1. Entrepreneurship and Public Policy Lecture 3: Overview of current research on entrepreneurship and public policy

2. EPP – Lecture 3 -2 Spring 2009 Lecture Overview Themes in current research on entrepreneurship What we do not know Guidelines on empirical methods in entrepreneurship research Data resources

3. EPP – Lecture 3 -3 Spring 2009 Economic Analyses Can Help Inform Policy Makers About Entrepreneurship Economics theories and methods can help policymakers assess the costs and benefits of policies related to entrepreneurship Types of questions asked in the economics of entrepreneurship: –What is the link between entrepreneurship and job and economic growth? –What are the implications of credit rationing? –What are the implications of pro-entrepreneurship policies such as tax cuts, credit policies? –What are the characteristics of successful entrepreneurs? –Why are some groups less likely than others to start businesses? –Is entrepreneurship beneficial to society?

4. EPP – Lecture 3 -4 Spring 2009 Theoretical Economic Models Useful in Analyzing Entrepreneurship Occupational choice under uncertainty –Models assume entrepreneurs are different in either entrepreneurial ability, probability of success, or risk preferences Credit rationing, efficient investment, entrepreneurship and public policy –Models assume entrepreneurs differ in risk preferences (investment risk levels), expected return profiles, or wealth which limits the amount of funds they have access to Innovation, entry, exit and the evolution of industry –Entrepreneurial learning –Product life cycles

5. EPP – Lecture 3 -5 Spring 2009 Theoretical Economic Models Useful in Analyzing Entrepreneurship Occupational choice under uncertainty –Models assume entrepreneurs are different in either entrepreneurial ability, probability of success, or risk preferences Credit rationing, efficient investment, entrepreneurship and public policy –Models assume entrepreneurs differ in risk preferences (investment risk levels), expected return profiles, or wealth which limits the amount of funds they have access to Innovation, entry, exit and the evolution of industry –Entrepreneurial learning –Product life cycles

6. EPP – Lecture 3 -6 Spring 2009 Theoretical Economic Models Useful in Analyzing Entrepreneurship Occupational choice under uncertainty –Models assume entrepreneurs are different in either entrepreneurial ability, probability of success, or risk preferences Credit rationing, efficient investment, entrepreneurship and public policy –Models assume entrepreneurs differ in risk preferences (investment risk levels), expected return profiles, or wealth which limits the amount of funds they have access to Innovation, entry, exit and the evolution of industry –Entrepreneurial learning –Product life cycles

7. EPP – Lecture 3 -7 Spring 2009 Other Disciplines Provide Insights on Different Issues Sociology is interested in –How attributes of culture, social class and ethnic group produce entrepreneurial behavior –Role of social networks in entrepreneurship Psychology –Role of personality characteristics in entry into entrepreneurship and business success (need for achievement, innovativeness, competitive aggressiveness, autonomy) Management

8. EPP – Lecture 3 -8 Spring 2009 Theoretical Economic Model of Entrepreneurial Choice Individuals choose between wage and salary employment and self-employment to maximize earnings subject to a capital constraint –max(Y SE, Y W ) s.t. 0 ≤ k ≤ L(A) Wage and salary earnings are given by: Y W = w + rA w = market wage, r = interest rate, A = individual assets. Self-employment earnings are given by: Y SE = θf(k)ε + r(A-k) θ = entrepreneurial ability, f(.) = production function, ε = random component of production, and k is the amount of capital. Capital constraint: L(.) is a function defining maximum liquidity as a function of A

9. EPP – Lecture 3 -9 Spring 2009 First, Potential Entrepreneurs Determine the Optimal Level of Capital The profit maximizing level of capital, k*, satisfies the first- order condition θf ‘(k*) = r and rises with ability. If θ is sufficiently small, k* = 0. If k* > L(A) then the individual chooses k’ such that k’ = L(A). Model assumes that f(k) = k α, so self-employment income, Y SE = θk α ε+ r(A-k).

