middle of the pack. However, incumbent exporters declined in the most they are outperformed by some eye- catching developed LAC countries but increased in the manufacturing industries (such as transport - processing countries and Ecuador. Incum - vehicles) that have been central for the indus bent destinations accounted for most of the trial resurgence of certain countries, such as export decline of incumbent exporters in Mexico. Industries related to agriculture— - Chile, Colombia, and Mexico. New desti vegetable products and oils; food, beverages, nations played a dominant role in boosting tend to have and tobacco; and live animals— the exports of incumbent exporters in the - Dominican Republic, El Salvador, Guate FIGURE 4.11 Conditional benchmarking of mala, and Nicaragua, and they played as 09 export entry rates by sector, 2005– important a role as incumbent destinations in increasing exports of incumbent exporters in Ecuador. For the LAC processing countries Food, beverages, and tobacco and Ecuador, the crisis was associated with an increase in export entrepreneurship by Live animals incumbent exporters through the exploration Vegetable products and oils of new export destinations. Chemicals Econometric benchmarking Paper of export entrepreneurship Minerals The descriptive benchmarking suggests that Plastics both new and incumbent exporters in LAC Textiles engaged in export entrepreneurship during (including leather) the crisis years. It is difficult to derive firm Base metals conclusions about LAC’s relative standing from descriptive statistics, however, because Others year, country, and industry characteristics Wood and articles thereof may jointly affect entrepreneurial outcomes. Cement, ceramics, For example, the finding that Chile and Peru and glass had both the highest export growth rates and Transportation vehicles the smallest number of new exporters dur - Electrical machinery ing 2005– 09 does not necessarily mean that both solely reflect these economies’ charac - Mechanical machinery teristics (such as relatively open and mining- 0.05 –0.05 –0.15 –0.10 0.10 0 dependent economies). Entry rates by sector This section presents the results of a sec - relative to benchmark ond set of benchmarking exercises that rely Natural resource Industry on an econometric decomposition of the sources of international differences in export Estimations based on data from the World Bank Exporter Dynam - Source: ics Database. - entrepreneurship indicators. This method Figure shows estimates of each sector’s dummy variable coefficient Note: ology entails the estimation of industry, from an econometric model that also includes country and year dummies. digit level of the Harmonized System. Industries are defined at the two- - country, and year effects on the export entre The excluded benchmark industry is apparel and footwear. The vertical preneurship indicators observed at the firm - firm entry in each sec axis measures the probability of observing export- tor relative to apparel and footwear in percentage points. level (full results are available upon request). 04_ENTinLAC_095-120.indd 112 11/21/13 5:34 PM

131 ENTREPRENEURShIP 113 ExPoRT relatively lower entry rates. The data thus do Export entrepreneurship not support the notion that entrepreneurship across countries is relatively weak in mining; to some extent, - We now turn to the conditional benchmark they support the notion in agriculture. ing of LAC countries. Figures 4.13 and 4.14 Figure 4.12 shows the industries’ relative - present the results for two export entrepre standing in terms of average survival rates neurship indicators, entry and survival rates. one year after entry into exporting. The cor - (Results for exit rates and size of exports at relation with the rankings for entry rates is entry are available upon request.) 0.977: industries with lower entry rates tend – to have higher export survival rates. Mining does not stand out, but agriculture exhibits higher survival rates. FIGURE 4.13 Conditional benchmarking of export entry rates in selected countries, 2005– 09 Conditional benchmarking of one- FIGURE 4.12 Chile 09 year export survival rates by sector, 2005– El Salvador Costa Rica Colombia Food, beverages, Bulgaria and tobacco Mexico Live animals Guatemala Vegetable products Macedonia, FYR and oils Peru Chemicals Ecuador Jordan Paper Morocco Mauritius Minerals South Africa Plastics Senegal Mali Textiles (including leather) Dominican Republic Nicaragua Base metals Bangladesh Others Kenya Burkina Faso Wood and articles thereof Tanzania Cement, ceramics, Pakistan and glass Cameroon Transportation Niger vehicles Cambodia Electrical machinery Malawi Mechanical Iran, Islamic Rep. machinery Uganda 0.08 0 0.02 0.04 0.06 –0.06 –0.04 –0.02 –15 15 –20 0 –5 –10 20 10 5 Average 1-year survival probabilities Marginal eect by sector relative to benchmark Natural resource Industry LAC countries Other countries - Estimations based on data from the World Bank Exporter Dynam Source: Estimations based on data from the World Bank Exporter Dynam Source: - ics Database. ics Database. Figure shows estimates of each sector’s dummy variable coefficient Note: Figure shows estimates of each country’s dummy variable coef- Note: from an econometric model that also includes country and year dummies. ficient from an econometric model that also includes industry and year Industries are defined at the two- digit level of the Harmonized System. digit level of the Harmonized dummies. Industries are defined at the two- The excluded benchmark industry is apparel and footwear. The vertical System. The excluded benchmark country is Albania. The vertical axis firm survival in each sector relative axis measures the probability of export- firm survival in each country relative measures the probability of export- to apparel and footwear in percentage points. to Albania in percentage points. LAC = Latin America and the Caribbean. 04_ENTinLAC_095-120.indd 113 11/21/13 5:34 PM

132 114 LATIN AMERICAN ENTREPRENEURS FIGURE 4.14 Conditional benchmarking of one- Islamic Republic of Iran and Uganda) are on year export survival rate in selected countries, the right. As the descriptive benchmarking 09 2005– suggested, entry rates may be higher in more difficult business environments. Like the sub - sistence entrepreneurs discussed in chapter 1, Chile El Salvador - entrepreneurs operating in difficult environ Costa Rica ments may be more likely to take risks and Colombia to enter export markets precisely because Bulgaria domestic profits may be relatively low. Mexico The negative correlation between entry Guatemala rates and survival probabilities (– 0.847) is Macedonia, FYR less strong than the correlation for the indus - Peru try benchmarking (compare figures 4.13 Ecuador and 4.14). In addition, relatively successful Jordan Morocco LAC exporters during 2005– 09 tend to have Mauritius relatively low (conditional) entry rates and South Africa relatively high (conditional) survival rates. Senegal Nicaragua appears to be an outlier in this Mali context: it had the highest conditional entry Dominican Republic rate in the sample of LAC countries and a Nicaragua high survival rate for new exporters. Bangladesh The higher survival probabilities of the Kenya LAC countries in this sample are explained Burkina Faso Tanzania - by their higher levels of development. Fig Pakistan specific export ure 4.15 presents the country- Cameroon entry and survival rates after controlling for Niger the level of development of each country and Cambodia comparative advantage. The evidence is clear: Malawi after taking into account the level of develop - Iran, Islamic Rep. ment, LAC countries underperform in terms Uganda - of export entry rates and are not overachiev 12 –4 8 6 4 2 –8 10 0 –2 –6 ers in terms of survival rates. (Comparative Marginal eect advantage did not affect the ranking of coun - LAC countries Other countries tries, however.) In fact, after controlling for GDP per capita, only the Islamic Republic of Estimations based on data from the World Bank Exporter Dynam Source: - ics Database. Iran has lower conditional survival rates than Figure shows estimates of each country’s dummy variable coef- Note: the LAC countries in the sample. ficient from an econometric model that also includes industry and year dummies. Industries are defined at the two- digit level of the Harmonized The benchmarking exercises reveal impor - System. The excluded benchmark country is Albania. The vertical axis - tant findings about the nature of export entre firm survival in each country relative to measures the probability of export- Albania in percentage points. LAC = Latin America and the Caribbean. preneurship. Economies that enjoyed relative high export growth rates also tended to have relatively low export entry rates, with entrants Most LAC economies appear on the left coming in at smaller sizes (compared with side (in red) of the rankings of entry rates in incumbent exporters), but their survival rates figure 4.13 (indicating poor performance). tended to be higher. Survival thus appears to Some of the best- performing countries in be the dominant variable underpinning export terms of export growth (including Chile, growth; it may also reflect adequate business Costa Rica, Colombia, and Guatemala) are - environments. However, as emphasized ear on the left, whereas economies with relatively - lier, when the going gets tough, as it did dur harsh business environments (such as the ing the global crisis of 2008– 09, incumbent 04_ENTinLAC_095-120.indd 114 11/21/13 5:34 PM

133 ENTREPRENEURShIP 115 ExPoRT Conditional benchmarking of FIGURE 4.15 The role of comparative advantage year survival rate in selected export entry and one- To assess the role of comparative advantage, countries after controlling for GDP per capita and Ana M. Fernandes and Daniel Lederman comparative advantage, 2005– 09 (World Bank) estimated the models of export entrepreneurship used for the conditional Chile benchmarking by adding an indicator of El Salvador - revealed comparative advantage (RCA) pro Costa Rica Colombia posed by Vollrath (1991) as well as the level Bulgaria of development. This indicator takes into Mexico account the structure of a country’s trade on Guatemala both the export and import sides and data Macedonia, FYR - digit level. In addition to coun at the HS six- Peru Ecuador try fixed effects, broad industry fixed effects Jordan digit level aggregation), (defined at the two- Morocco and year effects, the regressions include the Mauritius Vollrath index of RCA. The results for this South Africa variable are shown in figure 4.16. Dominican Republic Mali Consistent with the previous findings on Senegal the quality of the business environment and Nicaragua global economic conditions, the RCA has a Bangladesh negative partial correlation with a country’s Kenya Burkina Faso Tanzania Partial effects of 1 percent increase in FIGURE 4.16 Pakistan index of revealed comparative advantage on export Cameroon entrepreneurship indicators in seven countries in Iran, Islamic Rep. 09 Latin America and the Caribbean, 2005– Cambodia Malawi Niger 5 3.4 Uganda 2.8 –0.2 0.4 –0.3 –0.1 0 0.1 0.2 0.3 0 Log of GDP per capita Average entry rate Average 1-yr survival rate of new entrants –5 –6.0 Source: - Estimations based on data from the World Bank Exporter Dynam –10 ics Database. Note: Figure shows estimates of each country’s dummy variable coefficient Percentage point increase from an econometric model that also includes (the log of ) gross domestic product (GDP) per capita (adjusted for purchasing power parity), the –14.0 –15 Vollrath (1991) index of revealed comparative advantage at the six- digit Average Average Average Average level of the Harmonized System classification, industry dummies, and size of 1-yr survival exit rate entry year dummies. Industry dummies are defined at the two- digit level. The new rate of new rate excluded benchmark country is Albania. The vertical axis measures the firm survival in each country relative to Albania in probability of export- entrants entrants percentage points. yr = year. Source: Estimations based on data from the World Bank Exporter Dynam - ics Database. exporters become more entrepreneurial by Figure shows the estimated coefficients on Vollrath’s (1991) index of Note: revealed comparative advantage (RCA). The other variables included in the seeking new products and, to a lesser extent, econometric estimations are (the log of ) gross domestic product (GDP) per - new export destinations. In addition, analyz capita (adjusted for purchasing power parity) and sector, country, and year digit level of the Harmonized dummies. Industries were defined at the two- ing the role of comparative advantage as a System; the RCA indexes were computed at the six- digit level. Differences in determinant of export entrepreneurship out - the magnitudes of the effects across the four indicators of export entrepre - neurship reflect differences in the units of measurement: the average size of comes might shed further light on the whether new entrants is measured as the ratio of average exports of new entrants over necessity is the mother of innovation. average exports of the average incumbent exporter in the sector. yr = year. 04_ENTinLAC_095-120.indd 115 11/21/13 5:34 PM

134 LATIN AMERICAN ENTREPRENEURS 116 average export entry rate— that export promotion does little to explain that is, when export growth by increasing firm entry into countries offer favorable conditions, such as export activities. Bernard and Jensen (2004) driven factors, endowments or other policy- find that export promotion across states for a given product, entry falls, exit and the has no statistically significant impact on the probability of survival rise, and the average probability of exporting in a sample of U.S. size of new entrants relative to incumbents falls (by 14 percentage points of the average manufacturing firms. Görg, Henry, and value of exports of incumbent firms). Over - Strobl (2008) find that export promotion all, the data speak loud and clear: the key grants offered to Irish manufacturing firms had no impact on the probability of export - for success in export markets is entry com - ing but did affect the level of exports. Our bined with survival, which tends to increase results, based on different data, contradict when conditions are favorable. LAC appears these findings. to underperform poorer economies in terms - There is also a growing body of litera of entry, and it does not overachieve in terms ture on export promotion and its impact on of survival (after controlling for its level of exporting firms’ intensive and extensive mar - development). The question about the impact gins (where the extensive margin is defined of export promotion policies and how they either as the introduction of new products or affect the various dimensions of export entre - preneurship remains. entry into new export destinations). Based on a sample of Peruvian firms, Volpe and - Carballo (2008) conclude that export pro Export promotion policies motion affects exports mainly along the extensive margin, in terms of both markets Through what mechanisms do export promo - and products; it has little impact on intensive tion services affect export growth? Do such margins. Using product- mechanisms promote firm entry and survival level data, Volpe, in exporting activities? Do they help incum Carballo, and Gallo (2011) confirm this - bents by increasing the share of exports in finding in a sample of LAC countries for the total sales? Or do they operate through both period 1995– 2004. The finding of Volpe and Carballo (2008) channels? The answers to these questions can shed and Volpe, Carballo, and Gallo (2011) that - light on the social desirability of export pro export promotion works mainly through the extensive margins of products and markets - motion programs. Indeed, the economic jus does not necessarily contradict the findings of tification for export promotion is often based Bernard and Jensen (2004) and Görg, Henry, on the existence of asymmetric information and Strobl (2008) that export promotion has and other externalities associated with the collection of information on market condi no impact on the probability of a firm export - - tions and business opportunities in inter - ing. Volpe and Carballo (2008) used a sample national markets (Hausmann and Rodrik of exporting firms, and the results reported 2003). Private firms have no incentives to by Volpe, Carballo, and Gallo (2011) are not share this information with potential compet level data. Thus, they cannot based on firm- - itors after incurring the costs of discovering address the question of whether export pro - how to export profitably. This market failure motion raises the probability of firms becom - justifies government intervention. Given the ing exporters. nature of the market failure, such interven None of these studies distinguishes the - tions should affect firms’ extensive margins impact of export promotion on entry into export markets from its impact on survival in (that is, the decision to enter and survive in - export markets), not their intensive margins exporting activities. The distinction is impor (that is, the decision on how much to export). tant given the large number of firms that enter and exit export activities after one year, The literature on export promotion and firm entry is thin, but the evidence suggests as discussed earlier. 04_ENTinLAC_095-120.indd 116 11/21/13 5:34 PM

