LATIN AMERICAN ENTREPRENEURS MANY FIRMS BUT LITTLE INNOVATION

Daniel Lederman, Julián MessinaSamuel Pienknagura, Jamele Rigolini

Office of the Chief Economistfor Latin America and the Caribbean

2

Development is intimately related to occupational change – the generation of wage employment

What is the role of entrepreneurs in this process?

3

More than half of Latin American income-earners are employed in small firms, most of which are informal…

UruguayChile

ArgentinaCosta Rica

MexicoBrazil

LACDominican Rep.

HondurasEcuador

ColombiaParaguay

Peru

0 25 50 75 100

Informal (5 employees or less)

Formal (5 employees or less)

Informal (> 5 employees)

Formal (> 5 employees)

Employment by firm size and formality status, circa 2010

4

…which has understandably led to a policy focus on supporting small firms’ growth and formalization

UruguayChile

ArgentinaCosta Rica

MexicoBrazil

LACDominican Rep.

HondurasEcuador

ColombiaParaguay

Peru

0 25 50 75 100

Informal (5 employees or less)

Formal (5 employees or less)

Informal (> 5 employees)

Formal (> 5 employees)

5

Yet, contrary to popular belief, small firms are also common in the formal sector…

Size Distribution of Formal Firms, 2011

Eastern Europe

East Asian MICs

High Income

China

Caribbean

Other LAC

LAC-5

India

0 25 50 75 100

0 empleados 1 a 5 empleados 6 a 50 empleados

50+ empleados

6

…and the increase in formal jobs is associated with the expansion of large firms (not the formalization of small ones)

Bolivia

PeruCosta RicaParaguay

BrazilArgentina

Mexico

El Salvador

Chile

Source: Lederman, Maloney, and Messina (2013).

Formal Workers and Growth of Large firms, 2000-2010

-0.10

Chan

ge in

the

shar

e of

form

al e

mpl

oyee

s (in

p.p

.)20

00-2

010

Change in the share of employees working in large firms (>20 employees, in p.p.)2000-2010

10

8

6

4

2

0

-2

-4

-6-8

-10

-12

-0.08 -0.06 -0.04 -0.02 0.0 0.02 0.04 0.06 0.08 0.10

7

It is indeed the case that size matters: Innovation & wages

Medium and Large over Small (formal, manufacturing) Firms in LAC, 2010

Marginal effect (%)

Labor productivity

0 10 20 30 40 50

Exporter

Exports share

Invested R&D

Patent abroad

Patent, trademark, or copyright

New or significantly improved process

New products introduced

Tech. from a foreign-owned company

Cooperates on innovation

Large firms

Medium firms

95% confidence intervalPatent in country

In LAC, large firms pay, on average, 60 percent higher wages than small firms

8

Should we shift emphasis from small/low-growth to high-end/high-growth entrepreneurs that generate good jobs?

Uruguay

0 25 50 75 100

Informal (5 employees or less)

Formal (5 employees or less)

Informal (> 5 employees)

Formal (> 5 employees)

Employment by firm size and formality status, circa 2010

ChileArgentinaCosta Rica

MexicoBrazil

LACDominican Rep.

HondurasEcuador

ColombiaParaguay

Peru

9

What we mean by “high-end entrepreneurs”

• The introduction of a new good or a new quality good,• the introduction of a new method of production,• the opening of a new market,• the conquest of a new source of supply

of raw materials or half-manufactured goods,• the carrying out of the new organization of any industry.

We follow Schumpeter (1911):

10

Message 1. Numerous small firms reflect a deeper problem: large firms do not generate enough good jobs

East Asian MICs

Eastern Europe

LAC

33

35

33

23

After 40 years

170

220

255

110

High Income

Size at birth

Non

-ag

Empl

oyer

(%)

ln(GDP ppp per capita)

8

6

4

2

0

6 7 8 9 10 11

11

The problem is not in the number of enterprises – LAC is a region of employers …

Non Agricultural Employers vs. GDP per capita (ppp), 2010

LAC-4 3.5Hungary 4Poland 1Portugal 4

Share of Employers

12

…but they do not generate enough good jobs

Non Agricultural Wage and Salaried vs. GDP per capita (ppp), 2010N

on-a

g W

age

and

Sala

ried

(%)

ln(GDP ppp per capita)

100

80

60

40

20

0

6 7 8 9 10 11

Share of Employees LAC-4 55Hungary 84Poland 73Portugal 81

13

Message 2. Age matters more than size … for job creation by firms

Hence, need to rebalance SME programs towards younger firms?

