Local heroes: Enterprise for local economies

OECD Directorate for Employment, Labour and Social Affairs

For GRAPH and more on growth of business incubators, please click image. David Rooney

Entrepreneurship is a fundamental precondition of healthy economic growth. But can it be deployed to help depressed local economies? Yes, though there are conditions. 

Jerez, an historic town in Andalucia, Spain, is the home of sherry. In 1991, it had one of the highest levels of unemployment in Europe. Around 19,000 people – some 42% of the active population – were in search of work. But by 1998, the number of unemployed had fallen to 11,000. For a town undergoing major structural change, with severe downsizing in the wine industry, this was an impressive performance. Contributing to Jerez’s progress was a range of local government measures to stimulate entrepreneurial activity.

This should be no surprise, since economic growth and entrepreneurship are interdependent. And while public programmes to foster entrepreneurship may not be the magic solution for poor communities, they can help.

Encouraging business creation and development is an almost universal concern for local authorities, as well as for central governments wishing to raise standards of living in disadvantaged areas. The abundance of programmes is striking: in just one US state, Wisconsin, surveyed in the 1990s, there were over 400 enterprise schemes offering 700 services.

Nor is Jerez a unique success story: public enterprise schemes have been used in Genoa to reverse the fortunes of depressed steel communities. And in Camden, a borough of London that has also known its hard times, they have also been deployed to good effect. Backing for policies to encourage start-ups in underprivileged areas has also come from some renowned academic quarters. The Harvard University business expert, Professor Michael Porter, has established the Initiative for a Competitive Inner-City (ICIC) to promote enterprise development as an inner-city regeneration strategy.

But why, if at all, should governments foster entrepreneurship in local economies? The issues involved are weighty: in most OECD countries, unemployment, ill health, crime and social exclusion are concentrated in deprived communities. Addressing these issues, policymakers argue, demands public action. Some hold that business creation reduces unemployment and its social costs, and that local economies might be locked into low levels of entrepreneurship in the absence of public initiatives.

However, the strength of these claims is sometimes overstated. For instance, new firms are smaller than average and many grow slowly, creating few jobs in the early years. Where policy can be useful is in addressing problems in the markets that entrepreneurs rely on. For instance, governments might help to secure industrial real estate on flexible terms in property markets like London, where affordable rental space for small businesses is scarce, with prices being driven up by office and housing developments.

Intuitively, entrepreneurship should positively affect local economies through raising employment, income and tax revenues, and even motivation, especially in depressed areas. Yet, it is surprising that few studies have systematically examined the relationship between entrepreneurship and local economic change. Fast-growing regions tend to have high rates of enterprise start-up, as in the high-tech strips of California and parts of northern Italy. But in smaller local areas, the effect of entrepreneurship on incomes and employment may not be straightforward. Indeed, deprived areas can sometimes experience high rates of firm creation but remain relatively poor, as has been seen in some London boroughs.

There are obvious barriers to entrepreneurship in poor localities. Low levels of effective demand and high rates of crime can be constraints. The fact that many individuals live in rented accommodation, and that the value of housing is often low, can hinder access to finance, since housing often serves as collateral for bank loans. And poorer areas frequently lack role models, which might be important in the light of evidence suggesting that imitation of other entrepreneurs plays a part in the spread of entrepreneurship. These and other obstacles are not exclusive to deprived localities, but their presence and severity characterise poorer areas.

While increased enterprise offers important benefits, even successful strategies have their limitations. For instance, programmes may score some early successes with well-qualified entrepreneurs, but these are harder to achieve when dealing with candidates with fewer skills, work experience and networks. In fact, only about 5% of the unemployed are accepted for such schemes. After the early period, rates of success often fall off sharply. Overnight successes are rare, and most policies require time before yielding positive results. So programmes should not be viewed as a response to short-term employment crises. While entrepreneurship can address some of the many problems of disadvantaged areas, such as low incomes and inadequate retail services, it is not a silver bullet for dealing with poor standards of health or high crime rates, which are barely affected by the presence of new firms. The competition created by new, publicly supported enterprises can also crowd out existing businesses.

So what can governments do to promote entrepreneurship at the local level? There are many options. These include facilitating micro-credit in collaboration with banks, organising business networks and groups of informal equity investors, operating business incubators and information services, providing training, offering incentives to venture capitalists and advertising local entrepreneurial role models. Which programmes work depends on local circumstances as well as programme design and management. In the United States, the Small Business Administration’s special Small Business Investment Corporations, which directed equity investments to entrepreneurs from socially and economically disadvantaged backgrounds, had limited success, and the programme was discontinued in 1995. In this case, there had been too little recognition of the dangers of operating small-volume – and therefore high-risk and high-cost – venture-capital funds that pursue non-commercial objectives.