135 ENTREPRENEURShIP 117 ExPoRT propensity matching to control for the fact To identify the impact of export promo - that export promotion services are not ran tion activities on firm entry, exit, survival, - domly allocated across firms. Overall, the and export intensity, Lederman, Olarreaga, results suggest that entry and survival mar and Zavala (2013) used firm surveys from - gins are the main channels through which seven Latin American countries from 2006 export promotion agencies affect export and 2010. They estimated a multinomial logit growth and that they tend to be unsuccessful model to explain the probability of observing - at increasing export intensity, thus highlight four potential paths of the status of a firm: - ing the role of fixed costs of entry in export - from nonexporting to exporting (entry), con - ing activities. tinuity in exporting (survival), from export ing to nonexporting (exit), and continuity of nonexport status. The variable of interest is Concluding remarks whether the firm used the services of an EPA There is good news on the policy front. If between 2006 and 2010. The authors also the costs of entry into export markets reflect explored the treatment effect of EPA services the need to gather information about the on the change in the share of exports over characteristics of foreign markets, export total sales (export intensity) within firms, which provide estimates of the effect of EPAs promotion policies that focus on providing such information could both increase entry on the intensive margin of exports. - and enhance the chances of survival of entre The results, some of which appear in preneurs in global markets. Preliminary evi table 4.3, suggest that having used export - services significantly increases the probabil dence suggests that LAC export promotion - ity of entry and survival (with respect to the policies are having exactly these effects, but probability of exiting export markets). It also the region’s superstars still appear to have decreases the probability of remaining a non - relatively low entry rates into exporting, exporter. In contrast, firms that use export possibly revealing an innovation gap, with unimpressive survival rates to boot. Chap services do not seem to increase their export - intensity. These results appear in the (uncon - ter 5 continues the exploration of high- end entrepreneurs by examining the performance ditional) descriptive data and in the estimate of conditional EPA treatment effects; they are - of superstar firms that penetrate foreign mar robust to the use of three different types of kets by exporting capital. Treatment effects of export promotion agencies in seven countries in Latin America and TABLE 4.3 the Caribbean Size of control Outcome Average treatment Size of Bootstrapped effect on outcome variable standard errors t - statistic treatment group group Exit 1,13 4 0.000 0.018 – 0.01 401 Nonexporter 1,13 4 – 0.403 0.034 – 11.96*** 401 401 1,13 4 0.344 0.038 9.10*** Survival Entry 401 1,13 4 0.059 0.023 2.58*** D exp_int 1,133 0.014 0 . 012 1.15 401 exp_int D 261 0.035 0.018 1.92 265 Source: Lederman, Olarreaga, and Zavala 2013, based on data from World Bank Enterprise Surveys. Note: The propensity score was estimated using a logit on Size, FDI, Web, and Email. Size is the log of the firm’s full- time employment, FDI is foreign owner - ship of the firm as a share of total ownership, Web is a dummy for whether the firm has a website, and Email is a dummy for whether the firm communicates with clients via email. Exit is a dummy indicating that the firm exported in 2006 but not in 2010, Nonexporter is a dummy indicating that the firm did not export in either 2006 or 2010, Survival is a dummy indicating that the firm exported in both 2006 and 2010, Entry is a dummy indicating that the firm exported in 2010 but not in 2006, and D exp_int is the change in the firm’s total exports as a fraction of total sales between 2006 and 2010. Separation of firms into treatment and control groups was done using three different matching methods: kernel, stratification (with four blocks), and nearest neighbor. This table reports on the latter. The average treatment effect is reported as the difference in means between treatment and control groups. The last row in the table corresponds to estimations with the subsample of firms that were exporters in 2006. Bootstrapped standard errors were estimated with 50 repeti - tions. *** p < 0.01. 04_ENTinLAC_095-120.indd 117 11/21/13 5:34 PM

136 118 LATIN AMERICAN ENTREPRENEURS in developing countries. A growing body of Notes literature uses tariff (not firm) data showing 1. This chapter draws heavily on the work of that the intensive margin (that is, exporting Daniel Lederman and his coauthors, including more of the same product) explains most Ana M. Fernandes (Development Research export growth (see Felbemayr and Kohler Group, World Bank) and Marcelo Olarreaga 2006; Helpman, Melitz, and Rubinstein (University of Geneva). 2008; and Amiti and Freund 2010). The term was coined by export superstars 2. In a study commissioned for this report, Fer 8. - Freund and Pierola (2012). nandes, Lederman, and Gutierrez-Rocha 3. level data used in Lederman (2010) The firm- (2013) show that in Peru, the probability come from numerous World Bank’s Business of entry is more or less the same across the - Environment and Enterprise Performance Sur months of the year. This lack of systematic sea- veys (BEEPS) and Investment Climate Surveys sonality in export entry implies that the first- (ICS), conducted in various countries between year exports of the new entrant cohort should 2000 and 2006. The coverage of these data in probably be multiplied by 2. The reported terms of the sampling of firms is different. The 06 growth rates of the entry cohort for 2005– BEEPS use quota sampling, in which 10 per - can therefore be adjusted by subtracting 30.1 49 employ- cent of selected firms are small (2– percent (the natural logarithm of 2) from the ees), another 10 percent are large (250– 999 observed rates. employees), and the rest are randomly selected 9. This section draws heavily on the study by between these two extremes. The ICS sam- Fernandes, Lederman, and Gutierrez- Rocha pling differs across countries. In some cases, (2013), which was commissioned for this quotas by sector and size are used. In others, report. existing industrial census shares by industries The comparators selected are based on the 10. and size are used as benchmark sampling quo- availability of data on export entrepreneur - tas. Thus, there may be some selectivity of the ship in the Exporter Dynamics Database. sampled firms, which may raise doubts about 11. Most LAC countries are net exporters of the randomness of the sample. energy, mining, or agriculture. Costa Rica is a 4. The Exporter Dynamics data cover all export- net exporter of various agricultural commodi- ing firms in each country— that is, the data- - ties. It is also a major exporter of Intel super base provides a census of exporters but not conductors. The data used here exclude Intel a census of all firms operating in each coun- exports, following the literature (for example, try, because it records only export trans- Lederman, Rodriguez- Clare, and Xu 2011), actions, not domestic sales. The database partly because the story of Intel is well known. is available at http://econ.worldbank.org/ Furthermore, although Brazil and Mexico are exporter- dynamics- database. also net exporters of commodities, they have 5. For this analysis, we keep in the sample only much more diversified export structures (as the LAC countries with data for all years from measured by standard indicators, such as the 2004 to 2009 so that we can define the cohort Herfindahl index of export revenue concen- of 2005 exporter entrants and follow it until tration) as well as large shares of manufac- the end of the sample period in 2009. tured exports in total merchandise exports. The shares of total exports in figures 4.2 and 6. Although Mexico could be classified as a sim- 12. 4.3 need not add up to 100 percent, because ple processing country because of the impor - the figures omit the contribution of exporters tance of the maquila sector for its economy, that began exporting between 2006 and 2009. we classify it as a country with a broad manu- 7. An important body of literature shows that facturing base. the survival of new export “relationships” is 13. Brazil, New Zealand, and Spain were not an important determinant of export growth, included in the analysis in this section because at least in developing countries. This literature level cus- we did not have the raw exporter- focuses on products at the tariff- line level. toms data for those countries necessary to Evenett and Venables (2002) and Besedes and compute the measures used here. Egypt was Prusa (2011) show that growth in the value of not used because its exporter- level customs new export products or new export markets data are provided at the four- digit (not the accounts for a large share of export growth six- digit) level. 04_ENTinLAC_095-120.indd 118 11/21/13 5:34 PM

137 ENTREPRENEURShIP ExPoRT 119 Research Working Paper 6007, World Bank, The average number of HS six- digit products 14. Washington, DC . exported per incumbent exporter in LAC Cebeci, T., A. Fernandes, C. Freund, and M. countries ranged from 5.8 in Ecuador to 8.9 - Pierola. 2012. “Exporter Dynamics Data in Peru. base.” Policy Research Working Paper 6229, Brazil, New Zealand, and Spain were not 15. World Bank, Washington, DC. included in the analysis in this section, because Das, S., M. J. Roberts, and J. R. Tybout. 2007. level customs data necessary the raw exporter- “Market Entry Costs, Producer Heterogeneity, to compute the measures were not available. 75 (3): Econometrica and Export Dynamics.” The average number of destinations served 837– 73. per incumbent exporter in LAC countries Eaton, J., M. Eslava, M. Kugler, and J. Tybout. ranged from 2.6 in Mexico and Nicaragua to 2007. “Export Dynamics in Colombia: Firm- 4.7 in Chile. Level Evidence.” NBER Working Paper 13531, National Bureau of Economic Research, Cam - References bridge, MA. Eaton, J., and S. Kortum. 2002. “Technology, - Alcala, F., and A. Ciccone. 2004. “Trade and Pro 70 (5): Econometrica Geography and Trade.” Quarterly Journal of Economics ductivity.” 1741– 79. 45. 119 (2): 612 – Eaton, J., S. Kortum, and F. Kramarz. 2011. “An Amiti, M., and C. Freund. 2010. “Anatomy of Anatomy of International Trade: Evidence from - China’s Grow China’s Export Growth.” In 98. 79 (5): 1453– Econometrica French Firms.” ing Role in World Trade, edited by R. Feenstra Enterprise Surveys (database). World Bank Group, 36. Cambridge, MA: National and S. Wei, 35– Washington, DC. http://www.enterprise Bureau of Economic Research. http://www su r veys.org /. .nber.org /chapters/c10451. Evenett, S., and A. Venables. 2002. “Export Arkolakis, C., A. Costinot, and A. Rodriguez- Growth in Developing Countries: Market Clare. 2012. “New Trade Models, Same Old Entry and Bilateral Trade Flows.” University of Gains?” 102 (1): American Economic Review Bern Working Paper, Bern, Switzerland. 130. 94– Exporter Dynamics Database. World Bank, Baldwin, R. E., and F. Robert- Nicoud. 2008. Washington, DC. http://econ.worldbank.org “Trade and Growth with Heterogeneous /exporter- dynamics- database. Fi rms.” Journal of International Economics Felbermayr, G., and W. Kohler. 2006. “Exploring 34. 74 (1): 21– the Intensive and Extensive Margins of World Bernard, A. B., and J. B. Jensen. 2004. “Why Trade.” 142: Review of World Economics Review of Economics Some Firms Export.” 642–74. 69. 86 (2): 561– and Statistics Fernandes, A. M., D. Lederman, and M. Gutierrez- Bernard, A. B., J. B. Jensen, S. J. Redding, and Rocha. 2013. “Export Entrepreneurship and P. K. Schott. 2007. “Firms in International Trade Structure in Latin America during Good Journal of Economic Perspectives 21 Trade.” and Bad Times.” Policy Research Working (3): 105– 30. Paper 6413, World Bank, Washington, DC. Besedes, T., and T. J. Prusa. 2011. “The Role of Feyrer, J. 2009. “Trade and Income: Exploiting Extensive and Intensive Margins and Export Time Series in Geography.” NBER Working Grow t h.” Journal of Development Economics Paper 14910, National Bureau of Economic 96 (2): 371– 79. Research, Cambridge, M.A. Brambilla, I., R. Dix-Carneiro, D. Lederman, Frankel, J., and D. Romer. 1999. “Does Trade and G. Porto. 2012. “Exports, Skills and the Cause Growth?” American Economic Review - Wages of Seven Million Latin American Work 99. 89 (3): 379– 26 (1): World Bank Economic Review ers.” Freund, C., and M. Pierola. 2010. “Export 60. 34– Entrepreneurs: Evidence from Peru.” Policy Brambilla, I., D. Lederman, and G. Porto. Research Working Paper 5407, World Bank, 2012. “Exports, Export Destinations and Washington, DC . Skills.” 102 (7): American Economic Review ———. 2012. “Export Superstars.” Policy 3406– 38. Research Working Paper 6222, World Bank, Brückner, M., and D. Lederman. 2012. “Trade Washington, DC . Causes Growth in Sub- Saharan Africa.” Policy 04_ENTinLAC_095-120.indd 119 11/21/13 5:34 PM

138 120 LATIN AMERICAN ENTREPRENEURS Accounting of Costa Rica’s Export Growth Görg, H., M. Henry, and E. Strobl. 2008. “Grant World Bank Economic 2007.” during 1997– Review of Support and Exporting Activity.” 25 (3): 543– Review 61. 90 (1): 168– 74. Economics and Statistics Melitz, M. J. 2003. “The Impact of Trade on Hausmann, R., and D. Rodrik. 2003. “Develop - Intra- Industry Reallocations and Aggregate ment as Self- Discovery.” Journal of Develop - Industry Productivity.” Econometrica 71 (6): ment Economics 72: 603– 33. 1695 – 1725. Helpman, E., M. Melitz, and Y. Rubinstein. Rodríguez, F., and D. Rodrik. 2001. “Trade Policy 2008. “Estimating Trade Flows: Trading Part - and Economic Growth: A Skeptic’s Guide to Quarterly Journal ners and Trading Volumes.” the Cross- - National Evidence.” In NBER Mac 87. of Economics 1 2 3 : 4 41 – vol. 15, edited by roeconomics Annual, 2000, Lederman, D. 2010. “An International Multilevel B. Bernanke and K. Rogoff. Cambridge, MA: Journal of Analysis of Product Innovation.” MIT Press. International Business Studies 41 (4): 606– 19. Sachs, J., and A. Warner. 1995. “Economic . 2013. “International Trade and Inclu - — — — - Reforms and the Process of Global Integra sive Growth: A Primer.” Indian Growth and tion.” Brookings Papers on Economic Activity 6 (1): 88– Development Review 112. 1: 1– 118. Lederman, D., and W. Maloney, eds. 2007. - Nat Vollrath, T. 1991. “A Theoretical Evaluation ural Resources, Neither Curse nor Destiny. of Alternative Trade Intensity Measures of Latin American Development Forum Series. Revealed Comparative Advantage.” Review of Stanford, CA: Stanford University Press for the 2: 265– World Economics 80. World Bank. Volpe, C., and J. Carballo. 2008. “Is Export Pro - Does What Lederman, D., and W. Maloney. 2012. motion Effective in Developing Countries? You Export Matter? In Search of Empirical Firm- Level Evidence on the Intensive and the - Latin Ameri Guidance for Industrial Policies. Extensive Margins of Exports.” Journal of can Development Forum Series. Washington, International Economics 106. 76 (1): 89– DC: World Bank. Volpe, C., J. Carballo, and A. Gallo. 2011. “The Lederman, D., M. Olarreaga, and L. Zavala. Impact of Export Promotion Institutions on 2013. “Export Promotion and Firm Entry Trade.” 18 (2): Applied Economics Letters and Survival: Evidence from a Panel of Latin 32. 127– American Firms.” World Bank, Office of the Wacziarg, R., and K. H. Welch. 2008. “Trade Chief Economist for Latin America and the Liberalization and Growth: New Evidence.” Caribbean, Washington, DC, and University 31. 22 (2): 187– World Bank Economic Review of Geneva Department of Economics, Geneva. World Bank. 2010. Global Survey of Export Pro - Clare, and D. Xu. Lederman, D., A. Rodriguez- Washington, DC . motion Agencies. 2011. “Entrepreneurship and the Extensive Margin in Export Growth: A Microeconomic 04_ENTinLAC_095-120.indd 120 11/21/13 5:34 PM