Employment growth in Colombia, 1993-2008 Continuers (abstracting from entry/exit)

Gro

wth

rate

s

-.05

0

.05

.1

Small Medium Large

0 to 4 years 5 to 9 years 10 to 14 years

15+ years All

14

Message 3. Formal firms have an innovation deficit in various dimensions, including low product innovation…

Percentage of Firms that Developed or Introduced a New Product, 2010

St.

Luci

aJa

mai

caN

icar

agua

Mex

ico

Trin

idad

and

Tob

ago

Ecu

ador

Mal

aysi

aE

l Sal

vado

rU

rugu

ayR

oman

iaB

oliv

iaC

osta

Ric

aP

arag

uay

Gre

ece

Tur

key

Sur

inam

eK

orea

, Rep

.G

rena

daG

erm

any

Irel

and

Hun

gary

Pol

and

Slo

vak

Rep

ublic

Tha

iland

Ser

bia

Cze

ch R

epub

licA

rmen

iaS

love

nia

Bel

arus

0%

20%

40%

60%

80%

100%

15

…low R&D investment (which in LAC is mostly public)…

R&D by Region, 2008-2010

0.00

0.50

1.00

1.50

2.00

2.50Business Enterprise Government Higher EducationPrivate Non-Profit Abroad

LAC-5 China High Income

Perc

enta

ge o

f GD

P

Other LAC Eastern Europe

Brazil might be an exception: R&D above 1% and above prediction…

16

… subpar management practices…

• Operation Management• Performance Monitoring• Target Management• Talent Management

Four Management Categories:

Management Scores Across Countries, circa 2010(manufacturing firms with 100-5000 employees)

2.6

2.8

3

3.2

3.4

Aver

age

Man

agem

ent S

core

IndiaBrazil

ChinaGreece

Chile

Argentina

Republic of Ireland

Portugal

New Zealand

Northern IrelandPoland

MexicoAustra

liaFrance

Italy

Great Britain

CanadaSweden

GermanyJapan

United States

…not just at the bottom but across the entire distribution …

0

0.2

0.4

0.6

Densi

ty

1 2 3 4 5Management

USABrazil

17

Management Scores in Brazil and USA, circa 2010

18

…and uninspiring patent production

Number of Patents per 1 Million People (Average number of patents granted between 2006-2010)

1

10

100

1000

10000

Uzb

ekist

anH

aiti

Boliv

iaPa

ragu

ayAl

bani

aEl

Sal

vado

rIn

done

siaH

ondu

ras

Kaza

khst

anBo

snia

and

Her

zego

vina

Gua

tem

ala

Peru

Azer

baija

nCo

lom

bia

Ecua

dor

Mac

edon

ia, F

YRDo

min

ican

Rep

ublic

Phili

ppin

esU

krai

neTu

rkey

Vene

zuel

a, R

BSe

rbia

Bela

rus

Geo

rgia

Om

anIn

dia

Thai

land

Arm

enia

Mex

ico

Jam

aica

Braz

ilU

rugu

ayU

nite

d Ar

ab E

mira

tes

Arge

ntina

Saud

i Ara

bia

Latv

iaPo

land

Chile

Russ

ian

Fede

ratio

nCh

ina

Trin

idad

and

Tob

ago

Port

ugal

Slov

ak R

epub

licLi

thua

nia

St. K

itts a

nd N

evis

Gre

ece

Croa

tiaCo

sta

Rica

Bulg

aria

Kuw

ait

Antig

ua a

nd B

arbu

daCz

ech

Repu

blic

Mal

aysia

Hun

gary

Spai

nSl

oven

iaIta

lyN

ew Z

eala

ndIre

land

Fran

ceN

orw

ayBe

lgiu

mU

nite

d Ki

ngdo

mAu

stra

liaAu

stria

Hon

g Ko

ng S

AR, C

hina

Sing

apor

eN

ethe

rland

sDe

nmar

kCa

nada

Ger

man

ySw

eden

Finl

and

Kore

a, R

ep.

Switz

erla

ndIs

rael

Japa

n

Pate

nts

per 1

mill

ion

peop

le

19

Message 4. Even our superstar firms innovate little, as evidenced by the low average entry into export markets...

