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The Entrepreneurship-Innovation Nexus in Development

by Wim Naudé, Adam Szirmai

Wim Naudé and Adam Szirmai

Nobody can be left in any doubt as to the importance of innovation for prosperity on reading[i] that ‘People living in the first decade of the twentieth century did not know modern dental and medical equipment, penicillin, bypass operations, safe births, control of genetically transmitted diseases, personal computers, compact discs, television sets, automobiles, opportunities for fast and cheap worldwide travel, affordable universities, central heating, air conditioning … Technological change has  transformed the quality of our lives.’

Photo: IRIN Photo
Photo: IRIN Photo


Despite this, most of the work on understanding the process of innovation and its relationship to public policy has been conducted in economies at more advanced stages of development. Several authors have even downplayed the importance of innovation for developing countries. In a similar fashion there has been a resurgence of interest in the role of entrepreneurship in innovation, employment creation and economic growth, but in this literature the primary focus is on the advanced economies.

In the UNU book ‘Entrepreneurship, Innovation and Economic Development’, to be published in April 2011 by Oxford University Press, we deal with these relatively neglected issues, and argue for a better understanding of the roles that entrepreneurs can play in innovation even in the poorest countries. The book focuses in particular on the entrepreneurship–innovation nexus in the context of development. In this article, we share some of the findings from the book.

Defining Innovation                                             

The Oxford Handbook of Innovation describes innovation as the putting into practice of inventions. In a narrow sense innovation refers to product and process innovations, or technological innovation. In a broader sense innovation is the development of new products, new processes, new sources of supply, as well as the creation and exploitation of new markets and the development of new ways to organize business.

Different types and degrees of innovation may take place across different stages of development. For instance, recently Acz and Szerb[i] have made a renewed case for the distinction between a factor-driven stage, an efficiency-driven stage, and an innovation-driven stage of development. Innovation may account for only 5 per cent of economic activity in factor-based economies. In the efficiency stage innovation becomes more important and could contribute to around 10 per cent of economic activity. Finally, in the innovation stage knowledge becomes the driver of growth as countries with firms already on the production possibility curve try to shift their curves out. Innovation can contribute to more than 30 per cent of economic activity.

Though these distinctions are useful, they understate the importance of innovation by entrepreneurial innovation in the factor-driven and efficiency stages of development. One reason is that one should distinguish between incremental innovations and more radical innovations, and between innovation that is new to a country or firm, and innovation that is new to the world. The former type of innovation is imitation, where developing country entrepreneurs adopt new products or processes from the rest of the world. Such innovation can play an important role in technological upgrading and increasing the utilization and the efficient allocation of production factors.

Another reason is that several developing countries have indeed experienced rapid economic catch-up—in a sense leapfrogging development. They were able to absorb and creatively adapt international technological knowledge and thus to achieve accelerated growth. Such adoption of existing technologies goes beyond mere imitation—it is an example of creative and innovative behaviour and examples are provided in our book. In Alice Amsden’s chapter (chapter 3) it is argued that privately owned domestic firms in East Asia were better at adopting and absorbing technologies from advanced economies than foreign owned firms. Erik Stam and André van Stel (chapter 4) highlight how adoption of foreign technology provides entrepreneurs with a potential to create new markets and contribute to structural change and self-discovery.

Entrepreneurship and Firms

Entrepreneurship refers to the discovery and exploitation of opportunities. It plays a potentially important role in development, including in cost discovery, gap filling, accumulation of human and physical capital, input completion, reallocation of resources from less productive to more productive resources, and supporting the process of structural change. In this book we focus in particularly on incentives, policies and institutions that liberate the productive potential of entrepreneurship in development. Here three strands of work on entrepreneurship are distinguished. The first strand defines entrepreneurship as a creative, dynamic characteristic of actors, be it the managers, owners of small enterprises, or heads of departments. In this strand there is hardly any distinction between entrepreneurship and innovation. The second strand of literature focuses on firm behaviour. Here we can make a clear distinction between innovative and non-innovative firms. The third strand of literature focuses on a subset of firms, namely owner-operated firms. Owner operated firms are usually small and medium-sized but can also include large firms. In this strand we can also make the analytically desirable distinction between innovative and less innovative entrepreneurship.