139 Foreign Direct Investment, 5 Multinational Corporations, and Innovation Multinational corporations (MNCs) employ a large share of the labor force, pay higher wages than other firms, are more productive, and have the potential to trigger positive spillovers on local firms through knowledge and technological transfers. Affiliates of foreign MNCs in Latin America and the Caribbean tend to be less innovative than multinational affiliates in other regions, but the productivity gains associated with their entry are greater than in other regions. Multinationals from the region ( multilatinas ) tend to make horizontal investments abroad rather than participate in global value chains and tend to be less innovative than MNCs from other middle- income regions. of the production process. All these processes he past three decades were char - have played a role in reshaping the global acterized by a dramatic increase 1 landscape of FDI flows. T in foreign direct investment (FDI) A byproduct of the global rise in FDI flows flows across the world. According to data reported by the United Nations Conference is the consolidation of multinational corpora - 2 MNCs on Trade and Development (UNCTAD), the tions (MNCs) in the world economy. earned $12.4 trillion in 2010, almost 20 per - United Nations’ trade and development unit, cent of world gross domestic product (GDP), between 1980 and 2011 the dollar amount of a larger share than any economy except the - global FDI inflows increased at the stagger 3 Why should policy makers ing average rate of 8.7 percent a year. United States. - care about MNCs in a report on entrepre A number of changes in the world econ - neurship? The previous chapters described omy lie behind this pattern, changes that various dimensions of entrepreneurial acts have affected investment opportunities in high- ncome and developing countries alike. associated with the process of creation, i - They include the sharp reduction in transport growth, and consolidation of a firm. Chap and communication costs since the 1970s, ter 2 discussed the decision to enter the local the wave of opening to foreign activity trig market. Chapter 3 described the process of - gered by economic reforms, the recovery of innovation of incumbent firms, including the decision of whether and how much to economic performance in developing coun - tries since the 1990s, and the fragmentation innovate processes or products. Chapter 4 121 05_ENTinLAC_121-140.indd 121 11/20/13 8:38 AM

140 122 LA TIN AMERICAN ENTREPRENEURS - (LAC) are less innovative than multi focused on the decision to export to foreign national affiliates operating in other markets, an entrepreneurial act that is limited i middle- to a very small subset of firms, typically the ncome regions in several most productive. dimensions. In particular, MNCs in LAC are less likely to introduce new This chapter examines MNCs, perhaps products and to have international the ultimate manifestation of an entrepre - quality certifications. Evidence from neurial firm. These companies enter foreign U.S. MNCs shows that the share of markets to sell their products and organize - research and development (R&D) per their production and distribution processes formed by subsidiaries operating in - in a more efficient manner. Firms establish LAC is smaller than the share of R&D ing foreign affiliates must incur a number of costs associated with their activities, such as performed by Asian subsidiaries. More - - - acquiring information about foreign mar over, whereas the shares of R&D per formed by subsidiaries in Asia and the kets, paying establishment fees, and hiring Middle East have increased over time, and training new employees. The magnitude the share performed by subsidiaries in of these costs implies that only firms with LAC has contracted. the highest productivity will international - D espite the relatively low levels of • ize (Helpman, Melitz, and Yeaple 2004). Going back to the typology of entrepreneurs innovation undertaken by multina - presented in chapter 2, MNCs represent the tional affiliates operating in LAC, the entry of foreign MNCs appears to have very high- e nd segment of transformational firms. increased productivity in the region— more, in fact, than in any other region. - Transformational firms play a fundamen This a priori surprising result is likely tal role in spurring economic growth and a result of the low productivity levels development. MNCs employ a large por - of firms in LAC compared with tion of the labor force, pay higher wages firms than other firms, and are more productive AC firms start L from other regions— from a lower base, making the rela - than other firms (Lipsey 2002). More impor - tant, the coexistence of MNCs and local tive impact of productivity gains larger. non-MNC firms gives rise to the possibility Most of these productivity gains are a result of knowledge and technological of knowledge and technological spillovers, transfers from multinational affiliates which can enhance developing countries’ growth prospects. Hence, understanding the to local firms, especially through local suppliers. behavior of MNCs and the factors that allow tend to focus on horizon Multilatinas • them to excel is highly relevant for policy - tal investments abroad rather than par makers in LAC. - ticipation in global value chains. The This chapter characterizes some of the leading reason why MNCs from LAC defining traits of two types of MNCs in the region: foreign MNCs and emerging Latin cross borders is to serve foreign mar - multi - called the so- American MNCs— kets. In contrast, MNCs from other latinas. It uses new data sources that reveal emerging regions internationalize to the types of markets MNCs enter, the way take advantage of lower labor costs and they interact with their foreign affiliates, and access export promotion zones. 4 their innovation efforts. • Multilatinas tend to be less innovative - Four main findings emerge from this than other MNCs. Their R&D expen chapter: diture per $1,000 of revenue is low rela - tive to their counterparts in other devel - ultinational affiliates operating in oping countries, and their management • M Latin America and the Caribbean practices are far from best practices. 05_ENTinLAC_121-140.indd 122 11/20/13 8:38 AM

141 Fo D IRECT I N v ESTMENT , M ULTINATI o NAL C o RP o RATI o NS , AND I NN ov A TI o N 123 REI g N The rest of the chapter is organized as fol in 2004, 78 of 110 countries were actively - offering fiscal or financial concessions to for - lows. The first section explores some salient characteristics of MNCs operating in LAC eign companies that decided to set up produc - and quantifies the productivity spillovers tion or other facilities within their borders (see Harding and Javorcik 2011, 2012, for a on local firms. The second section describes multilatinas. some of the characteristics of description of the census). The last section provides some concluding Are these policy choices justified? Is the - relatively large number of MNCs operat remarks. ing in LAC beneficial for the region? Luring foreign firms into developing economies is Foreign multinational potentially appealing for two broad reasons. corporations in Latin America The first, and perhaps more obvious one, and the Caribbean is enhancing factor accumulation. Foreign After some decades of adjustments, LAC firms are likely to add to the capital stock sailed through the wave of globalization of the host economy by building factories and investing in machinery and equipment. in the first decade of the 21st century with This reason alone hardly explains the vigor - unprecedented economic strength. A series of ous efforts exerted by countries to attract institutional and policy changes undertaken MNCs, however. Policy makers believe that over the past two decades, especially but not exclusively in the macro f the overall benefits of foreign presence go inancial terrain, allowed the region to enjoy a decade of solid beyond factor accumulation. Proponents of attracting FDI suggest that foreign presence growth and macroeconomic stability during benefits the host country in a second and the 2000s. more important way: by bringing advanced Not surprisingly, these factors made LAC technologies and know- ow that lead to an appealing destination for foreign inves - h tors. Almost 70 percent of the countries aggregate productivity improvements and in the region show levels of FDI inflows in positive externalities to local firms through 6 2010 above those predicted by their GDP and technological spillovers. 5 A similar This discussion makes the crucial assump population (figure 5.1, panel a). - tion that MNCs are technologically superior picture emerges when looking at the revenues of multinational affiliates in the region (fig - to local firms, an idea that is supported by 5.1, panel b). at least three arguments. First, most of these ure corporations come from high- Two groups of countries in LAC deserve - ncome econo i mies, which are closer to the technological special attention. Brazil and Mexico, LAC’s largest economies, have not only achieved frontier. The theory of MNCs goes beyond levels of FDI that exceed those predicted by mere country advantages; it argues that MNCs rely heavily on intangible assets, such their country characteristics, they also place as firm- stablished pecific technologies, well- s e among the world’s top 15 recipients of FDI h ow or manage - brand names, and know- - flows, above India and South Africa. In con ment techniques that give them an “owner - - trast, Guatemala, Haiti, and República Boli ship advantage” over other organizations (see variana de Venezuela appear to be lagging in Dunning 1988). Subsidiaries operating in terms of attracting foreign firms. developing economies could therefore poten - Policy makers in developing countries tially benefit from aggregate technological place attracting FDI and MNCs high on their 7 advantages from the MNC as a whole. agendas. They use incentives such as income Second, recent theoretical work high - tax holidays, tariff exemptions, and subsidies lighting firm heterogeneity points out that for infrastructure to attract foreign firms. only the most productive establishments can - According to a census of investment promo afford the extra cost of setting up production tion agencies carried out by the World Bank 05_ENTinLAC_121-140.indd 123 11/20/13 8:38 AM

142 nward foreign direct investment and multinational activity in Latin America and the Caribbean F I G U R E 5.1 I a. FDI inows into LAC in the 2000s: observed and benchmarked values b. Revenue of MNC foreign subsidiaries: observed and benchmarked values by host country Cuba Dominica Guyana LAC countries Haiti Dominica St. Vincent and the Grenadines Other countries Haiti Grenada Azerbaijan and economies Guyana Grenada St. Kitts and Nevis Benchmark Armenia Paraguay Uzbekistan Saint Lucia Antigua and Barbuda Moldova Kuwait Nicaragua Moldova Macedonia, FYR Macedonia, FYR Georgia Nicaragua Dominican Republic Armenia Honduras Bolivia Guatemala El Salvador Oman Uzbekistan Bosnia and Herzegovina Costa Rica Albania Philippines Ecuador Paraguay Guatemala Belarus Honduras El Salvador Jamaica United Arab Emirates Azerbaijan Bolivia Georgia Saudi Arabia Slovenia Latvia Albania Lithuania Trinidad and Tobago Trinidad and Tobago Uruguay Belarus Ecuador Uruguay Kuwait Oman India Costa Rica Kazakhstan Turkmenistan Dominican Republic Venezuela, RB Philippines Bosnia and Herzegovina Venezuela, RB Latvia Greece Israel Serbia Croatia New Zealand Lithuania Croatia Bulgaria Slovak Republic China South Africa Peru Serbia Bulgaria Peru Hungary Malaysia Ukraine Indonesia Indonesia Greece Finland Colombia Malaysia New Zealand Portugal Chile Romania Argentina Portugal Colombia Thailand Korea, Rep. Turkey Czech Republic Finland Israel Hungary Norway Australia Kazakhstan Argentina United Arab Emirates Korea, Rep. Thailand Denmark Romania Japan Japan Chile Austria Austria Denmark Turkey Ireland Ireland Czech Republic Poland Poland Saudia Arabia Switzerland Sweden Sweden Brazil India Canada Italy Singapore Mexico Mexico Australia Norway Russian Federation Russian Federation Singapore Belgium Brazil Netherlands Switzerland Spain Italy Canada Spain Hong Kong SAR, China France Germany Hong Kong SAR, China France Netherlands Belgium Germany China United States United Kingdom United States United Kingdom 100 1 10 10,000 10 100 1,000 100,000 10,000 1,000 100,000 1 FDI inows (US$ millions) Revenue produced by MNC aliates (US$) World Bank, based on data from UNCTAD’s FDI database and Orbis. Source: Note: Diamonds in panel a represent the predicted value of a regression of log foreign direct investment (FDI) inflow, after controlling for log average gross domestic product (GDP) and average population in the 2000s using all countries and economies with available FDI data. Only comparable countries are displayed in the graph. Diamonds in panel b represent the predicted value of a regression of log revenue, after controlling for log average GDP and average population in the 2000s. Panel b uses the latest available information of firms that were active in 2011. LAC = Latin America and the Caribbean, MNC = multinational corporation. 124 05_ENTinLAC_121-140.indd 124 11/20/13 8:38 AM

143 TI N D IRECT I N v ESTMENT , M ULTINATI o NAL C o RP o RATI o NS , AND I NN ov A g o N 125 Fo REI ifference in number of patents held D FIGURE 5.2 facilities in a foreign country. MNCs are thus by multinational parent and local firms in home predicted to come from the upper tier of the country in selected country groups, countries, and productivity distribution of firms in the home economies, 2010–11 country (Helpman, Melitz, and Yeaple 2004). - Third, by definition MNCs are multi 1.8 plant, multilocation organizations and thus typically larger than non-MNCs. Their size 1.6 advantage allows them to operate more effi - 1.4 ciently by benefiting from economies of scale 1.2 and scope. Origin, selection, and economies 1.0 of scale all point in the direction of higher 0.8 efficiency and better technologies from 0.6 MNCs. 0.4 Dierence in patents (log) The data support the view that on aver - 0.2 age, MNCs are more productive and innova - 0 tive than other firms. In 2002, for example, ECA LAC5 EAP4 China India High- MNCs accounted for almost half of total income R&D expenditure and almost 70 percent of economies business R&D (Javorcik 2010). Source: World Bank, based on data from Orbis. Patenting is another area where MNCs Note: Calculations based on the latest available information of firms that - have a clear advantage. Across regions, head were active in 2011. Bars represent estimated coefficients of a dummy variable taking the value 1 if the firm is a multinational parent firm in a quarters of MNCs hold more patents than regression of ln (1 + patents in 2010) using all firms from a given country local firms in the country where the head - o (excluding foreign- wned firms). Additional controls include the firm’s revenue in 2006, industry fixed effects, and country fixed effects. Standard 5.2 shows the aver - quarters is located. Figure errors are clustered at the industry level. For countries and economies age difference between the number of patents included in each group, see note 8. held by parent firms of MNCs and local firms in the country origin of the MNC, control- and productivity advantage of MNCs trans - ling for country, firm, and sectoral character - lates into technological advantages of their istics. Thus, in Chile, it compares the number affiliates in the developing world. The empir - of patents of Concha y Toro, a multinational ical literature shows evidence of such an wine company, with the number of patents effect. Studies on Mexico (Blomström 1983); held by nonmultinational winemaking com - Uruguay (Kokko, Zejan, and Tansini 2001); panies in Chile. These data reveal very large and República Bolivariana de Venezuela differences in the patent gap between MNCs (Aitken and Harrison 1999) find evidence of and local firms across regions. China and o higher labor productivity in foreign- wned India have the largest gaps, followed by high- firms than local firms. Although part of this income and LAC5 countries; Eastern Europe productivity advantage is explained by higher and Central Asia (ECA) and East Asia and 8 capital intensity, differences in other inputs Pacific (EAP4) have the smallest differences. may also be responsible. Work by Bloom These differences do not necessarily mean and others (2012), for example, shows that that MNCs from ECA or EAP4 countries o foreign- wned firms in Argentina, Brazil, have fewer patents than MNCs from LAC5 Chile, and Mexico have better management countries; they could reflect the poor perfor - practices than local firms and that the quality mance of local firms in LAC relative to their of management practices by foreign- o wned counterparts in ECA and EAP4 (see chapter firms in LAC is much closer to best practices - 3). Later in this chapter we return to the com than to local practices, giving support to the parison of MNCs from different regions. idea that multinational affiliates “import” More important to developing countries is 9 knowledge from headquarters. the extent to which the overall technological 05_ENTinLAC_121-140.indd 125 11/20/13 8:38 AM