Not due to specialization in extractive industries: the result compares entry rates in similar sectors

Rela

tive

entr

y ra

tes

with

resp

ect t

o be

nchm

ark

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

0.2

Conditional relative entry rates to export markets, 2005-2009

20

…except when against the ropes, suggesting insufficient incentives to grow and innovate in normal times

Decomposition 2005-2007 Decomposition 2008-2009

Export Growth Components in Different Countries

-.1

0.1

.2.3

.4

A.Natural Resource B.Simple Processing C.Broad Manufactures

Chile

Peru

Ecu

ador

Sou

th A

fric

aC

osta

Ric

a

Nic

ara

gua

Ban

gla

des

hC

ambod

iaG

uat

emala

Dom

inic

an R

epEl S

alva

dor

Egyp

t

Bra

zil

Mex

ico

LA

C a

vera

ge

-.2

-.1

0.1

.2.3

A.Natural Resource B.Simple Processing C.Broad Manufactures

Ecu

ador

Cos

ta R

ica

Peru

Col

ombia

Chile

Sou

th A

fric

a

Cam

bod

iaBan

gla

des

hN

icar

agua

Guat

emal

aD

omin

ican

Rep

El S

alva

dor

Egyp

tBra

zil

Mex

ico

LA

C A

vera

ge

Incumbents EntrantsExiters

Expo

rt G

row

th R

ates

High Income

China East Asian MICs

Eastern Europe

LAC-5 India0

0.5

1

1.5

2

2.5

3

21

While multilatinas perform better than other local firms, they are less innovative than MNCs from other EMs…

R&D by Multinationals Across Regions, 2010-2011

R&D

Exp

endi

ture

per

US$

1000

of R

even

ue

Management Practices Across LAC- Local firms, “Multilatinas”, and Foreign-owned firms

01

23

40

12

34

No multin

ational

Domestic Mult.

Foreign Mult.

No multin

ational

Domestic Mult.

Foreign Mult.

No multin

ational

Domestic Mult.

Foreign Mult.

No multin

ational

Domestic Mult.

Foreign Mult.

No multin

ational

Domestic Mult.

Foreign Mult.

Argentina Brazil Chile

Mexico United States

Mean M

anagem

ent

Sco

re

22

…and the main motivation for multilatinas to go abroad is not to connect to global value chains

23

And while MNCs can bring significant productivity gains to LAC via learning spillovers and technology diffusion…

High Income China ECA LAC50.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

Knowledge Spillover Market Reallocation

in p

erc

en

tag

e p

oin

ts

Source: Alfaro & Chen (2013)

24

…the MNCs that operate in LAC are less innovative than similar ones operating in East Asia or Eastern Europe

Percent of Foreign MNCs Introducing a New Product, circa 2010

0

10

20

30

40

50

60

70

80

90

100

In p

erce

nt

Caribbean Other LAC LAC-5 East Asian MICs

Eastern Europe

High-Income

25

Summing up: Some encouraging trends and policy developments in LAC…

Trends• LAC’s a region of entrepreneurs• The emergence of Multilatinas and high potential benefits from

MNC activity• Strong export responses under adverse circumstances

Policies• Effective export and investment promotion agencies• The emergence of empowered competition agencies• Awareness and policy experimentation (Star-up Chile, policy

evaluation through randomized experiments)

26

…but the challenge is great, as the innovation gap is structural and goes beyond culture and individuals

• We seem to be barking up the wrong tree• LAC’s main problem is not one of lack of entrepreneurs…

• …and LAC’s main challenge is not to formalize micro firms

• LAC’s main problem is the low generation of good jobs, hence our main challenge is to find strategies to push LAC firms to grow and innovate

• Innovation gap is structural; goes beyond individuals & culture • Even foreign MNCs are less innovative in LAC than they are in other middle income

regions

• Tailor solutions to country characteristics – no silver bullets

27

The innovation deficit and its potential correlates

Country Patenting Access tofinance

Intellectualproperty

rightsContractual

certaintyCompetitionin tradables(openness)

Competition innontradables

Human capitalfor innovation

(number ofengineers per

capita)

Bolivia 1 0 0 1 0 1 -

Brazil 1 0 1 1 1 0 1

Chile 1 0 0 0 0 1 1

Colombia 1 1 0 0 1 0 1

Dominican Republic 1 0 1 0 1 1 -

Ecuador 1 0 0 1 0 0 -

El Salvador 1 0 0 1 0 1 1

Guatemala 1 0 1 0 1 1 -

Mexico 1 1 1 0 0 1 1

Paraguay 1 0 1 0 0 1 -

Peru 1 0 1 1 0 1 -

Uruguay 1 0 1 0 1 1 1

Venezuela 1 0 1 1 1 1 -

28

Area 1: Low competition in (17) non-tradable sectors, but Brazil might be different …