10. EPP – Lecture 3 -10 Spring 2009 Individual Chooses the Activity that Generates Higher Expected Earnings The individual chooses self-employment if this income level is higher than income from the wage and salary sector. Model works through cases for those who are liquidity constrained or not. An individual chooses self-employment if:

11. EPP – Lecture 3 -11 Spring 2009 Implications of the Model In the presence of liquidity constraints, workers with low asset levels are less likely to choose self-employment. –Their earnings in self-employment are more likely to be sub-optimal earnings in the self-employment sector. Rates of entry into self-employment that increase with assets is consistent with the existence of liquidity constraints. All else equal, lower wages and lower assets increase the likelihood of becoming an entrepreneur.

12. EPP – Lecture 3 -12 Spring 2009 Measuring Levels of Entrepreneurship in the U.S. Different measures of entrepreneurship are used in the literature –Proportion of American households owning a business –New employer firm creation per population –Rates of self employment –Rates of entry into self-employment

13. EPP – Lecture 3 -13 Spring 2009 Is U.S. Entrepreneurship Increasing? Conventional wisdom suggests that more and more people are becoming entrepreneurs Different measures provide a different perspective on whether entrepreneurship is increasing or decreasing –Proportion of American households owning a business declined from 14.2 percent to 11.5 percent between 1983 and 2004 –New employer firm creation per population has varied over time with no clear trend –Rates of self employment have been relatively stable at about 11 percent since 1989 Declines in unincorporated self-employment Increases in rates of incorporated self-employment

14. EPP – Lecture 3 -14 Spring 2009 Is U.S. Entrepreneurship Increasing? Conventional wisdom suggests that more and more people are becoming entrepreneurs Different measures provide a different perspective on whether entrepreneurship is increasing or decreasing –Proportion of American households owning a business declined from 14.2 percent to 11.5 percent between 1983 and 2004 –New employer firm creation per population has varied over time with no clear trend –Rates of self employment have been relatively stable at about 11 percent since 1989 Declines in unincorporated self-employment Increases in rates of incorporated self-employment

15. EPP – Lecture 3 -15 Spring 2009

16. EPP – Lecture 3 -16 Spring 2009

17. EPP – Lecture 3 -17 Spring 2009

18. EPP – Lecture 3 -18 Spring 2009 Empirical Analysis of Entrepreneurship Has Focused on Several Important Issues Entrepreneurship as a labor market choice –Who becomes an entrepreneur? –Factors driving entrepreneurial choice Transitions into and out of entrepreneurship –Relationship to education, age, wealth, race, gender, etc Outcomes of entrepreneurs –Which entrepreneurs succeed –Factors contributing to entrepreneurial success Correlational analyses of the relationships between entrepreneurship and macoreconomic outcomes

19. EPP – Lecture 3 -19 Spring 2009 Many Factors Have been Associated with the Entry into and Exit From Self-Employment Probability of switching into self-employment is independent of age and experience Probability of leaving self-employment decreases with duration in self-employment Fraction of labor force that is self-employed increases with age People with higher assets are more likely to switch into self- employment Poorer wage workers (i.e. unemployed, lower wage, frequent job changers) are more likely to enter self-employment African Americans and Latinos are less likely than Whites and Asian Americans to own a business; women are less likely than men

20. EPP – Lecture 3 -20 Spring 2009 There is Wide Variation in the Outcomes of New Businesses Most new firms fail –The typical entrepreneur exits self-employment within eight years –Of new businesses founded in 1992 50 percent survived until 1996 29 survived until 2002 Data are inconclusive on whether self-employed people earn more or less they would working for someone else On average, business owning households earn much more and have much higher net worth than non-business owning households

21. EPP – Lecture 3 -21 Spring 2009 There is Wide Variation in the Outcomes of New Businesses Most new firms fail –The typical entrepreneur exits self-employment within eight years –Of new businesses founded in 1992 50 percent survived until 1996 29 survived until 2002 Data are inconclusive on whether self-employed people earn more or less they would working for someone else On average, business owning households earn much more and have much higher net worth than non-business owning households

22. EPP – Lecture 3 -22 Spring 2009 Women Owned Businesses are Less Successful than Men Owned Ones Women comprise only 27% of U.S. business owners Smaller average sales ($87,585 in sales in 2002 vs $1,862,159 for businesses owned by men) Smaller employment (7.79 employees vs 12.04 employees for men owned businesses) Start-ups owned by women are less likely to grow over time Lower 4 year survival rate Female business owners are less likely to have had a self- employed family member prior to starting their business (50.6% v. 52%) and are less likely to have worked in a family business (19.4% v. 24%)