144 126 LA TIN AMERICAN ENTREPRENEURS is not significant from a statistical point of Multinational affiliates in the region appear to be more innovative than local view); and almost 13 percentage points more 5.3 likely to adopt foreign technologies. The firms in almost every dimension. Figure shows the difference between the proportion - differences are even larger when compar o wned and local manufacturing ing efforts to improve quality. MNCs are of foreign- - 21 percentage points more likely to engage firms that engage in a number of entrepre neurial activities after controlling for country in quality- mproving investments and almost i 10 25 percentage points more likely to have and sectoral characteristics. international quality certifications than local Everything else equal, the likelihood of a firms, perhaps indicating their higher likeli - firm in LAC introducing or producing a good hood of exporting. that is new to the market is about 11 percent - age points higher for foreign- The evidence so far appears to suggest o wned firms, - that multinational affiliates operating in LAC and the likelihood of introducing a new pro - cess is about 5 percentage points higher (fig are able to overcome the obstacles that deter .3). Foreign- ure innovation by local firms in the region. Is 5 o wned firms are also about - 5 percentage points more likely to file for a this really the case? A comparison of multi - national affiliates across regions suggests it patent, trademark, or copyright or to collab orate with other institutions for innovation is not: although multinational affiliates are purposes; 6 percentage points more likely more productive than local firms, foreign- owned firms in LAC are less innovative than to invest in R&D (although this difference their counterparts in other regions. Figure 5 .4 uses data from World Bank Enterprise Surveys to compare the likeli - FIGURE 5.3 ifference in innovation between multinational D hood that manufacturing multinational affiliates and local firms in the host economy in Latin America and affiliates in different country groups intro - the Caribbean, 2010 duce a new product. Foreign subsidiaries in - aribbean LAC countries are on aver non- C age almost 20 percentage points less likely to Has an international quality certication introduce new products than foreign subsid - Invested to improve quality ncome countries. The picture i iaries of high- control or obtain certication is even gloomier for multinational affiliates Uses foreign technology in the Caribbean, which are almost 40 per - New or signicantly improved product centage points less likely to introduce new products than their high- i ncome counter - Invested in research and development parts. Countries in ECA and EAP4 have an New or signicantly improved process average propensity to innovate that is close to that of affiliates operating in high- i ncome Cooperates on innovation with others economies. Filed for patent, trademark, or copyright - The underperformance of subsidiar - ies operating in LAC relative to subsidiar 10 25 5 0 20 15 ies operating in other regions is also evident Additional likelihood by MNC aliates from their participation in the production of (percentage points) knowledge. In 2008, the share of total R&D Signicant at 10% Not signicant at 10% by foreign affiliates of U.S. MNCs coming from LAC countries was almost 70 percent - Source: World Bank, based on data from Enterprise Surveys. Note: Bars are the coefficients of a dummy variable taking the value 1 if the firm is foreign owned age points lower than that coming from sub - in a regression of innovation variables. Additional controls include country and industry fixed sidiaries operating in Europe and Canada effects. Countries include Antigua and Barbuda, Argentina, Chile, Colombia, Costa Rica, Dominica, the Dominican Republic, Ecuador, El Salvador, Grenada, Guatemala, Guyana, Honduras, Jamaica, (figure 5.5). Differences in characteristics - Mexico, Nicaragua, Panama, Paraguay, Peru, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grena between Canada and countries in LAC and dines, Suriname, Trinidad and Tobago, and Uruguay. Standard errors are clustered at the industry level. MNC = multinational corporation. Europe explain part of these differences. 05_ENTinLAC_121-140.indd 126 11/20/13 8:38 AM

145 Fo D IRECT I N v ESTMENT , M ULTINATI o NAL C o RP o RATI o NS , AND I NN ov A TI o N 127 REI g N FIGURE 5.4 roduct innovation by foreign multinational affiliates P A broader comparison shows equally dis - in selected country groups and economies, 2010 - couraging results, however. LAC’s participa tion was 16 percentage points lower than that 100 of Asia and only 1 percentage point higher 90 than that of the Middle East. Moreover, the 80 share of R&D undertaken by subsidiaries of 70 U.S. MNCs operating in LAC has fallen over 60 time: in 2008, only 3 percent of total R&D 50 by overseas affiliates of U.S. MNCs came Percent 40 from LAC, down from 5 percent in 1998. In 30 contrast, between 1998 and 2008, the share 20 of overseas R&D by Asian affiliates increased 10 9 percentage points and the share by Middle 11 Eastern affiliates rose 2 percentage points. 0 High- LAC5 Other Caribbean EAP4 ECA In sum, the presence of multinational LAC income affiliates appears to benefit countries in LAC economies by raising their productivity and innovation Other countries and economies LAC countries activities, albeit less so than in other regions. Source: World Bank, based on data from Enterprise Surveys. The factors that deter innovation by local Bars represent the coefficient regional dummies in a regression of innovation variables using Note: firms also appear to constrain the ability of o wned firms. Additional controls include industry fixed effects. Standard errors are only foreign- clustered at the industry level. All coefficients are significant at the 10 percent level. For countries wned firms to tap the pool of intan - foreign- o and economies included in each group, see note 8. gible assets held by the MNC and to innovate in the host country. (Chapter 6 explores the factors that are likely to be behind this lack esearch and development R FIGURE 5.5 of innovation in the region.) by foreign affiliates of U.S. multinational corporations in selected regions, 1998 and 2008 Spillovers and aggregate productivity gains from foreign- o wned firms 100 90 Although the direct impact of innovation 80 by multinational affiliates is an important 70 channel through which MNC activity fosters 60 50 growth and innovation in the host country, 40 Percent efforts by policy makers to attract foreign 30 firms are based on the belief that MNCs can 20 lead to productivity improvements in local 10 0 firms and, through this channel, at the aggre - 1998 2008 gate level. This motivation is of particular LAC Europe and Africa Asia Middle importance in LAC, where low productivity Canada East is widely recognized as the region’s Achilles S erra 2010; de la Torre and oth - heel (Pagés- Source: National Science Board 2012. Note: LAC = Latin America and the Caribbean. ers 2011). Has multinational entry in LAC led to positive productivity spillovers to local firms The first is competition in product and factor and aggregate productivity improvements? If markets. The arrival of MNCs clearly affects so, how large are these effects? Before trying to answer these questions, - the profitability of local firms. The pres - it is important to point out two economic ence of MNCs most likely increases prod channels through which MNCs could affect uct and factor market competition, which may depress goods prices and exert upward domestic productivity and entrepreneurship. 05_ENTinLAC_121-140.indd 127 11/20/13 8:38 AM

146 128 LA TIN AMERICAN ENTREPRENEURS 12 pressure on factor prices. Greater compe variety of inputs produced by Intel’s suppliers - tition should lead to a reduction in profits that were previously unavailable in the local economy. MNCs are also a useful conduit among local firms, perhaps even precipitat - 13 to inform local firms about new technolo - ing the exit of less productive firms. This gies, new marketing techniques, and export - shutdown of inefficient firms is not necessar markets (see Aitken, Hanson, and Harrison ily bad news for the aggregate economy: in a healthy economic environment, it leads to 1997; Javorcik and Spatareanu 2005; Chen the reallocation of resources toward the most and Swenson 2008). productive firms, increasing aggregate pro Worker turnover is yet another way in - 14 which local firms may appropriate part of the ductivity (see Alfaro and Chen 2013). The second channel is direct and indirect MNCs’ intangible assets. The accumulation knowledge transfers. Direct knowledge trans of experience and the training received dur - - fers could arise, for instance, through the ing workers’ tenure at an MNC can enable them to take part of the firm’s stock of engagement of MNCs with local suppliers to knowledge with them if they decide to move raise the quality of inputs. Employee train - (Fosfuri, Motta, and Rønde 2001). Using ing, quality control, the lending or leasing of employer- machinery, and the provision of advice on the - mployee matched data for Bra e zil, Poole (2013) finds a positive correlation - firm’s business strategy are some of the com - monly observed support activities provided between the share of former MNC employ - by MNCs to local suppliers (Moran 2001; ees and the wages paid to incumbent work ers with no prior MNC affiliation, suggesting Javorcik and Spatareanu 2005). that the presence of employees with former An often cited case is that of Intel’s plant in Costa Rica. Larrain, Lopez- MNC experience raises the productivity of C alva, and 15 other workers in the firm. Rodriguez- - lare (2001) show that 35 per C Local firms can also benefit from public cent of local service providers and 17 percent goods arising from the presence of MNCs. of input providers received training from For instance, part of the commitments made Intel. Doing business with Intel Costa Rica also appears to have led to organizational by local governments to attract foreign firms changes: 18 percent of the goods provid may include public investments, which then - ers reported changes in their organizational become available to local firms. Similarly, the presence of MNCs may induce skill upgrades structure because of their activities with Intel, and 10 percent reported being associ - in the local economy that could benefit indig - ated with foreign firms after the arrival of the 5.1). enous firms (box semiconductor manufacturer. Although aggregate productivity increases with MNC activity irrespective of the chan - Knowledge transfers from multinational nels at work, the effect on local firms depends presence are not limited to transfers aris - - ing from their dealings with local suppliers: on whether competition or knowledge trans fers dominate. Local firms with more expo - intangible assets of MNCs, such as manage - ment practices, business models, or special sure to the competition channel, such as firms inputs and services, may also become avail- in the sectors in which the MNCs operate, able to local firms outside the MNCs’ pro typically suffer from negative spillovers, - duction chain. MNCs may require local whereas firms with more exposure to the knowledge channel, such as local suppliers, suppliers to provide inputs or services new - are more likely to benefit from positive pro to the host economy that in turn can be sold 16 C to other local firms (Rodriguez- lare 1996; Quantifying the relative ductivity spillovers. Blalock and Gertler 2005). Larrain, Lopez- - importance of the competition and knowl lare (2001), for C Calva, and Rodriguez- edge transfer channels is crucial to assessing the impact of MNC entry on firm- example, document that local firms in Costa l evel and Rica unrelated to Intel gained access to a aggregate productivity. 05_ENTinLAC_121-140.indd 128 11/20/13 8:38 AM

147 RATI N D IRECT I N v ESTMENT , M ULTINATI o NAL C o RP o g o NS , AND I NN ov A TI o N 129 Fo REI C an a whale in a swimming pool create a splash? Intel and the upgrading of B O X 5.1 tertiary education in Costa Rica year certificate program and a one- - • A one- In November 1996, Intel, the world’s largest semi year - conductor producer, announced that it would con associate degree at ITCR focused on new tech - struct a new $300 million assembly and test plant nical fields, such as semiconductor manufac - in Costa Rica. The investment community was ini - turing and microelectronics, and, later, materi- tially stunned by Intel’s announcement. After all, als science Costa Rica, a relative small economy, was chosen - Links with UCR’ • s School of Physics and tech over some of LAC’s biggest economies. Even Intel nological and vocational schools for electronics officials recognized that the decision was bold. Bob - Support for the electrical, electronics, comput • ing, and industrial engineering fields. Perlman, an Intel vice- - resident, stated that bring p ing Intel to Costa Rica was “like putting a whale The benefits of these programs have exceeded in a swimming pool.” The country’s economic and those that came directly from Intel. A survey of political stability, its proximity to the United States, 20 Costa Rican firms identified by CINDE, Costa usiness environment were all important b and its pro- Rica’s investment promotion agency, as potential factors in Intel’s decision (Spar 1998). competitors of Intel in the labor market revealed Some bottlenecks and limitations in the Costa that all but one saw the arrival of Intel as positive for Rican economy raised concerns for Intel. One was the accumulation of human capital. Of these firms, education. Costa Rica had a high literacy rate and a ear eight had hired a graduate from ITCR’s one- y - good education system, but the low number of engi - certificate, and all reported benefiting from the cre neers and workers with technical skills was consid - ation of this program. ered a constraint on Intel’s operation. The spillovers of Intel’s presence can also be To overcome this hurdle, the Costa Rican gov - seen in the stock of engineers in Costa Rica. The ernment, Intel, and major academic institutions and number of graduates from engineering programs in technical schools joined forces to help strengthen Costa Rica reportedly increased by almost 40 per - the country’s educational system. They developed cent between 2002 and 2011, from 1,580 to almost a series of programs and relationships designed to 2,200 (UNESCO [United Nations Educational, Sci - increase both the number of graduates in engineer - entific and Cultural Organization]). ing and technical degrees and the proficiency of In sum, Intel’s presence has played an important the graduates. These programs and relationships role in increasing the stock and the quality of work - included the following: ers with technical skills in Costa Rica. The ben - • Programs and enhanced curricula at the three efits associated with these achievements go beyond ecnológico major educational institutions— T the boundaries of Intel. To put it in Bob Perlman’s de Costa Rica (ITCR), Universidad de Costa words, the whale in the swimming pool created a - Rica (UCR), and Instituto Nacional de Apren big splash. 2003 dizaje (INA)— especially during 1999– Calva, and Rodriguez- Spar 1998; Larrain, Lopez- Sources: Clare English reinforcement program at ITCR • 2001; World Bank Group 2006. This is precisely what Alfaro and Chen competition in explaining these gains. They (2013) do. They use a standard economic use a sample of manufacturing firms taken model of MNC activity similar to the one from Orbis from 60 countries, 5 of which (Argentina, Brazil, Chile, Colombia, and presented in Helpman, Melitz, and Yeaple - (2004) to estimate the aggregate produc Mexico) are in LAC. tivity gains from MNC entry as well as the The results are striking: doubling MNC relative weight of knowledge transfers and entry into LAC countries would increase 05_ENTinLAC_121-140.indd 129 11/20/13 8:38 AM

148 130 TIN AMERICAN ENTREPRENEURS LA o wned and to a large gap between foreign- aggregate productivity by 3.8 percent (fig - local firms and to low productivity by local 5.6). This number is six times higher ure than in ECA or high- ncome economies and i firms (Pagés- S erra 2010), suggesting a large seven times higher than in China. More potential for spillovers in the region even in important, and in contrast to other regions, the absence of vigorous innovation activity from MNCs operating in the region. In con - knowledge spillovers run the entire show trast, in other regions there appears to be a - in LAC, explaining 100 percent of the esti mated aggregate productivity gains from smaller gap between multinational affiliates 17 MNC entry. and local firms. Although the large spillovers Alfaro and Chen (2013) find for LAC may seem at odds Capitalizing on the spillovers with the poor performance of the region from multinational activity: in terms of productivity and the under - Scope for policy intervention performance of MNCs operating in LAC in terms of innovation, all these pieces are The policy implications of this surprising - result are immense. In particular, it highlights consistent. Indeed, the marginal productiv the large premium of policies that foster the ity gains for local firms from MNC entry through knowledge spillovers are expected attraction of MNCs and their spillovers to local firms. What types of policy interven - to depend on both the technological gap tions could yield these goals? - between local firms and multinational affili Policy makers have typically pursued ates and the productivity level of local firms: three sets of policies to achieve these objec - spillovers are likely to be larger, the larger the technological gap between local and tives. The first are policies aimed at attracting FDI and MNCs, such as tax holidays or cash foreign firms and the lower the productivity of local firms. The evidence in LAC points incentives. One policy tool that has proven very effective in attracting FDI is the estab - lishment of investment promotion agencies FIGURE 5.6 urces of predicted productivity So - (IPAs). IPAs actively look for foreign inves gains associated with entry of multinational tors and provide them with valuable sectoral corporations, by country groups, countries, and and country information during their deci - economies, 2002– 10 sion process. Using information from a survey of actual 4.0 and potential foreign investors, Kenyon and 3.5 Margalit (2012) show that the information provided by IPAs about local markets to 3.0 foreign investors is crucial in their decision- 2.5 making process. Harding and Javorcik (2011) 2.0 show that FDI into sectors targeted by IPAs is 1.5 larger than FDI to other sectors. Percentage points These agencies have flourished in LAC 1.0 since the 1990s. Are they working? More 0.5 efforts are needed to improve the quality of 0 these institutions, as suggested by the results ECA LAC5 China High-income of the 2012 Global Investment Promotion economies Knowledge spillover Market reallocation Best Practices (GIPBP) report prepared by the World Bank Group. The GIPBP assesses Alfaro and Chen 2013. Source: two aspects of the information facilitation Note: Bars represent total productivity gains from doubling the probability - role of IPAs: their ability to handle inqui of entry by a multinational corporation, estimated though a structural model. For countries and economies included in each group, see note 8. ries from foreign investors in a professional 05_ENTinLAC_121-140.indd 130 11/20/13 8:38 AM