An important question throughout the book refers to who are the innovative actors in a developing country context. Are these large domestic firms, subsidiaries of multinationals, owner operated small and medium enterprises or micro enterprises? In chapter 3 of the book Alice Amsden argues that large private owned enterprises are much more flexible and innovative and the subsidiaries of foreign owned firms and that the importance of privately owned enterprises in East Asia explains the economic success of this region as compared to the foreign dominated economies of Latin America.

Other authors in the book emphasize the importance of small and medium-sized enterprises. They account for a very substantial part of employment in developing countries across the globe. Most small scale entrepreneurs however are survival entrepreneurs and entrepreneurs are hampered by weak infrastructure, lack of finance and lack of capabilities. The systems of innovation are often not providing the best incentives for entrepreneurs to become more innovative. However, in our book Jaap Voeten et al. provide an encouraging example of innovative behaviour amongst clusters of handicraft enterprises in Vietnamese villages, which are transforming themselves through new products or more advanced production techniques.

Policy Implications

Promoting innovation by entrepreneurs across the stages of development therefore seems justified. But how? Answering this question first necessitates raising the question, why do entrepreneurs innovate? The answer is they are driven by profit motives. Adam Smith realized that although entrepreneurs act in pursuit of their own profits, they may generate benefits to the broader society in the process, and that there is a link between the degree to which the entrepreneur will engage in innovation and the size of the market. Markets can thus been seen as important drivers of growth and development.

In the poorest developing countries, markets unfortunately fail to fulfil this driving role. Developing country markets are often small, fragmented, and imperfect due to lack of infrastructure, low per capita incomes, misguided policies and institutional constraints. The political stability, predictability and transparency, peace and other institutional prerequisites for the functioning of markets are often absent. With fragmented, small and uncertain markets there is often insufficient incentive for entrepreneurs to innovate. Where markets are restricted because of barriers to trade (either natural barriers such as lack of infrastructure or man-made barriers) it is difficult for innovations to spread. Through the ages international trade has exposed traders and merchants to new ideas, and technologies. This is one of the reasons why trade functions as an engine of growth. Where markets are restricted by inappropriate regulations or strangled by predatory governments or monopolies, there is no incentive for entrepreneurs to introduce innovations that are new to the firm. And where inappropriate property rights and contract enforcement makes any returns on innovative activity risky, there will be little incentive for entrepreneurs to invest in innovations, new to the domestic market or new to the world.

While broadening the market may be one of the necessary conditions for innovation as outlined in the previous section, it will often not be sufficient. The reason is that innovation is increasingly knowledge and skill-intensive. Because of the positive externalities inherent in investment in knowledge, technological advance and human capital, public policy has been increasingly recognized as having an important complementary role to play in fostering entrepreneurial innovation. Innovation requires not only highly knowledgeable, experienced, and skilled entrepreneurs, but also highly skilled labour. Thus, educational policies and capability-building are important public policies.

Without the latter, well-meaning donor and development organization policies may fail to stimulate innovation. For instance, trade liberalization is often prescribed for small developing countries as a development strategy, assuming that knowledge will automatically and without friction flow to these countries, not taking into account the need for absorptive capacity. And donors often promote competition through private sector development programmes not realizing that with too much competition, there may be little opportunity for entrepreneurs to recoup investments in innovative activities, particularly if domestic financial markets are underdeveloped and entrepreneurs have to finance innovation out of profits. Thus, in the absence of careful government interventions and policies, the operation of markets may result in underinvestment in knowledge and innovation. Nowadays, ‘innovation policy’ and ‘national innovation systems’ have become a standard part of the economic growth discourse in both advanced and developing economies.

The interplay between market development, systems of innovation and government science, technology and innovation policies is an important theme of this book—particularly taken up in section III. Here for instance Sunil Mani (chapter 9) discusses the innovation system that gave rise to rapid growth in technological entrepreneurship in India. Here the emergence of private institutions and initiatives to complement government support programmes for innovation, as well as an increased availability of skilled labour were essential for the fast growth of India’s ICT sector.  