23. EPP – Lecture 3 -23 Spring 2009

24. EPP – Lecture 3 -24 Spring 2009

25. EPP – Lecture 3 -25 Spring 2009 There Are Significant Racial and Gender Disparities in Business Outcomes in the U.S. Businesses owned by African Americans have lower sales, profits, payrolls and have higher closure rates Businesses owned by Asian Americans (excluding the smallest businesses) have better outcomes Racial disparities in business outcomes have not improved over the past two decades

26. EPP – Lecture 3 -26 Spring 2009 These Racial Disparities Can Be Attributed to Several Sources Relative lack of success of Black-owned businesses is attributable to: –Lower levels of start-up capital –Disadvantaged family background (in terms of family members who are self-employed) –Lower educational attainment Relative success of businesses owned by Asian Americans attributable to: –Higher levels of start-up capital –Higher levels of education

27. EPP – Lecture 3 -27 Spring 2009

28. EPP – Lecture 3 -28 Spring 2009

29. EPP – Lecture 3 -29 Spring 2009 There is Wide Variation in the Outcomes of New Businesses Most new firms fail –The typical entrepreneur exits self-employment within eight years –Of new businesses founded in 1992 50 percent survived until 1996 29 survived until 2002 On average, self-employed people earn substantially less they would working for someone else On average, business owning households earn much more and have much higher net worth than non-business owning households –Differences driven by differences between the most successful in each group

30. EPP – Lecture 3 -30 Spring 2009 But Self-Employment May Provide Other Benefits to Individuals and Society Psychological benefits of self-employment : –Happiness –Flexibility in work schedules –Working on own terms –Business owners have higher savings rates and accumulate more wealth (Bradford, 2003) An avenue for economic advancement for less-educated workers. –More upward income mobility than low-income wage and salary workers (Holtz-Eakin, Rosen and Weathers 2000) –Faster earnings growth on average than wage and salary workers after a few initial years of slower growth (Fairlie 2004). An avenue for job creation in low-income and immigrant communities (Bates, 1993; Boston 1999,2006).

31. EPP – Lecture 3 -31 Spring 2009 Small and New Businesses May Play an Important Role in Job Creation The role of small firms in creating new jobs is an important factor driving policy makers’ support for small enterprises Small and new businesses make significant contributions to job creation –Between 1969 and 1976, firms employing under 20 workers generated 66% of all new US jobs; those with less than 100 employees accounted for 82% of net job gains (Birch, 1979) –More recent research has found similar results in the US and in other countries About 10 percent of new businesses ever grow –A very small number of new firms account for the growth described above

32. EPP – Lecture 3 -32 Spring 2009 Entrepreneurship May Generate Economic Growth Small and new firms are positively related to productivity growth –At the firm level –At the industry level –At the national level But it is not clear whether entrepreneurship causes economic growth or simply results from economic growth and change

33. EPP – Lecture 3 -33 Spring 2009 New Firms May Contribute to Innovation New firms that enter the market need to be more innovative and more productive to survive Existing firms that remain in the market need to be innovative to compete Evidence suggests smaller and younger firms are relatively more innovative than larger and older firms

34. EPP – Lecture 3 -34 Spring 2009 Yet, A Majority of New Firms Are Not on the Cutting Edge of Innovation In ordinary run-of-the-mill industries, not high-tech, technology intensive industries Are not innovative Are very small Few intend to grow Lack a competitive advantage Most are home based Most are in service industries

35. EPP – Lecture 3 -35 Spring 2009 Racial Disparities in U.S. Business Outcomes Have Potentially Important Policy Implications Total earnings inequality would decline by about 20% if the business outcomes of African Americans were on par with those of white Americans Business success could have important implications for minority employment –Forty percent of black and Latino employer firms hire 90 percent or more minority employees –A majority of the workforce at fast-growing Black-owned firms is Black

36. EPP – Lecture 3 -36 Spring 2009 Literature Explores how Public Policy Shapes New Business Creation and Survival Credit market and capital constraints Taxes Liability pressure Education Health insurance costs

37. EPP – Lecture 3 -37 Spring 2009 Lecture Overview Themes in current research on entrepreneurship What we do not know Guidelines on empirical methods in entrepreneurship research Data resources

38. EPP – Lecture 3 -38 Spring 2009 Entrepreneurship Policy Research Is Relatively Underdeveloped With Many Open Questions How can we distinguish new entrepreneurial firms from other new firms? How do government policies and regulation affect entrepreneurship? Does entrepreneurship create spillovers for the rest of the economy? What is the role of individual human capital? What determines labor supply of entrepreneurs? What is the role, if any, for pro-entrepreneurship government policies?