149 o D IRECT I N v ESTMENT , M ULTINATI o NAL C o RP o RATI N NS , AND I NN ov A TI o N 131 Fo REI g minimum local content requirements, labor and speedy manner and the clarity and con - - tent of their websites. Harding and Javor requirements, and import substitution poli - cik (2013) find that countries with IPAs cies. This set of policies is more complex to that are better able to handle queries and evaluate at a regional or even country level, have clearer information on their websites d epth analysis because doing so requires in- of their detailed characteristics and interac - tend to attract more FDI. The 2012 GIPBP highlights that IPAs from LAC still suffer tions. Their characterization goes beyond the from weaknesses in handling inquiries from scope of this chapter. potential investors and serious deficiencies Fine- t uning the balance among these three policy areas is fundamental and constitutes in their websites, especially in countries in a serious challenge for policy makers, as South America. As a result, IPAs from LAC p oint scale— fa - policies aimed at strengthening one objec r from the score 48 on a 100- tive may end up weakening the other. Take, i ncome Organ - 64 scored by IPAs from high- - isation for Economic Co-operation and for, instance, minimum content require Development (OECD) countries. ments. Such requirements strengthen the A second set of policies concentrates on link between multinational affiliates and - - local firms and could generate larger knowl improving the general business environ ment. Policies that improve human capital edge spillovers. But in countries where the quality of inputs produced by local firms is or institutions fall in this category. These policies typically seek to achieve multiple poor, they could discourage new MNCs from objectives at the same time. They are good - entering the host country and limit the incen tives of incumbent multinational affiliates to ways to attract FDI while reducing the bar - innovate. The balance among the three types riers that hinder both the ability of multina - tional affiliates to innovate and the capacity of policies will depend on the specificities of of local firms to absorb knowledge transfers each cou nt r y. from MNCs. These policies are of tremendous impor - Multilatinas tance in achieving the goals mentioned above Foreign presence is an important aspect of because LAC still suffers from substantial deficiencies in areas such as human capital globalization and economic integration for and financial access, some of which are likely developing countries, but not the only one. to prevent it from exploiting the full potential An equally important feature of the increase 18, 19, 20 of MNC activity. in global FDI flows is the role played by These barriers have implications for the developing countries as a source of FDI and allocation of the productivity gains from the rise of MNCs from these countries. Aggregate FDI outflows from LAC grew knowledge transfers in the host economy. Indeed, many studies find that MNC spill - at an annual rate of 16 percent from 1980 to 2011, rising by a factor of 15 as share of overs in LAC are concentrated among the 21 As a result, barriers in the largest firms. - GDP over the same period (from 0.13 per absorptive capacity of local firms could cause cent of LAC’s GDP to 1.9 percent). LAC’s - MNC activity to accentuate productivity dif weight in total FDI outflows also increased. ferences across firms in a region that suffers In the 1980s, a meager 1.2 percent of total from a very uneven productivity distribution FDI outflows came from LAC countries; in (Busso, Madrigal, and Pagés-Serra 2012), the 2000s, this number reached 5.2 percent. something that can create political economy are now global players, Many multilatinas constraints to the attraction of FDI. with 18 of them among Boston Consulting A third set of policies attempts to Group’s list of top 100 firms from emerg - wned strengthen the links between foreign- o ing markets to watch (BCG 2006; Santiso firms and the local economy. They include 2008). 05_ENTinLAC_121-140.indd 131 11/20/13 8:38 AM

150 132 TIN AMERICAN ENTREPRENEURS LA hare of total revenues of S FIGURE 5.7 be another vehicle for multilatinas Can multilatinas by country or country group of origin, innovation upgrades in LAC? The interna - 2 010 –11 tionalization of these firms could give them h access to technologies and know- - ow avail 1% able in foreign markets, which they can 2% import back home. In addition to giving 3% multilatinas access to existing top technolo - gies, the internationalization of these firms 4% can boost their own innovation potential. For instance, access to a large pool of skilled - workers and more developed financial mar 39% 16% kets may allow these firms to overcome some of the constraints to innovation they face at 22 Good knowledge of the workings home. of the home country’s economy (institutions, 31% - markets, and so forth) and the tight connec tion with local firms might suggest that the mul potential for knowledge spillovers from - 23 tilatinas to the local economy is large. Brazil Peru In fact, the evidence indicates that the Mexico Argentina potential for to bring wide multilatinas - Chile Trinidad and Tobago spread productivity and innovation gains Colombia Uruguay into the region is limited, for a few reasons. Costa Rica Caribbean multilatinas First, the emergence of - is heav Venezuela, RB Other LAC ily tilted toward a very small number of countries. Indeed, from Brazil, multilatinas Source: World Bank, based on data from Orbis. Chile, Colombia, and Mexico account for Note: Calculations are based on the latest available information of firms 90 percent of the revenue earned by these that were active in 2011. For countries included in Other LAC, see note 8. LAC = Latin America and the Caribbean. 5.7). Interestingly, MNCs from firms (figure Costa Rica, a relative small country in the by their income and population. Even LAC’s region, have positioned themselves as impor - two top performers in absolute numbers, tant players, accounting for about 3 percent Mexico and Brazil, are far from their bench - of total revenue and standing above their mark level. There are, however, some bright - counterparts from countries such as Argen spots. Chile and Colombia are not only tina, Peru, and República Bolivariana de producing - among the top four multilatina Venezuela. countries, they also overperform relative to To be sure, country characteristics such as Multilatinas their country characteristics. - GDP and population partly explain the het from the Caribbean countries also appear to erogeneity in the performance of multilatinas excel once the size of their economies is taken from different countries. Figure 5.8 takes into account. - these differences into consideration by pre Anecdotal evidence suggests that there are senting both the observed dollar amount of multilatinas large differences in the origins of the revenue produced by MNCs from differ - and MNCs from other regions. In the United ent countries and the level predicted by GDP States— a nd to a lesser extent East Asia and and population by means of a multivariate the Pacific and the Republic of Korea— m ost regression. MNCs are private firms that took the leap 5.8 is The picture that emerges from figure and started operating in foreign markets. In from discouraging. Revenues of multilatinas contrast, many multilatinas, especially the most LAC countries are lower than predicted 05_ENTinLAC_121-140.indd 132 11/20/13 8:38 AM

151 FIGURE 5.8 A ctual and benchmarked revenue of multinational corporations in selected countries and economies, relative to given characteristics, 2010–11 LAC countries Nicaragua Grenada Other countries Suriname larger ones, were public sector companies Haiti or economies Paraguay - that were privatized in the wave of liberal Georgia Benchmark Honduras ization of the 1990s and enjoyed monopoly Cuba El Salvador power for long periods of time (Casanova Albania Macedonia, FYR and others 2009). Bolivia Moldova Dominican Republic Armenia Drivers of internationalization Guyana Romania Bosnia and Herzegovina In addition to differences in origin, there also Costa Rica Dominica appear to be differences in the motivation Guatemala Oman and multilatinas for internationalization of Bulgaria Ecuador MNCs from other regions. Tapping into for - Serbia Peru eign countries to open up new markets and Uzbekistan Philippines to diversify country risk is one of the leading St. Kitts and Nevis Latvia reasons why LAC firms cross borders (Alfaro Croatia St. Vincent and the Grenadines and Hammel 2006; Casanova and others Belarus Uruguay 2009). Kenyon and Margalit (2012) asked Trinidad and Tobago Indonesia firms in four emerging market countries— Antigua and Barbuda St. Lucia Brazil, India, Korea, and South Africa— Azerbaijan Lithuania about the main motivations for investing in Venezuela, RB Ukraine other emerging markets. The firms were ran - Slovak Republic domly drawn from registries that included all Argentina Czech Republic firms in each country with annual revenues Slovenia Hungary of at least $25 million and that operated in Kazakhstan Turkey one of five sectors: finance and insurance, Thailand New Zealand manufacturing, wholesale trade, retail trade, Chile Colombia and transportation and warehousing. Kuwait Greece The results yield two conclusions. First, Poland Israel the decision by Brazilian firms about where Saudi Arabia Hong Kong SAR, China to invest is driven primarily by market oppor - Malaysia Portugal tunities. In particular, the presence of key Russian Federation Mexico customers and attractive domestic markets Singapore Brazil are key factors (figure 5.9, panel a). Second, United Arab Emirates Norway Brazilian firms are much more focused on the Australia Austria opportunities offered by the domestic market Denmark Finland than are firms from other countries. They are India - significantly less concerned than their coun Korea, Rep. Belgium terparts about the quality of the workforce, Ireland Canada labor costs, and regulatory transparency of Spain Sweden 5.9, panel b). the host country (figure China Italy The fact that multilatinas internationalize Netherlands Switzerland in order to expand markets implies that their Japan Germany foreign subsidiaries tend to operate in the France United Kingdom same sector as the headquarters. Figure 5.10 United States divides the subsidiaries of MNCs from differ - 1 10 100 0.1 0.01 1,000 100,000 0.001 10,000 10,000,000 ent regions into three groups: firms operat - (US$ thousands) multilatinas Revenue of ing in the same sectors as the headquarters (horizontal), firms providing inputs to the Source: World Bank, based on data from Orbis. headquarter (upstream of headquarters), and Note: Calculations are based on the latest available information of firms that were active in 2011. Diamonds represent the predicted value of a regression of log revenue, after controlling for log average gross domestic product and average population in the 2000s. LAC = Latin America and the Caribbean. 133 05_ENTinLAC_121-140.indd 133 11/20/13 8:38 AM

152 134 LA TIN AMERICAN ENTREPRENEURS F actors driving Brazilian firms to cross borders, 2010–11 FIGURE 5.9 b. Dierences in drivers of internationalization: Additional likelihood a. Drivers of internationalization in Brazil of Brazilian rms relative to those from other emerging countries Presence of foreign investors Domestic market 10% Availability of joint 14% Export processing venture partners zones 7% Domestic market Security Regional market Presence of key Labor costs client/sellers 28% Political stability 27% Transparency 20151050–5–10–15–20–25 Percent 14% Source: Kenyon and Margalit 2012. Note: Comparator countries are India, the Republic of Korea, and South Africa. Se F I G U R E 5.10 ctoral position of foreign subsidiaries relative firms obtaining inputs from the headquarters 24 to headquarters in selected country groups, countries, and (downstream from headquarters). economies, 2010–11 The results show that the pattern of link - ages between headquarters and subsidiaries multilatinas observed for stands in sharp 60 contrast to that observed in other regions. By 50 and large, multilatinas establish horizontal links with their subsidiaries: almost half of 40 their foreign subsidiaries operate in the same sector as their headquarters. In contrast, for - 30 eign subsidiaries of MNCs from other regions 20 tend to establish vertical linkages with their headquarters. For example, about 40 percent 10 Share of foreign subsidiaries (%) of foreign subsidiaries of Asian MNCs oper - ate in the same sector as the headquarters. 0 LAC ECA EAP4 China and High-income This number is even lower in ECA and high- India economies income countries, where only 35 percent of Location of headquarters subsidiaries operate in the same sector as the Upstream (relative to parent) Horizontal parent company. Downstream (relative to parent) An implication of this pattern is the lim - ited scope for - to transfer knowl multilatinas World Bank, based on data from Orbis. Source: edge to the home economy through their Note: Calculations are based on the latest available information of firms that were active in 2011. Sectoral position was calculated using the input- o utput matrix for the United States. A subsidiary involvement in global value chains. Global is defined as downstream if the parent company’s sector is a net supplier of the subsidiary’s sector. value chains are the ultimate manifestation A subsidiary is defined as upstream if the subsidiary’s sector is a net supplier of the parent com - pany’s sector. For countries and economies included in each group, see note 8. of the fragmentation of the production pro - cess of MNCs, whereby each subsidiary in the organization produces inputs based on 25 its comparative advantage. This fluid move - ment of tangible and intangible inputs within 05_ENTinLAC_121-140.indd 134 11/20/13 8:38 AM

153 , I N v ESTMENT , M ULTINATI o NAL C o RP o RATI o NS IRECT AND I NN ov A TI o N 135 REI D Fo g N O 2010 F I G U R E 5 .11 rigin of revenues of multilatinas, MNCs leads to enhancements in the transfer of a wide array of technologies and knowl - In 2010, by revenue edge across borders. Brazil 0.3% d riven orientation of - mul The market- 0.2% 2.7% Mexico has also led to a specific sequence tilatinas 1.3 % 0.0% 1.9% 1.9% Chile 0.9% of geographical expansion in which firms 1.4% United States establish operations in neighboring countries 2.4% Colombia before crossing beyond regional borders. In 3.2% Spain remain multilatinas fact, most subsidiaries of 5.5% Argentina constrained to LAC: nearly 85 percent of 36.1% Bermuda the revenues of their subsidiaries come from United Kingdom within the region (figure 5.11). Although this 8.0% Canada pattern leads to regional integration, which High-income could have important benefits, it prevents economies multilatinas from seizing some of the poten - 12.7% Other LAC tial innovation boosters from operating in 22.7% ECA ncome, countries. i non-LAC, especially high- EAP4 China Innovation deficit Other The scope for productivity gains from the World Bank, based on data from Orbis. Source: emergence of multilatinas is hindered by Note: For countries and economies included in each group, see note 8. - their underperformance in terms of innova tion. Maloney and Sarrias (2013) show that although they engage in better management manufacturing sector invest on average only lag practices than local firms, multilatinas $0.06 per $1,000 of revenue (figure 5.13). o foreign- wned firms in all LAC countries for This spending stands in sharp contrast with which data were available (figure 5.12) (See R&D intensity by manufacturing MNCs chapter 3 for a detailed description of the ncome economies and even other i from high- management practices data.) developing countries and regions, such as also fall behind their coun- Multilatinas China and EAP4. For example, MNCs terparts from other regions in terms of from EAP4, the region with the lowest aver - R&D investments. Multilatinas from the age R&D intensity among the three regions anagement practices by firms in the United States and selected countries in Latin America and the M F I G U R E 5.12 Caribbean, by type of firm a. Argentina b. Brazil c. Chile d. Mexico e. United States Local rms Local rms Local rms Local rms Local rms Domestic Domestic Domestic Domestic Domestic multinationals multinationals multinationals multinationals multinationals Foreign Foreign Foreign Foreign Foreign multinationals multinationals multinationals multinationals multinationals 3 0 0 0 0 1 2 3 4 1 2 3 4 1 2 3 4 2 0 1 2 1 4 3 4 Mean management score Source: Maloney and Sarrias 2013. 05_ENTinLAC_121-140.indd 135 11/20/13 8:38 AM

