1 Entrepreneurship and Employment Michael Fritsch 3rd Summer School on “Knowledge Dynamics, Industry Evolution, and Economic Development”, Nice (France) July 11, 2014 Contact: Prof. Dr. Michael Fritsch, Friedrich Schiller University Jena, Carl-Zeiss-Str. 3, Room 5.12 Phone (03641) 9 – , Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, 2014

This lecture is based on Basic source: Fritsch, Michael (2013): New business formation and regional development - A Survey and Assessment of the Evidence. Foundations and Trends in Entrepreneurship, 9, 249–364. Recent research papers: Fritsch, Michael and Florian Noseleit (2013): Investigating the Anatomy of the Employment Effect of New Business Formation. Cambridge Journal of Economics, 37, Fritsch, Michael and Florian Noseleit (2013): Start-Ups, Long- and Short-Term Survivors, and their Contribution to Employment Growth. Journal of Evolutionary Economics, 23, 719–733. Fritsch, Michael and Florian Noseleit (2013): Indirect Employment Effects of New Business Formation Across Regions: The Role of Local Market Conditions. Papers in Regional Science, 92, Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11,

3 Main topics 1.Development of the research field 2.Theoretical and conceptual considerations 3.Results of empirical research 4.Implications for entrepreneurship policy 5.Avenues for further research Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, 2014

Joseph A. Schumpeter Schumpeter wanted to identify the sources of economic growth. He identified entrepreneurs who revolutionized the economy by introducing radical innovation. But these Schumpeterian entrepreneurs are very, very few! My question: What is the effect of new business formation in general on economic development? Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11,

5 The ‚Birch‘-debate Initiated by a study of David Birch: The Job Generation Process, Boston 1979: MIT (mimeo). Main statements of this study: Large firms in the USA have massively reduced employment during the 1970s. In the same time period small firms in the USA have created many new jobs. A relatively large contribution to employment growth came from the service sector and from new businesses. The Birch-Study induced many empirical analyses of job generation by small and new firms and a long-lasting debate about the role of small businesses, particularly new businesses, in the economy. Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, 2014

6 New business formation and the market process Start-ups or market entries Market process (selection) Exiting capacities: Decline or closure of incumbents New capacities : Development of new businesses Supply-side effects: Securing efficiency Acceleration of structural change Amplified innovation Greater variety Improved competitiveness Growth Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, 2014

New businesses Growth Incumbent firms Direct effect Indirect effect Direct and indirect effects of new businesses on growth Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Hypothesis: The indirect effect of new business formation is much larger and more important than the direct effect (= development of the start-ups).

Direct and indirect effects of new business formation on economic development A positive effect of new business formation on employment can only result from the supply-side effects which occur rather indirectly. If competition does not work according to a survival of the fittest scenario then the supply-side effect of new business formation can well be negative. Not all start-ups will have the same effect on economic growth. It is particularly those start-ups that exert a strong challenge on incumbents (e.g. innovative start-ups) that have a main effect on growth. The indirect effect will be the larger, the more productive / innovative the reaction of the incumbents. The effects may be rather different across industries and regions. Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11,

Factors that may determine the effect of new business formation on regional development Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11,

10 Approaches to analyze the effect of new firm formation on economic development empirically Cohort analysis. Correlation and regression analysis (cross section, longitudinal) of the relationship between new firm formation rate and growth at an industry level at a regional level Including new firm formation / entrepreneurship into a regional production function. Dependent variable: employment, GDP, productivity (for smaller regions the available information on employment is most reliable). Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, 2014

Number of firms Time Number of firms Number of exits Number of entries Net entry Shake out ‘Entrepreneurial‘ regime‘Routinized‘ regime Stylized paths in the numbers of entries, exits, and firms over the industry lifecycle Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11,

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Analyzing the lag-structure of the effect of new businesses on employment – basic approach (Fritsch & Mueller, 2004) Regional employment change (%) t0 = a + b 1 start-up rate t0 + b 2 start-up rate t-1 + b 3 start-up rate t-2 + b 4 start-up rate t-3 + … + b 11 start-up rate t-10 + c n X n + u X n = further determinants, u = stochastic error term Method: Fixed-effects panel regression.

13 Effects of new firm formation on employment change over time – third-order polynomial I II III New capacities Supply-side effects Exiting capacities Source: Fritsch and Mueller (2004). Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, 2014

14 Evolution of employment in entry cohorts (all private industries) Source: Schindele and Weyh (2011).

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Direct effect Regional data about employment cohorts of new businesses is used to analyze the direct effect. Largest impact on total employment change when the new businesses enter the market. Small positive contribution one year after start-up.Slightly negative impact in later periods.

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Indirect effects Empirical strategy: Regress employment change of incumbents on start-up rate of the year t=0 and of each of the preceding ten years (t-1 to t-10)  indirect effect Compute the average percentage employment change of the indirect effect “Reassemble” the overall effect

17 Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, 2014 Fritsch & Noseleit (2013): The employment effect of short- term and long-term survivors on regional growth

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Results and conclusions Indirect effects are quantitatively much larger than direct effects.  A large part of the “Birch-debate” was misleading. The effect may differ by type of start-up. Short-term survivors have no significant positive effect. The effect differs considerably by the size of the entry. Positive effects of new business formation on economic development occur with a considerable time-lag.  Long-term policy orientation needed! Policy should not interfere with the process of market selection.  No significant subsidization of new businesses after start-up! Presumably, the quality of start-ups with regard to challenging the incumbents is important for their effects.  Try to increase the quality of start-ups and/or focus on higher quality start-ups!