39. EPP – Lecture 3 -39 Spring 2009 Lecture Overview Themes in current research on entrepreneurship What we do not know Guidelines on empirical methods in entrepreneurship research Data resources

40. EPP – Lecture 3 -40 Spring 2009 Establishing the Policy Context is Critical What problem does a particular policy strive to address? –Define the policy context Key policy actors Consider relevant policy levels (I.e. national, state, local) Who are major stakeholders? Political viability –What are the objectives of the policy? –What are the cost-benefit trade-offs? What are the specific research questions that need to be answered?

41. EPP – Lecture 3 -41 Spring 2009 Empirical Approach Should Relate to Big Policy Picture Outcomes –Can we observe all outcomes important for policy makers? Consider both intended and unintended consequences –Do we observe changes in behavior of all agents affected by the policy? –Do we expect the short run response to differ from the long run response? Can we observe both? Policy Levers –What policies can be changed? –What behavior can be modified? Method –Is our method appropriate? Ex ante vs ex post policy analysis –Does our method estimate a causal effect of the policy change? –Does the analysis help evaluate performance of policies in achieving their objectives? –Connection to the theory

42. EPP – Lecture 3 -42 Spring 2009 Possible Issues in Empirical Studies Sample selection bias Unobserved heterogeneity Endogeneity Non-stationarity

43. EPP – Lecture 3 -43 Spring 2009 Nature of Outcome Variable May Determine a Choice of Approach Discrete Choice Models (logit, probit, multinomial choice models) –Selection into, or survival in, entrepreneurship Hazard Models –How long individuals remain in entrepreneurship Count Models (Poisson, negative binomial) –Explore number of firms in the market –Patenting behavior of firms Earnings functions, quantile regressions –Examine determinants of earnings Sample selection (Heckman) models –Self-employment earinings

44. EPP – Lecture 3 -44 Spring 2009 Causal Inferences May Rely On Specific Methods Difference-in-differences models –Often used to explore the effects of changes in state level policies –Derives causal estimates by comparing observations that were affected by changes in policies over time to those that were not Instrumental variables approach –Corrects for possible endogeneity in explanatory variables

45. EPP – Lecture 3 -45 Spring 2009 Lecture Overview Theoretical views on entrepreneurship Themes in current research on entrepreneurship What we do not know Guidelines on empirical methods in entrepreneurship research Data resources

46. EPP – Lecture 3 -46 Spring 2009 There Are Several Reviews of the Available Data on Entrepreneurship 2007 Kauffman Symposium on Entrepreneurship and Innovation Data –Provides documentation and description for 38 datasets –Online at http://www.ssrn.com/link/2007- Kauffman.html Haviland and Savych (2007) –Describes 24 datasets –Cites some research done with the data –Lists whether the dataset is publicly available

47. EPP – Lecture 3 -47 Spring 2009 Possible Concerns When Working with Entrepreneurship Data What measures of entrepreneurship are available? –Do these measures allow you to effectively address the policy issue under consideration What is the unit of observation? –Firm, establishment, or individual –How does the unit of observation relate to the policy issues? How reliable are these data? –Survey or administrative Is this a panel ? Can records can be linked longitudinally? Are the data publicly available?

48. EPP – Lecture 3 -48 Spring 2009 Examples of Available Datasets http://www.ssrn.com/link/2007-Kauffman.html Kauffman Firm Survey NBER Patent database County Business Patterns

49. EPP – Lecture 3 -49 Spring 2009 Discussion Policymakers are concerned that the current crisis in the financial markets will have a detrimental effect on entrepreneurship What specific problems or issues could one study empirically? What are some plausible outcomes related to entrepreneurship that one could relate to the economic crisis? What are plausible policy levers -- assuming evidence of an effect was found? What are the specific research questions that need to be answered? What methods could be used?