154 136 TIN AMERICAN ENTREPRENEURS LA esearch and development by multinational R F I G U R E 5.13 s pecific characteristics that by some LAC– corporations in selected country groups, countries, and economies, prevent them from excelling. 2 010 –11 - Understanding the exact causes hamper ing innovation in LAC or the exact policy 30 interventions to relax these constraints is a daunting task that goes beyond the scope 25 of this report. However, chapter 6 discusses and characterizes the key factors that may 20 be hindering LAC’s innovation potential 15 and puts on the table broad policy areas of intervention. 10 Notes 5 einhold (2002) document the 1. Freund and W 0 US$ of R&D per thousand US$ of revenue High- EAP4 China LAC5 ECA India positive effect of the expansion of the Inter - income net on trade in services. Hummels (2007) economies - documents the effect of reductions in trans port costs on trade. Sachs and Warner (1995) Source: World Bank, based on data from Orbis. describe the economic reforms undertaken in Note: For countries and economies included in each group, see note 8. the 1990s. parts of this chapter treat FDI and Many . 2 MNCs as if they were the same thing. There mentioned earlier, invest $1.70 on R&D for are, however, important differences to keep in lmost 30 times every $1,000 of revenue— a mind when analyzing the effects of the two 26 multilatinas. the R&D intensity of variables. FDI is a form of investment that In sum, the picture emerging from this creates an asset held by the home economy. multilatinas analysis is that the scope for This asset can come from the creation of a new firm or project or from the acquisition to generate technological and productiv - of an existing firm or project. FDI does not ity spillovers to LAC countries is limited. necessarily imply control over the firm or Multilatinas are concentrated among very project. In contrast, multinational activity is few countries (Brazil, Chile, Colombia, and associated with control of production and Mexico), and the size of these firms is smaller employment decisions in the host economy than predicted by the level of development of by a foreign- owned firm. their country of origin. Moreover, the expan - 3. calculation was made using Bureau van This sion of multilatinas is horizontal and oriented Dijk’s Orbis dataset. For more information on toward regional markets, limiting the scope the data, see box 2.1 in chapter 2. for technological gains from participating in This chapter relies on two primary data 4. ncome, i global value chains and serving high- sources: the World Bank’s Enterprise Surveys and Orbis. For more information on these technologically advanced, economies. Multi - datasets, see box 2.1 in chapter 2. latinas - are also less likely than their counter - For each variable of interest, we ran a regres 5. parts from other regions to innovate. sion using all countries for which information was available, controlling for the natural loga- Concluding remarks rithm of GDP in constant 2000 U.S. dollars and the natural logarithm of population. The results presented in this chapter lead to 6. Romer (1993), for instance, argues that one important conclusion: something in the MNC presence can lead to a narrowing of - business environment in LAC deters inno - the “object gap” and “ideas gap” in develop vation even among the high- e nd segment of ing countries. The “object gap” refers to the transformational firms. Affiliates of foreign shortage of physical goods, such as factories and roads, in developing countries. The “ideas MNCs and multilatinas alike are constrained 05_ENTinLAC_121-140.indd 136 11/20/13 8:38 AM

155 NS D IRECT I N v ESTMENT , M ULTINATI o NAL C o RP o RATI o N , AND I NN ov A TI o N 137 REI Fo g be reflecting differences in the propensity to gap” refers to the shortage of knowledge used conduct R&D instead of capturing differences to create value added in the modern economy. across types of firms. Industry fixed effects Following the literature in international eco - 7. correct for the fact that MNC affiliates may nomics, we label the country that receives have a propensity to locate in sectors that have the MNC or FDI the “host country” and the a natural bias toward, say, conducting R&D. country of origin of the capital the “home country.” 11. - Distance to headquarters may also be a fac tor explaining these patterns. For instance, Throughout this chapter we use the follow - 8. Keller and Yeaple (2013) explore the relation ing groups of economies unless otherwise between trade costs, which are expected to be includes Argentina, Brazil, Chile, LAC5 noted. associated with distance, and the way in which Other LAC includes Colombia, and Mexico. knowledge is produced and transferred within Bolivia, Costa Rica, the Dominican Republic, the boundaries of MNCs. The theoretical Ecuador, El Salvador, Guatemala, Honduras, model they present predicts that subsidiaries in Nicaragua, Paraguay, Peru, Uruguay, and locations farther away from headquarters will República Bolivariana de Venezuela. Carib- rely less on imported knowledge, embodied in bean includes Antigua and Barbuda, Cuba, sophisticated goods, and more on knowledge Dominica, Grenada, Guyana, Haiti, Jamaica, produced in the host economy. This may be St. Kitts and Nevis, St. Lucia, St. Vincent and one reason why U.S. MNCs have located their the Grenadines, Suriname, and Trinidad and R&D more in Asia or the Middle East and less Tobago. ECA (Eastern Europe and Central in LAC. Asia) includes Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, 12. instance, industry wages in Mexico and For Georgia, Kazakhstan, Latvia, Lithuania, FYR República Bolivariana de Venezuela have been Macedonia, Moldova, Romania, the Russian shown to increase with foreign production Federation, Serbia, Turkey, Turkmenistan, (Aitken, Harrison, and Lipsey 1996). Ukraine, and Uzbekistan. includes Indo- EAP4 Ramondo (2009) 13. shows that exit rates among nesia, Malaysia, the Philippines, and Thailand. the least productive firms in Chile increase include Australia; High-income economies with foreign presence. Canada; Hong Kong SAR, China; Israel; Japan; 14. In addition, competition could lead to dynamic the Republic of Korea; Kuwait; New Zealand; changes in productivity. The expectation of Oman; Saudi Arabia; Singapore; Switzerland; lower future profits causes the productiv- the United Arab Emirates; the United States; ity of new entrants to be higher. Competi - and all countries in the European Union not tion also reshapes the innovation decision of included in ECA. The set of economies from entrants. The direction of this change depends each group used in figures throughout this on whether the “escape competition” effect chapter varies according to data availability. faced by incumbents outweighs the potentially lower postinnovation profits and higher costs - 9. affiliates have a productivity and man MNC of innovation these firms face. agerial advantage over local firms in other Other empirical studies find similar results. 15. income regions as well. developing and high- - Görg and Strobl (2005) find that firms in Lipsey (2002), for instance, provides a thor ough review of the empirical work on pro- - Ghana run by owners with past MNC affili ation have higher productivity than compa- ductivity differences among foreign- owned rable local firms. Balsvik (2011) finds that the and local firms. He finds that foreign- owned productivity of local producers in Norway is firms are more productive than local firms positively correlated with the share of employ- almost everywhere. Bloom and others (2012) ees with prior MNC experience. examine management differences in 16 non- LAC countries. Their results are similar to the - The empirical literature finds almost com 16. results for LAC countries. - plete support for the presence of productiv ity spillovers of MNCs through backward Country fixed effects are included to take 10. linkages (to local suppliers); such spillovers account of the fact that on average, some countries may have a larger share of MNCs Cordova have been found in Brazil (Lopez- or a greater propensity to, say, conduct and Mesquita Moreira 2004), Colombia R&D. If this is the case, differences in R&D (Kugler 2006), and Mexico (Lopez- Cordova between MNC affiliates and local firms may 2003). The evidence for horizontal spillovers 05_ENTinLAC_121-140.indd 137 11/20/13 8:38 AM

156 138 LA TIN AMERICAN ENTREPRENEURS 23. and spillovers through forward linkages V - an Pottelsberghe de la Potterie and Lich tenberg (2001) use data for 13 industrial is less conclusive. Evidence of horizon - economies and show that the growth effect tal spillovers from MNC activity has been of knowledge spillovers from outward FDI is - Cordova and Mes found in Brazil (Lopez- positive and greater than that of inward FDI. quita Moreira 2004) and Mexico (Lopez- - 24. Classification of sectors as upward or down Cordova 2003) following periods of trade - ward relative to the headquarters was done integration. Ramondo (2009) finds posi tive horizontal spillovers on Chilean firms. using U.S. input- e assumed output tables. W Kugler (2006) finds no significant horizon- that the sectoral linkages observed in the United tal spillovers from MNC activity on Colom- States are similar to those in other countries. Cordova bian manufacturing firms. Lopez- 25. A consequence of the emergence of global and Mesquita Moreira (2004) find positive value chains is the increased importance of and significant spillovers for Mexico but not intrafirm trade in the global economy. Brazil. (For a comprehensive review of the 26. The low average R&D intensity observed in literature on spillovers, see Harrison and multilatinas is driven partly by the prevalence multilatinas with zero R&D. Although the of Rodriguez- Clare 2010.) is much multilatinas average R&D intensity of 17. The estimated contributions of knowledge higher once firms with zero R&D are excluded, transfers to aggregate productivity from it remains much lower than other regions. Alfaro and Chen (2013) are likely to have an upward bias, because small firms in LAC, which are more prone to suffer from factor References market competition, are underrepresented in Orbis. Taking into account that the negative Skills for the 21st Aedo, C., and I. Walker. 2012. impact of MNC is underestimated in the anal - Century in Latin America and the Caribbean. ysis, we could consider the above estimates as Washington, DC: World Bank. upper bounds of the true effects. Aitken, B., G. Hanson, and A. Harrison. 1997. “Spillovers, Foreign Investment, and Export 18. Borensztein, De Gregorio, and Lee (1998) B ehavior.” - Journal of International Econom find that the relation between inward FDI ics and growth is positive and significant only for 3 43 (1): 103– 2. countries with a minimum level of education. Aitken, B., and A. Harrison. 1999. “Do Domestic Alfaro and others (2003) find a similar result Firms Benefit from Direct Foreign Investment? for financial development. They show that the Evidence from Venezuela.” American Eco - effect of FDI on growth is higher in countries nomic Review 1 89 (3): 605– 8. with a higher level of financial development. Aitken, B., A. Harrison, and R. Lipsey. 1996. - “Wages and Foreign Ownership: A Com and Walker (2012) show that LAC high 19. Aedo parative Study of Mexico, Venezuela and the school students score below their peers from United States.” - Journal of International Eco other countries on the standardized math and nomics reading Programme for International Student 40 (3– 4): 345– 71. Assessment (PISA) tests. Chapter 2 discusses O Alfaro, L., C. Areendam, S. Kalemli- zcan, and the region’s underperformance in terms of S. Selin. 2003. “FDI and Economic Growth: financial development. Journal The Role of Local Financial Markets.” of International Economics 3 3. 20. Javorcik and Spatareanu (2005) use a survey 61 (1): 512– of firms in the Czech Republic and Lithu - Alfaro, L., and M. Chen. 2013. “Market Real - location and Knowledge Spillovers: The Gains ania to show that the likelihood of a local from Multinational Production.” NBER Work - firm acting as a supplier for a foreign- owned ing Paper 18207, National Bureau of Economic firm increases with the local firm’s access to Research, Cambridge, MA. financing. - Alfaro, L., and E. Hammel. 2006. “Latin Ameri 21. Blyde, Kugler , and Stein (2004) find that spill - can Multinationals.” In The Latin American - overs from MNC activity in República Boli Essay 2.11. New Competitiveness Report, variana de Venezuela are concentrated among York: Oxford University Press for the World large firms. Kokko, Zejan, and Tansini (2001) - Economic Forum and the Center for Interna find a similar result for Uruguay. tional Development. 22. Alfaro and Hammel (2006) suggest that access Balsvik, R. 2011. “Is Labor Mobility a Channel to finance is one of the motivations for firms for Spillovers from Multinationals? Evidence from LAC to start operating in foreign markets. 05_ENTinLAC_121-140.indd 138 11/20/13 8:38 AM

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159 Toward an Enabling Environment 6 for Innovative Entrepreneurs Creating an enabling environment for innovative entrepreneurship is difficult because it involves - inadequate pro multiple policy areas that interact in complex ways. Of the usual suspects— tection of intellectual property rights and contracts, access to finance, competition, openness to international trade, and human capital— the region appears to underperform other regions most clearly on the human capital front and the lack of competition in nontradable industries. - More research is needed before definitive conclusions can be reached, but some evidence sug gests that the small share of engineers in the population and excessive concentration of domes- tic nontradable markets in a few firms may be major factors behind the region’s innovation deficit. Intellectual property rights might also be important, but more research is definitely needed on this complex policy area. firm. Eventually, Shiller and his two partners Ne w York e d piece in the n an op- sold the company (and the rights to use his Times, Nobel Prize laureate Robert economic ideas about how to measure the Shiller argued that innovation remains I evolution of the real estate market in the the engine of growth in market economies. - United States) for an undisclosed but pre - His opening salvo was “Capitalism is cul sumably attractive sum. His emphasis on the ture. To sustain it, laws and institutions are eberian idea– a a W spirit of capitalism— nd important, but the most fundamental role is his lukewarm tribute to laws and institutions, - played by the basic human spirit of indepen however, suggest that Shiller is a bit skeptical dence and initiative” (Shiller 2013). about the ability of public policies to become Shiller was writing as both an academic drivers of innovation. and an entrepreneur, narrating his attempts Javier— t - he fictional entrepreneur intro - to secure financing for a new business ven duced in chapter 1— aught the Weberian c ture that would commercialize an idea that spirit early on, making choices that were emerged out of his academic research. He qualitatively different from those of his sib - expressed frustration with the lack of interest lings. He took financial risks, which paid shown by potential investors until he mort - off handsomely. As suggested in chapter 2, gaged his home to help finance the young 141 06_ENTinLAC_141-152.indd 141 11/19/13 3:53 PM

160 142 tin a meric an e ntrepreneurs La - entrepreneurs like Javier are rare but impor What are the elements of an tant for the development of Latin America enabling environment for and the Caribbean (LAC): although their innovative entrepreneurs? numbers are small, they employ more than Chapter 1 concluded that regulatory barri - half of all formal sector salaried workers in - ers to entry are unlikely to be a major con the region. If LAC had more entrepreneurs straint for LAC entrepreneurship and that it like Javier, the number of formal salaried jobs is difficult to find conclusive evidence that the would probably be larger and the number of region’s culture is less inclined toward entre - rowth entrepreneurs smaller. low- g preneurship than other cultures. Rather, we - Chapter 3 argued that LAC can be char must search for answers in Shiller’s “laws - acterized by both its large number of entre and institutions.” Chapter 2 provided some preneurs and by their underperformance in additional clues. It identified important corre - terms of innovation. Shiller seems to believe lates of innovation by incumbent firms, such that entrepreneurship and innovation go as regulation of entry, competition, access to hand in hand, drawing little distinction finance (especially by young enterprises), and between the two. But some dimensions of entrepreneurial skills. entrepreneurship (such as firm creation and survival) are clearly present in LAC even as Interactions and complexity - there is a deficit along the innovation dimen sion. Although we embrace the presump - Pinpointing the enablers of innovative entre - tion that the spirit of innovation is a driver preneurship is fraught with complexity. The of modern market economies around the difficulty may stem from the intricate inter - - world, not just in the United States, a chal actions between the various dimensions of lenge for policy makers remains figuring the enabling environment that matter for out how to shape policies, including laws innovation; it may also reflect the fact that and institutions, to enhance the incidence both entrepreneurial innovation and its of transformational entrepreneurship so possible determinants may be affected by that surviving entrepreneurs become true - common factors and, hence, jointly deter innovators. mined. For instance, an economy’s laws and Chapters 4 and 5 focused on the region’s i ts contractual environment— institutions— n top high- e nd entrepreneurs— amely, large m ight simultaneously affect firms’ access formal enterprises that compete in global to credit and innovation. Young firms con- - markets through exports of goods and capi sidering whether to invest in research and tal. They show that LAC economies tend to development (R&D) to develop new prod - - underperform in terms of export entrepre ucts or services might have access to credit - neurship and that multinational corpora in economies where intellectual property tions headquartered in LAC ( multilatinas ) rights are well established in law. Similarly, tend to be less innovative than similar firms an institutional and legal environment in elsewhere. which contracts are unevenly enforced or What should leaders and policy makers in economic transactions depend on informal LAC focus on? Where should they look for enforcement mechanisms might limit access insights into the fundamental drivers of both to finance for young firms and reduce risky e nd entrepreneurship and innovation by high- investments in innovation. A long history entrepreneurs in the region? Perhaps looking of macroeconomic and financial instabil - at the region’s laws and institutions is not a ity might undercut both the incentives to - bad place to start. This chapter examines ele innovate— y, for instance, widening the b ments that might be the cornerstones of an gap between downside risks and upside enabling environment to foster innovative potential— a nd the availability of suitable entrepreneurs. financial services for firms. Furthermore, in 06_ENTinLAC_141-152.indd 142 11/19/13 3:53 PM