What makes the “quality” of a start-up? Tautological definition: The higher the challenge for the incumbents the higher the quality of the start-up. The quality of a new business is indicated by: Ex ante indicators: Innovativeness of the supplied goods and services (e.g., high tech manufacturing, knowledge intensive services, etc.) ; Qualification of the entrepreneur (e.g., academic start-ups); Main motivation for starting a business (e.g., ‘opportunity’ versus ‘necessity’ entrepreneurship; part time versus full time entrepreneurship); Growth ambitions (e.g., growth oriented versus non-growth oriented new businesses); 19 Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, 2014

What makes the “quality” of a start-up? (continued) Ex ante indicators (continued): Amount and quality of the employed resources (e.g. size of start-up, team start-up, ability to attract VC, …); Productivity of start-up as compared to incumbents; … Ex post indicators: Survival over a certain period of time; Growth (e.g. ‘gazelles), size, market share after a certain time period ; … 20 Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, 2014

21 The relationship between start-up rate and regional employment change Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, 2014

22 Effects of new firm formation on employment change in different types of region (West Germany) Source: Fritsch and Mueller (2008). Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, 2014

23 Impact of new firm formation on employment change – England vs. Scotland and Wales Source: Mueller, van Stel and Storey (2008). Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, 2014

24 The effect of new business formation on regional employment in urban and rural in the Netherlands Source: Van Stel & Suddle (2008)

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Regional differences I Direct effect

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Regional differences II Indirect effects

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Why Does the Effect of New Business Formation Differ Across Regions ? Estimation approach (Fritsch & Schroeter, 2011) E it =0 / E it-2 = a + b1 * average start-up rate it + b2 * average start-up rate2 it + b3 * control variable it + b4 * control variable it * average start-up rate it + b5 * control variable it + b6 * control variable it * average start-up rate it + b7 * average start-up rate in adjacent regions it + u. Pure cross-section regressions using regional average values.

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Marginal effect of start-ups on employment change Source: Fritsch & Schroeter (2011)

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Marginal effect of start-ups on employment change with different levels of population density Source: Fritsch & Schroeter (2011)

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, The Role of Local Market Conditions for the Indirect Employment Effects (Fritsch & Noseleit, 2013) Results The indirect employment effect of new business formation is more pronounced in areas with relatively high population density than in less density regions. in small business regions than in large business regions. in regions characterized by a high concordance between the industry structures of start-ups and local incumbents than in regions where the correspondence of the industry structure of newcomers and incumbent firms is relatively low. in small business regions where there is also high similarity between the industry structure of start-ups and incumbents than in large business regions with high similarity.

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Speculations: Why are the indirect effects so much higher in agglomerations ? Higher share of high quality start-ups in agglomerations because of higher qualification of the workforce? higher level of knowledge spillovers? higher level of cultural, technological and economic creativity? better supply of inputs? … Higher intensity of competition leading to higher quality of surviving start-ups and incumbents? − Could explain higher productivity and competitiveness of agglomerations. Competition on input or on output markets?

Safeguard that competition works according to a survival of the fittest. Do not interfere with this kind of selection. Focus on stimulating high quality start-ups. A main part of the measures for stimulating high-quality new businesses should be region-specific. A policy that aims at stimulating entrepreneurship needs a long- term perspective. … Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Policy Implications

Using other performance indicators than employment: GDP, productivity, innovation, … Analyzing direct employment effects / fast growing firms (gazelles) Identifying and analyzing the indirect effects of new business formation The effect of entries of different quality The role of new businesses for the generation and dissemination of innovation and knowledge (spin-offs) Universities and other research institutions as incubators (entrepreneurial university) The role of non-innovative entry Developing and analyzing indicators for the formation of growth- relevant new businesses Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Some avenues for further research

The role of the conditions on input and on output markets for the effects of new business formation on economic development Effects of entry on competition in input markets and output markets The role of the institutional environment The role of regional characteristics The role of the level of new business formation The role of the economic development level/ effects of new business formation on economic development in developing countries Entry as a cause or as a symptom of growth? Longer-run effects of new business formation on regional development Entrepreneurship policy (effectiveness, recommendations, etc.) Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Some avenues for further research (continued)

35 Thank you for your attention ! Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, 2014

36 The effect of new business formation on regional employment in US-MSAs (Acs & Mueller, 2008) Source: Acs & Mueller (2008) All start-ups

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, The effect of new business formation on regional employment in US-MSAs (Acs & Mueller, 2008) Source: Acs & Mueller (2008) Small start-ups

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, The effect of new business formation on regional employment in US-MSAs (Acs & Mueller, 2008) Source: Acs & Mueller (2008) Large start-ups

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Regression results for high and low population regions

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Regression results for regions with high and low shares of small business employment

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Regression results for high and low correspondence of industry structure between entries and incumbents

Fritsch: Entrepreneurship and Economic Development, 3rd KID Summer School, Nice, July 11, Regression results for small business regions