Many developing country governments have in recent years attempted to overcome some of the weaknesses in the institutional environments by supporting business incubators. In chapter 10 of the book Semih Akçomak provides a discussion of incubators as tool for innovation in developing countries. He proposes eight dimensions of a good incubator policy, including clarity of mission and purpose; clear selection, entry and exit criteria; managerial capacity and incubator management skills; engagement in constant monitoring and performance evaluation of participating firms; strategic selection of services; minimization of start up costs and red tape; a focus on intangible services rather than tangible services such as office space or infrastructure; promotion of networking as a deliberate strategy and finally financial sustainability.

Finally, there is the puzzle of how many entrepreneurs succeeded in innovating in often deeply adverse environments, characterized by overregulation, high cost of doing business, weak enforcement of property rights, poor capital markets and underdeveloped markets. India is a case in point, as Suma Athreye discuss in chapter 11. In India it seems, adversity promoted creativity. She finds that the very success of the software industry was a source of subsequent improvement in the institutional environment—not brought about by government taking the lead these, but through institutional entrepreneurship. As she put it, the ‘impetus for institutional reform has not come from government, international institutions or their advisors, but primarily from the business sector itself’.

Concluding Remarks

There are three general lessons from our book. First, the impact of innovation is important across countries and institutional contexts. Entrepreneurs in developing countries provide innovations that are important for firm and country growth. Innovation can play an important role in catch-up and growth in a global economy. This is so first and foremost through the varied innovations of local entrepreneurs, but also through the role of entrepreneurs in advanced countries where innovations are generated and applied in developing country context.

Second, large and small firms can be equally innovative, but in different ways. Strong emphasis is in this book on small and medium enterprises as these predominate in developing (and many advanced) countries but which also face particular constraints to innovation. Often such small firms contribute to growth, but not optimally, since they lack innovativeness. Here, characteristics of the entrepreneur (education, age, experience, networks), the region (location), and the sector (technological intensity) were identified to be important determinants of innovation.

Third, the policy and institutional environment is an important determinant of entrepreneurs’ innovative behaviour. Governments need to support innovation directly and indirectly. This can take many forms—from reform of the environment for doing business, to providing venture capital, to tapping into migrant workers and diasporas, provision of technical and managerial education, infrastructure, and state–private sector partnerships. Sometimes, even an adverse environment can spur innovative behaviour, and entrepreneurs may become the drivers of policy and institutional change. The relationship between entrepreneurs and the institutional environmental is further taken up in the UNU-WIDER study on Entrepreneurship and Economic Development .

About the authors

Wim Naudé is Senior Research Fellow at UNU-WIDER.

Adam Szirmai is Professorial Fellow at UNU-MERIT and Professor of Development Economics at the Maastricht Graduate School of Governance of Maastricht University.

Further Reading

Entrepreneurship-OUP-cover-.jpg
Entrepreneurship, Innovation, and Economic Development, edited by Adam Szirmai, Wim Naudé, and Micheline Goedhuys, April 2011, Oxford University Press.

 

‘I learnt a lot from this book. Innumerable books discuss innovation and entrepreneurship, on the one hand, and specific problems of developing countries, on the other, but connecting them in Schumpeter’s and Gerschenkron’s spirit is rare. The volume edited by Szirmai, Naudé, and Goedhuys stands above the literature with its thorough research, clarity of discussion, and relevance of conclusions for society.’

János Kornai, Professor of Economics, Emeritus, Harvard University and Collegium Budapest

Other (References)

[i] Acs, Z. and Szerb, L. (2009). ‘The Global Entrepreneurship Index (GEINDEX)’, Foundations and Trends in Entrepreneurship, 5 (5). 341-435. 

[i] Lipsey, R.G., Carlaw, K.I. and Bekar, C.T. (2005). Economic Transformations: General Purpose Technologies and Long-Term Economic Growth, p.5., Oxford: Oxford University Press.

WIDER Angle newsletter
March 2011
ISSN 1238-9544

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