161 i e nab L ing e nvironment for ard an nnovative e ntrepreneurs 143 t ow g F ure 6.1 A ctual and benchmarked access to credit by young I economic environments in which a few firms firms in selected countries enjoy economic rents because of the lack of antitrust laws or competition laws that lack teeth, one might observe little innovation, LAC countries Jamaica Honduras because high- e nd entrepreneurs might be Other countries Uzbekistan - able to make hefty profits with little innova Benchmark Suriname tive effort and would thus see little benefit Ukraine to changing the mix of products or services Kazakhstan Indonesia they offer. The numerous potential elements Grenada of an enabling environment for innovative Philippines entrepreneurship mean that any analysis St. Lucia Russian Federation must remain speculative but comprehensive. Dominica The following sections discuss potential Poland elements of such an enabling environment. Argentina Azerbaijan They cover a broad swath of economic and Mexico institutional characteristics, including access St. Vincent and the Grenadines to finance, intellectual property rights, con - Albania tractual certainty, competition in nontradable Moldova Latvia industries, competition in tradable industries, Armenia and human capital. The discussion focuses Hungary on each topic separately before summariz - Nicaragua Bulgaria ing the main findings of the benchmarking Romania exercises. Guatemala Colombia Turkey Access to finance by young firms Belarus El Salvador Entrepreneurs decide whether to invest in Antigua and Barbuda innovation and, if so, how much to invest. St. Kitts and Nevis Uruguay - A key consideration is the costs of the nec Dominican Republic essary investments in innovation (investment Lithuania in R&D). Financial markets play a role in Ecuador Trinidad and Tobago determining this cost. In some environments, Guyana young firms may be credit constrained or Croatia financial institutions may lend to them only Slovak Republic at exorbitant interest rates, thus raising the Macedonia, FYR Georgia costs of innovation investments. Lack of Bosnia and Herzegovina - access to financing was Shiller’s main obsta Serbia cle to commercializing his ideas. Paraguay Costa Rica To push the debate forward without offer - Chile s ing country- pecific policy prescriptions, we Venezuela, RB rely on simple international benchmarking. Slovenia 6 .1 presents evidence compiled from Figure Czech Republic Peru - the World Bank’s Enterprise Survey data Brazil base. It shows the percentage of surveyed Bolivia firms in each country that reported being 100 0 20 40 60 80 less than five years old and having access to Firms less than 5 years old (%) credit. The bars represent the actual share of firms that meet these criteria; the dots repre - World Bank, based on data from World Development Indicators and 2006– 1 Source: 0 World Bank Enterprise Surveys. sent the share of firms predicted by country Bars show the percentage of firms that are five years old or younger and have access to credit. Note: Dots show the predicted percentage of firms from a regression that includes (the log of ) population and gross domestic product (GDP) adjusted for purchasing power parity as explanatory variables. The regression used all available countries. The figure presents only comparator countries. LAC = Latin America and the Caribbean. 06_ENTinLAC_141-152.indd 143 11/19/13 3:53 PM

162 144 La a meric an e ntrepreneurs tin the problem may affect many developing characteristics. The LAC economies in the countries, not only countries in LAC. sample (the dark bars) tend to be above the median and in most cases near or above their predicted shares. Some notable exceptions Property rights and are several small Caribbean economies plus contractual certainty Jamaica and Mexico. The expected payoff from an investment in It is difficult to conclude that for the region as a whole, lack of access to finance innovation affects an entrepreneur’s deci - is a main driver of the underperformance in sion to take the necessary risk. It depends innovation. To be sure, as documented in on the probability of discovering a profitable - idea as well as on the ability of inventors to the World Bank’s flagship report on finan appropriate the commercial windfalls of their cial development in LAC (de la Torre, Ize, and Schmukler 2012), the region’s gap in investments in innovation. The most directly - bank credit to the private sector (relative to relevant set of laws and institutions is argu ably related to intellectual property rights a carefully constructed international bench - (IPRs) and contractual certainty. mark) is not only significant but appears to Laws and regulations define the number have been growing over the past 15 years. However, much of this gap appears to be and types of industries subject to IPRs, the number of international agreements on IPRs explained by LAC’s turbulent macro and to which a country is a signatory, and the financial history and by a shortage of prom - ising productive projects (that is, a shortage legal recourse available to patent holders in of innovation) rather than by credit ration- case of an alleged infringement of their IPRs. ide constraints per ing and credit supply- 6.2 displays the benchmarking of Figure se. s Park’s (2008) index of IPRs. This index is the Moreover, a relevant constraint for bank sum of five components: coverage of patents credit supply in LAC may be weaknesses in in eight industries; participation in five inter - - the contractual (rather than the informa tional) environment, and contractual weak - national IPR treaties; duration of protection nesses and property rights may be a common 0 2 (relative to a global standard, such as 15– factor that undermines both the supply of years for patents); the existence of up to three enforcement mechanisms; and the existence bank credit and entrepreneurial innovation, as discussed below. of up to three types of restrictions on patent rights. As of 2005, the Park index scores of Finance can come from various sources, all LAC countries in the sample except Chile not just from banks but also from venture - capital and capital markets. Chapter 3 dis - were below the median. Some of these coun tries appear to have de facto IPRs that exceed cussed recent data on the size and destination those predicted by their size and level of devel- of venture capital deals in LAC, concluding that such transactions are large and pursue opment, however. These countries include r - traditional (natural resource– (in ascending order of the index score) Haiti, elated) sec tors, presumably because expected profits are Jamaica, Bolivia, El Salvador, Colombia, Ecuador, and Argentina. Although LAC does high. Ongoing research by Didier, Levine, and Schmukler (2013) in a sample of six not underperform relative to the predicted lev - - - countries (Argentina, Brazil, Chile, Colom els of IPR protection, it lags comparator coun tries in actual terms, which may explain why bia, Mexico, and Peru) shows that firms e - that issue bonds or equity tend to be much it also lags in innovation by high- nd entre larger than those that do not (3,484 versus preneurs. The IPR policy area might therefore 859 employees on average). This relationship be a potentially fruitful avenue to explore. is also apparent in the authors’ global sample Intellectual property rights, however, of 51 countries, however. Thus, although it is are complex relative to other legal areas. d Hence, the establishment of well- plausible that financial markets do not meet efined and the financing needs of small and young firms, enforceable intellectual property rights is 06_ENTinLAC_141-152.indd 144 11/19/13 3:53 PM

163 t ard an e nab L ing e nvironment for i nnovative e ntrepreneurs 145 ow F I g ctual and benchmarked index of intellectual A ure 6.2 - inextricable from the quality and functional property rights in selected countries or economies, 2005 ity of the broader legal and judicial system. If there are deficits in the legal definition and enforcement of more tangible property rights, LAC countries Guyana Thailand the difficulties in setting up a suitable intel - Other countries Indonesia or economies lectual property right system are a fortiori Dominican Republic Costa Rica Benchmark going to be greater. Thus, fixing intellectual Paraguay Haiti property right regimes is in many cases likely Nicaragua to involve accompanying broader reforms to Saudi Arabia Honduras the legal and the judiciary frameworks. Grenada Guatemala Like the potential effects of IPRs on the Venezuela, RB expected payoff of investments in innovation, Peru Jamaica an economy’s contractual environment can Uruguay - affect economic incentives for private invest Bolivia El Salvador ments, including in R&D. The contractual Malaysia Brazil environment can also affect other elements Ukraine of the enabling environment for innovative Russian Federation Colombia entrepreneurship, such as access to finance. Ecuador - Figure 6.3 presents international com Trinidad and Tobago Hong Kong SAR, China parisons for an indicator of contract cer - India Mexico tainty from the International Country Risk Argentina Guide (ICRG), a private firm that assesses Lithuania Turkey the sources of country risk for international New Zealand China investors and other private sector clients. This Israel type of “expert” indicator is imperfect; it is Australia Norway used because it is difficult to find alternative Romania indicators of such a complex phenomenon. Philippines Poland Figure 6.3 suggests that LAC as a whole Slovak Republic Singapore does not underperform in terms of contract Chile certainty. It suggests that there are two types Greece Switzerland of LAC countries: those with high contract Spain Austria viability and those that underperform. The Czech Republic high contract viability group includes Chile, Korea, Rep. Portugal the Dominican Republic, Mexico, Trinidad Germany and Tobago, and Uruguay, among others. Hungary Bulgaria The underperformers include Brazil, Costa Sweden United Kingdom Rica, and El Salvador, among others. This Belgium bifurcated picture contrasts in part with France Canada the findings of the 2011 flagship report on Italy financial development in LAC (de la Torre, Japan Finland Ize, and Schmukler 2012), which identi - Ireland Denmark fies contractual weaknesses as an important Netherlands t erm driver of credit depth and access to long- United States - finance, which itself may affect entrepre 3 5 4 2 Park index (as of 2005) neurship. These nuances suggest that more research needs to be done to understand the World Bank, based on data from World Development Indicators and Park 2008. Source: complex and multifaceted relation between Bars show the 2005 Park index for each country. Dots show the predicted percentage of firms Note: the contractual environment (in particular from a regression that includes (the log of ) population and gross domestic product (GDP) adjusted for purchasing power parity as explanatory variables. The regression used all available countries. the governance side), access to finance, and The figure presents only comparator countries. LAC = Latin America and the Caribbean. entrepreneurship. 06_ENTinLAC_141-152.indd 145 11/19/13 3:53 PM

164 F I g A ure 6.3 ctual and benchmarked contract certainty in selected countries or economies, 2012 Competition in nontradable industries Venezuela, RB LAC countries Bolivia Other countries Argentina - Potential innovators assess the potential pay Portugal or economies Honduras off from innovation relative to the profits from Benchmark Haiti China continuing to produce the same set of prod - Belarus ucts or services with the same level of quality, Greece Ecuador technology, and management practices. When Indonesia Spain competitive pressures are low, enterprises may Peru Costa Rica choose to invest little in innovation, enjoying Hungary El Salvador the rents from market power. Although it is Italy Moldova - plausible that too much competition can actu Ukraine ally reduce incentives to innovate by firms, United Kingdom Slovenia especially for firms with low capabilities, it is Russian Federation Suriname likely that most of LAC suffers from too little Australia Kuwait competition (see chapter 3). Cuba Ireland This section benchmarks LAC economies Kazakhstan in terms of market concentration in indus - Guyana Serbia - tries that are arguably not subject to inter France Philippines national competition (the following section Brazil Bulgaria discusses the role of competition in trad - Romania India ables). The distinction between tradables and Latvia Austria nontradables is important. Domestic market Belgium concentration could be high in the sense that Slovak Republic Mexico few domestic firms participate in an industry, Paraguay Nicaragua but if domestic firms compete with imports, Armenia Turkey domestic market concentration would be a Colombia Thailand poor proxy for competition. To avoid this Lithuania Netherlands problem, we examine data from 17 sectors Czech Republic that seem to be nontradable service industries Albania Poland (and for which there is sufficient information Guatemala Jamaica across countries to conduct the benchmark - Dominican Republic 1 Denmark ing exercises). Finland 2 Saudi Arabia .4. LAC The results are shown in figure 6 Israel Japan - countries seem to have excessively concen Malaysia trated domestic markets in nontradables; Trinidad and Tobago Korea, Rep. most countries appear at the upper end of Croatia Norway the distribution of the market concentration Azerbaijan Uruguay index. Moreover, all but two LAC countries Hong Kong SAR, China Germany (Colombia and Brazil) exhibit average levels Oman Chile of market concentration that are higher than New Zealand the levels of countries with similar popula - Canada Switzerland tions and gross domestic products (GDPs). United States Singapore (Argentina appears to have a relatively Sweden low level of concentration, but it did not 3 1 4 2 appear in the regression analysis because ICRG index (as of 2012) of data limitations.) Consequently, lack of World Bank, based on data from World Development Indicators and the International Coun Source: - - competition appears to be a strong candi try Risk Guide (ICRG). date for explaining the region’s lackluster Bars show the 2012 contract viability index for each country, as reported by ICRG. Dots show Note: the benchmark predicted by a regression with (log of ) population and gross domestic product innovation. (GDP) adjusted for purchasing power parity as the explanatory variables. The regression used all available countries. The figure presents only comparator countries. Bolivia and República Bolivari - ana de Venezuela are not covered by the ICRG data. LAC = Latin America and the Caribbean. 146 06_ENTinLAC_141-152.indd 146 11/19/13 3:53 PM

165 nnovative nab L ing e nvironment for i e e ntrepreneurs 147 ard an t ow ure 6.4 A g F I ctual and benchmarked index of competition in Competition in tradables 17 nontradable industries in selected countries or economies - Some industries face competition from for - eign competitors. The literature on interna United States LAC countries tional trade and growth has tended to focus Bulgaria Other countries Romania on the ratio of international trade flows Poland or economies Canada (the sum of imports plus exports) to GDP. Benchmark Hungary Russian Federation This variable tends to rise with the share of Lithuania Czech Republic domestic consumption that is satisfied by Norway imports from abroad and with the share of Colombia Latvia domestic production sold to consumers in Korea, Rep. Japan u sually foreign countries. We use this ratio— Portugal United Kingdom called the “openness” ratio— s the proxy for a Switzerland Macedonia, FYR the extent of competition affecting tradable China industries. Italy Ireland Figure 6.5 benchmarks the region’s level Germany Croatia of openness as of 2012. By and large, LAC Serbia Belarus countries are either above the median coun - Thailand Spain try in the sample or have trade shares above Sweden - what is expected given their geographic char Austria Finland acteristics and size. There are two important Netherlands Argentina exceptions, Brazil and Colombia. Brazil has Greece Denmark the lowest level of openness in the sample; it Brazil ercentage is underperforming by about 3– 5 p Bosnia and Herzegovina Singapore - points of GDP. Two of its Mercosur (South Australia Belgium ern Cone Common Market) partners also Turkey Mexico appear to be unexceptional. Argentina seems France Philippines to have the level of trade that is expected Malaysia given its characteristics, and Uruguay should Moldova Israel be trading more than it was in 2012. Hence, New Zealand Kuwait it is potentially relevant for future research to Hong Kong SAR, China Ecuador assess whether the South American trading Kazakhstan Indonesia bloc could be opened further. Chile Colombia is an interesting case, as it Peru Albania belongs to the much touted recent trade ini - Saudi Arabia India Alianza tiative called the Pacific Alliance ( Uruguay Dominican Republic in Spanish). This initiative, del Pacifico, Oman Guatemala launched in 2012, includes Chile, Mexico, Bolivia and Peru. Chile and Mexico are extremely Jamaica United Arab Emirates - open to trade, given their geographic charac Paraguay Venezuela, RB - teristics and size. Peru is performing accord Trinidad and Tobago Nicaragua ing to expectations. The Alliance, however, is El Salvador Costa Rica supposed to be a group of countries oriented Honduras toward free trade and deep economic inte - 0.6 0.8 0.4 0 0.2 - gration. Colombia has become such a coun Herndahl index try, but only in recent years. Its free trade Source: World Bank, based on data from World Development Indicators and firm- l evel data from Orbis. agreement (FTA) with the United States was Note: Bars show the average Herfindahl index of concentration of revenues across a selection of approved by the U.S. Congress only in 2011. igit nonfinancial services sectors for which data were available for more than 80 countries. d two- - A value of 1 represents a market captured entirely by a single firm (the highest level of concentra Colombia also has an FTA with Canada, - 0. Dots rep 1 tion); lower values indicate less concentration. Revenues were averaged across 2007– resent a benchmark predicted value from a regression for each sector with (log of ) population and gross domestic product (GDP) adjusted for purchasing power parity as explanatory variables. The regression model was estimated for each of 17 sectors separately; the dots are the averages of all sectors. The regression used all available countries. The figure presents only comparator countries. LAC = Latin America and the Caribbean. 06_ENTinLAC_141-152.indd 147 11/19/13 3:53 PM