Adaptation also beats adoption. For instance, many micro-credit schemes have been copied from micro-lending programmes in the developing world, such as Bangladesh’s Grameen Bank. But these have not been easy to reproduce in depressed, socially fragmented areas of Europe or North America.

Before embarking on a venture, professional advice can help strengthen less viable business plans, caution against excessive optimism and improve the viability of nascent firms. A wider adoption of commercial approaches to providing business development services for entrepreneurs would also help, as the likes of Greater London Entreprise Ltd and Chicago’s Shorebank Corporation have shown. Market-led approaches help avoid the displacement of private service providers by public bodies and increase the probability that programmes are relevant, mobilise resources additional to those of the public sector, and improve sustainability and overall impact. And rather than simply creating new initiatives, governments might be advised to revise the focus and introduce new ideas to already existing schemes.

Local governments should ensure the availability of business premises offering affordable and flexible rents, but they do not need to invest in the buildings themselves. This is an overly capital-intensive use of public funds, with limited prospects for cost recovery through the onward sale of the property, once vacated. A preferred alternative might be for public authorities to guarantee the rents of a privately funded building for a fixed period of time. Practice shows that this can be a low-risk undertaking if tenant firms are selected based on their likelihood of success. This approach has been adopted in the United Kingdom and other countries.

Another interesting area to focus on is the encouragement of team-based firms. Only a minority of all new firms comprise team-starts, though firms established by groups of entrepreneurs working together tend to last longer and enjoy more rapid growth. Some initiatives, such as North-Rhine Westphalia’s “Go” Programme, have sought to encourage team-starts, for instance, by prioritising support for projects promoted by more than one entrepreneur.

Catalonian network

In June 2001, some 10,000 small firms located around Barcelona – about half that city’s total population of small firms – organised six territorial networks to purchase electricity at approximately 30% below the previous rate. This kind of initiative shows that networks can facilitate the identification of business opportunities and improve access to resources. Entrepreneurs who develop and maintain ties with other entrepreneurs often outperform those who do not.

The public sector also has a catalytic role to play in establishing business networks and accommodating such initiatives as the one in Barcelona. Networks can clearly encourage rapid learning and facilitate the reconfiguration of relationships with suppliers. For small enterprises, working in networks with their larger counterparts can help them to reach international markets more quickly at lower cost and risk. This is an outcome that is of direct interest to local policymakers.

Entrepreneurship is promising stuff, but one problem is that policymakers sometimes lose interest soon after programmes are launched, preferring new initiatives rather than monitoring existing ones and patiently helping them to succeed. The paucity of reliable research to evaluate support for entrepreneurship strikes a marked contrast with the large sums spent on such schemes; precise expenditure figures are hard to find, but in the US, support for various forms of state-level business development may amount to several billion dollars each year.

And at the end of the 1990s, local councils in England and Wales spent more than £300 million on economic development annually, including entrepreneurship support, and managed billions of pounds of national and European funds aimed at regeneration. The lack of follow-up makes it difficult to assess whether local development initiatives fulfil their brief. In addition to making recommendations across the entire range of policies and programmes open to local and national governments, an OECD report, Entrepreneurship and Local Economic Development suggests ways of improving evaluation and monitoring (for instance, by showing how the choice of different evaluation criteria provides incentives that affect the way in which programmes are designed and managed). Even commonly used programmes, such as business advisory services, management training and micro-lending, need further evaluation. Such assessments could be of great help in allowing national and local authorities to enhance their entrepreneurship strategies.

References

Entrepreneurship and Local Economic Development (OECD, 2003) is one of a number of recent and forthcoming works on the local dimension of entrepreneurship, prepared by the OECD’s Local Economic and Employment Development (LEED) Programme (see link below). In undertaking this work, exchanges with leading enterprise development agencies across the OECD – through the LEED Partners Club and its Forum on Entrepreneurship – have provided a rich source of practical information. Such exchanges have also afforded a test of the utility and practicability of policy recommendations.

• The Jerez experience is detailed in Best Practices in Local Development – LEED Notebook 27 (OECD, 1999); see link below.

©OECD Observer No 237, May 2003




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