0

0.2

0.4

0.6

0.8

Herf

ind

ahl in

dex

Unit

ed

Sta

tes

Bulg

ari

aR

om

ania

Pola

nd

Canad

aH

ung

ary

Russ

ian F

ed

era

tion

Lith

uania

Cze

ch R

ep

ub

licN

orw

ay

Colo

mb

iaLa

tvia

Kore

a, R

ep

.Ja

pan

Port

ug

al

Unit

ed

Kin

gd

om

Sw

itze

rland

Mace

donia

, FY

RC

hin

aIt

aly

Irela

nd

Germ

any

Cro

ati

aS

erb

iaB

ela

rus

Thaila

nd

Sp

ain

Sw

ed

en

Aust

ria

Finla

nd

Neth

erl

and

sA

rgenti

na

Gre

ece

Denm

ark

Bra

zil

Bosn

ia a

nd

Herz

eg

ovin

aS

ing

ap

ore

Aust

ralia

Belg

ium

Turk

ey

Mexic

oFr

ance

Phili

pp

ines

Mala

ysi

aM

old

ova

Isra

el

New

Zeala

nd

Kuw

ait

Hong

Kong

SA

R, C

hin

aEcu

ad

or

Kaza

khst

an

Ind

onesi

aC

hile

Peru

Alb

ania

Saud

i A

rab

iaIn

dia

Uru

guay

Dom

inic

an R

ep

ub

licO

man

Guate

mala

Boliv

iaJa

maic

aU

nit

ed

Ara

b E

mir

ate

sPa

rag

uay

Venezu

ela

, R

BTr

inid

ad

and

Tob

ag

oN

icara

gua

El S

alv

ad

or

Cost

a R

ica

Hond

ura

s

29

Area 2: Deficit in innovation-friendly human capital, where Brazil appears with a glaring gap (like U.S., Norway…)

0

10

20

30

Gra

duate

s per

one t

housa

nd

inhabit

ants

aged

15

-24

Hond

ura

sG

uyana

Uru

guay

El S

alv

ad

or

Bra

zil

Arg

enti

na

Ind

onesi

aC

olo

mb

iaM

exic

oS

erb

iaS

aud

i A

rab

iaC

hile

Turk

ey

Hung

ary

Neth

erl

and

sA

rmenia

Norw

ay

Unit

ed

Sta

tes

Latv

iaC

roati

aS

wed

en

Bulg

ari

aB

elg

ium

Gre

ece

Germ

any

Denm

ark

Jap

an

Mala

ysi

aPo

rtug

al

Aust

ria

Lith

uania

Pola

nd

Slo

venia

Sw

itze

rland

Sp

ain

Cze

ch R

ep

ub

licN

ew

Zeala

nd

Slo

vak

Rep

ub

licIr

ela

nd

Finla

nd

Ukr

ain

eThaila

nd

30

Area 3: Low competition in tradables? Brazil might be different…

31

Area 4: IPRs – A complex area where law and economics intersect (and Park’s index from 2005)

1

2

3

4

Index

32

The innovation deficit and its correlates: The biggest gap might be the one between benchmarks and policies – let’s talk!

Country Patenting Access tofinance

Intellectualproperty

rightsContractual

certaintyCompetitionin tradables(openness)

Competition innontradables

Human capitalfor innovation

(number ofengineers per

capita)

Bolivia 1 0 0 1 0 1 -

Brazil 1 0 1 1 1 0 1

Chile 1 0 0 0 0 1 1

Colombia 1 1 0 0 1 0 1

Dominican Republic 1 0 1 0 1 1 -

Ecuador 1 0 0 1 0 0 -

El Salvador 1 0 0 1 0 1 1

Guatemala 1 0 1 0 1 1 -

Mexico 1 1 1 0 0 1 1

Paraguay 1 0 1 0 0 1 -

Peru 1 0 1 1 0 1 -

Uruguay 1 0 1 0 1 1 1

Venezuela 1 0 1 1 1 1 -

Do not forget Management Practices…

Thank you, obrigado!

The full report is available at:

http://go.worldbank.org/Z1D3AJFNP0