166 ctual and benchmarked index of openness to trade g ure 6.5 A F I in selected countries, 2012 LAC countries Brazil Japan Other countries United States India Zero-inated Poisson Argentina which was implemented in August 2011. An Australia Poisson FTA with the European Union was signed Colombia Uzbekistan Negative binomial in August 2013 but has not yet been imple - Russian Federation Philippines mented; an FTA with the Republic of Korea Greece Indonesia is expected by 2014. Hence, Colombia’s rapid China Venezuela, RB move toward free international trade is a Peru United Kingdom recent phenomenon that may take time to be Dominican Republic Turkey reflected in the data. Broadly speaking, how - Spain ever, LAC does not appear to systematically Italy France underperform in terms of openness. Thus, Norway Jamaica tradable industries are presumably facing Uruguay Canada - tougher competitive pressures than nontrad Guatemala Albania able industries. Kazakhstan Azerbaijan Armenia Turkmenistan Suriname Human capital for innovation Portugal Chile - The broad agenda of human capital forma Croatia Ecuador tion in LAC and elsewhere is well known Finland Denmark (see, for example, Aedo and Walker 2012). El Salvador Sweden A country’s stock of human capital is often Bolivia Switzerland measured by the average years of schooling of Mexico Paraguay the labor force (that is, the adult population). Haiti Because the quality of education also matters Bosnia and Herzegovina Serbia for economic performance, researchers often Germany Korea, Rep. look at evidence of quality of education, as Poland Georgia reflected in student scores on internationally Ukraine Honduras - standardized scholastic tests. The few coun Ireland Austria tries in the region that participate in such Moldova Trinidad and Tobago ncome i tests tend to perform below high- Nicaragua countries and a handful of fast- rowing g Malaysia Thailand emerging market countries. Macedonia, FYR Latvia Human capital for entrepreneurship and Costa Rica Guyana innovation needs to be assessed with some Bulgaria Slovenia - nuance, as it only partially overlaps with gen Belarus Lithuania eral curricula, as discussed in chapter 3. Since Czech Republic at least the early 20th century, LAC has had a Netherlands Hungary relatively low number of engineers per capita. Slovak Republic Belgium More recent data from UNESCO (United 0 150 200 100 50 Nations Educational, Scientific, and Cultural % of GDP Organization) show the average number of - engineers per capita from 2008 to 2010 (fig - World Bank, based on data from International Monetary Fund; Rose 2004; World Develop Source: ure 6.6). The few LAC countries included ment Indicators; and Penn World Tables 7.1. Bars show the openness ratio, calculated as the sum of exports and imports of merchandise Note: all have fewer engineers than the median over GDP. Dots are benchmarks predicted by the gravity model of openness proposed by Frankel country and fewer than expected given their and Romer (1999). The regression included the following explanatory variables: log of the area of the reporting country, log of the area of the partner country, landlocked, common border, and inter - level of development. This finding holds even action with border. Fitted values of openness are the sum across partner countries. Models exclude a for the region’s relatively large middle- nd the following economies: (a) Liberia; Hong Kong SAR, China; and Singapore (outliers); (b) major oil producers with production exceeding 200,000 barrels of oil per day in 1985 (following Alcala and i high- ncome countries, such as Brazil, Chile, Ciccone 2004): Angola, Gabon, Congo, Iraq, Oman, Kuwait, Qatar, Saudi Arabia, and the United 3 Indeed, if these Colombia, and Mexico. Arab Emirates; and (c) countries with populations of less than 500,000. Following Santos Silva and Tenreyro (2006) on the estimation of the gravity model of trade, the figure includes benchmarks limited data are reflective of the region as a i nflated Poisson, Poisson, and negative binomial. LAC = Latin America from three estimators: zero- whole, this constraint may be the single most and the Caribbean. 148 06_ENTinLAC_141-152.indd 148 11/19/13 3:53 PM

167 i e nab L ing e nvironment for ard an nnovative e ntrepreneurs 149 t ow g F ure 6.6 A ctual and benchmarked share of I important barrier to innovative entrepreneur - 0 1 engineers in selected countries, 2008– ship found in this brief empirical tour. What factors underlie the inclination of - LAC students toward nonscientific stud LAC countries Honduras ies? Two stand out: path dependency and Other Guyana countries the broader socioeconomic context. For his - Uruguay Benchmark torical reasons, LAC universities have been El Salvador Brazil locked into an emphasis on the humanities Argentina and law, as well as social, economic, and Indonesia political fields. This tendency may constrain Colombia the ability to switch rapidly to educating Mexico more engineers and scientists. Such a switch Serbia would require very aggressive public policy, Saudi Arabia such as the United States adopted when it Chile - developed mining and engineering stud Turkey ies in the early 20th century. Young people Hungary may be attracted to fields of studies that are Netherlands relevant to pressing problems faced by their Armenia societies, which may explain why LAC may Norway have formed more macro than micro econo - United States Latvia mists and sociologists. Given the progress the Croatia region has made in taming macroinstability, Sweden there may be more incentives for students to Bulgaria embark on scientific careers. Belgium Greece What explains the Germany Denmark region’s innovation gap? Japan The leading suspects Malaysia At least 13 LAC economies underperform Portugal in terms of patenting activity (see chapter 3). Austria Table 6.1 indicates the areas in which each Lithuania country underperforms relative to both the Poland Slovenia median in the global sample and the expected Switzerland level of performance given its size and level Spain s of development, among other issue- pecific Czech Republic relevant factors. New Zealand The first place to look is human capital. Slovak Republic The evidence is not ironclad; because of the Ireland 13 LAC economies that have a deficit in inno - Finland - vation (measured by their patenting activ Ukraine ity), data are available for only 6. But all six Thailand countries exhibit a deficit in the number of 10 20 30 0 engineers per capita. (Honduras, which does Engineering graduates per million not have a deficit in patenting, because of its inhabitants, ages 15–24 relatively low GDP per capita, also has a defi - cit in engineers.) Source: World Bank, based on data from World Development Indicators and UNESCO. Another place to look is competition. Note: Bars show average number of engineering graduates per million Of the 13 countries with a deficit in inno - - 4. Dots show the benchmark predicted by a regres 2 inhabitants, ages 15– sion with (the log of ) population and gross domestic product (GDP) vation, 10 have a deficit in competition in adjusted for purchasing power parity as the explanatory variables. The regression used all available countries. The figure presents only compara - tor countries. LAC = Latin America and the Caribbean. 06_ENTinLAC_141-152.indd 149 11/19/13 3:53 PM

168 an 150 tin a meric La e ntrepreneurs A b le 6.1 F actors that may account for innovation deficits in 13 countries in l a tin American and the Caribbean, 2005 T Human capital for innovation (number of Competition Competition in Access to engineers per in tradables Intellectual Contractual a certainty nontradables finance (openness) Patenting Country capita) property rights Bolivia 0 0 1 0 1 — 1 1 1 0 1 razil B 1 0 1 1 Chile 1 0 0 0 0 1 Colombia 1 0 0 1 0 1 1 Dominican 1 Republic 1 — 1 0 1 0 1 E — 0 0 0 0 1 cuador 0 l Salvador E 0 1 1 0 1 1 Guatemala 1 0 1 0 1 1 — M exico 1 1 0 0 1 1 1 Paraguay 1 0 1 0 0 1 — — 1 0 1 ru Pe 0 1 1 U 1 0 1 0 1 1 1 ruguay 1 Venezuela, RB 1 0 — 1 1 1 Note: A 1 indicates a variable in which a country is below the median country and below the level predicted by its level of development and size or other benchmarking explanatory .7). The median country is calculated within the sample of Latin American and Caribbean and comparator countries; samples vary with data variables (see notes to figures 6.1– 6 availability. — ot available. = N a. A value of 1 on this measure indicates only that the country is below the predicted level. nontradable industries. This finding is in about why it has so many entrepreneurs stark contrast with openness, in which only 6 and so little innovation. Issues that warrant examination include human capital, competi - have a deficit. Simply put, the challenge lies in enhancing the level of competition in sectors tion, and intellectual property rights. - that are not exposed to international compe tition. This implication is consistent with the Notes call in chapter 3 to take a second look at the The 17 sectors are electricity 1. , gas, steam, and unfinished agenda of competition policy in air conditioning supply; construction of build- the region. ings; civil engineering; specialized construc- A third element of the enabling environ - tion activities; wholesale and retail trade and ment that might pose obstacles for innova - repair of motor vehicles and motorcycles; tion is IPRs. Of the 13 countries with a deficit wholesale trade, except of motor vehicles and in innovation, 8 lagged in IPR protection. motorcycles; retail trade, except of motor More research needs to be undertaken to vehicles and motorcycles; land transport and transport via pipelines; air transport; ware- understand how contractual enforcement - housing and support activities for transpor and viability may affect access to credit and tation; accommodation; telecommunications; entrepreneurship. Although the ICRG indica - insurance, reinsurance, and pension funding, tors indicate that the region is not necessarily except compulsory social security; real estate underperforming in contract viability, other activities; architectural and engineering activi- research finds that contractual weaknesses ties; technical testing and analysis; other pro- - are an obstacle to access to finance. The spe fessional, scientific, and technical activities; cific aspects that indicators measure therefore and travel agency, tour operator, reservation matter; it may be too generic to speak about service, and related activities. “contract viability.” These findings should be interpreted with 2. Our hope is that the evidence presented some caution, because the concentration indicators were constructed from the Orbis in this report will feed debate in the region 06_ENTinLAC_141-152.indd 150 11/19/13 3:53 PM

169 ard an e nab L ing e nvironment for i nnovative e ntrepreneurs ow 151 t de la Torre, A., A. Ize, and S. L. Schmukler. 2012. - level database, which contains informa firm- Financial Development in Latin America and tion for all firms on which it collects data. - Washing the Caribbean: The Road Ahead. Sample selection biases could play a role in ton, DC: World Bank. the ranking, as better and more numerous Didier, T., R. Levine, and S. Schmukler. 2013. data may have been collected in some coun- “Finance and Growth for Whom?” World tries than in others. To cope with this poten- Bank, Washington, DC. tial risk, we averaged revenues for each firm Enterprise Surveys (database). World Bank Group, between 2007 and 2010 (which increases the Washington, DC. http://www.enterprisesurveys likelihood that a firm was sampled in these .org /. four years); we included only firms with rev- Frankel, J., and D. Romer. 1999. “Does Trade enues of more than $1 million (which are Cause Growth?” American Economic Review more likely to be surveyed); and we included 9. 9 89 (3): 379– only countries for which information was Park, W. 2008. “International Patent Protection, available for at least 30 firms (thus dropping 20 05.” 6. 1960 – 6 37: 761– Research Policy several Caribbean countries). However, some Penn World Tables Version 7.1 (database). Center measurement errors and selection biases may for International Comparisons of Production, persist. The selection of firms with revenues of Income and Prices, University of Pennsylvania, more than $1 million does not seem to affect h ttps://pwt.sas.upenn.edu Philadelphia, PA. concentration much: in LAC, for instance, /php_site/pwt_index.php. the correlation between the Herfindahl index Rose, A. K. 2004. “Do We Really Know That the with all firms in Orbis and only firms with WTO Increases Trade?” American Economic more than $1 million in revenues is 0.95. Review 94 (1): 98– 14. 1 Chile was reclassified as a high- 3. income coun - Santos Silva, J. M. C., and S. Tenreyro. 2006. try in 2013. “The Log of Gravity.” Review of Economics 88 (4): 641– 8. and Statistics 5 - Shiller, R. S. 2013. “Why Innovation Is Still Capi References A u g u s t New York Times, talism’s Star.” 17. World Development Indicators (database). World Aedo, C., and I. Walker. 2012. Skills for the 21st Bank, Washington, DC. http://data.worldbank - Century in Latin America and the Carib .org/data- catalog/world- development bean. Washington, DC: World Bank. - indicators. - Alcala, F., and A. Ciccone. 2004. “Trade and Pro Quarterly Journal of Economics duc tivit y.” 119 (2): 612 – 4 5. 06_ENTinLAC_141-152.indd 151 11/19/13 3:53 PM

170 ECO-AUDIT Environmental Benefits Statement The World Bank is committed to pre- Saved: serving endangered forests and natural • 6 trees resources. Latin American Entrepre- • 2 million BTUs of neurs: Many Firms but Little Innova- total energy tion is printed on recycled paper with 543 pounds of net • 30 percent postconsumer fiber in accord- greenhouse gases ance with the recommended standards • 2,945 gallons of for paper usage set by the Green Press waste water Initiative, a nonprofit program sup- • 198 pounds of porting publishers in using fiber that solid waste is not sourced from endangered for - ests. For more information, visit www .greenpressinitiative.org. 06_ENTinLAC_141-152.indd 152 11/19/13 3:53 PM

171 FM_main_ENTinLAC_i-xvi.indd 2 11/21/13 5:30 PM

172 ntrepreneurship is a fundamental driver of growth, development, and job creation. While Latin America and E the Caribbean has a wealth of entrepreneurs, firms in the region, compared to those in other regions, are small in size and less likely to grow or innovate. Productivity growth has remained lackluster for decades, including during the recent commodity boom. Enhancing the creation of good jobs and accelerating productivity growth in the region will require dynamic entrepreneurs. Latin American Entrepreneurs: Many Firms but Little Innovation studies the landscape of entrepreneurship in Latin America and the Caribbean. Utilizing new datasets that cover issues such as firm creation, firm dynamics, export decisions, and the behavior of multinational corporations, the book synthesizes the results of a comprehensive analysis of the status, prospects, and challenges of entrepreneurship in the region. Useful tools and information are provided to help policy makers and practitioners identify policy areas governments can explore to enhance innovation and encourage high-growth, transformational entrepreneurship. ISBN 978-1-4648-0012-2 90000 9 781464 800122 SKU 210012

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