EU growth, innovation, entrepreneurship and the role of SMEs
Reinhilde Veugelers
University of Leuven, MSI
Outline
The importance of SMEs for post-crisis growth potential Pivotal role of SMEs as drivers of Growth:
Churning process (entry, growth, exit), entrepreneurship, innovation Especially young highly-innovative companies (YICs)
Impact of the crisis on the SME-growth nexus
Assessing SMEs’ potential for driving post-crisis growth in the EU: Assessing pre-crisis role of SMEs/YICs in EU growth: structural
weaknesses ? A role for government intervention in the EU? How?
Long-term economic growth driven by innovative entry by entrepreneurs, even if they destroy the value of established companies: the many faces of Joseph Schumpeter
Large firms operating in concentrated markets are the main engine of technological progress.
New (often small) firms, not being blocked by incumbency, leverage the innovation process to challenge established firms: “Gale of creative destruction”
Financial system enhances productivity by accelerating capital reallocation in the process of creative destruction: “the banker authorizes people, in the name of society, to innovate”
A Schumpeterian look at growth and innovation
Decomposing aggregate productivity growth into (i) contribution from entry, (ii) expansion of more productive
firms, (iii) scaling down and exit of less efficient firms;
Churning process (entry & exit) is important for aggregate growth; Studies from the nineties, suggest that the net contribution from
entry and exit account for between 20 and 50% of productivity growth
Churning (entry & exit) is associated with experimentation;
Experimentation with novel approaches typically comes from smaller entrants, young radical innovators not infected by incumbency.
Experimentation involves high risk, but also higher growth rates upon success;
A Schumpeterian look at growth and innovation
Heterogeneity among SMEs: Majority of SMEs: not innovation active Also many adopting SMEs: acquire, adapt, apply technology new to the firm A few Leading SMEs: develop innovations that are not only new to the firm, but
also new to the market Particularly Young Innovative Companies (YICs) are more likely to create radical
breakthrough innovations, whose further developments are done by large firms:
Beyond direct also indirect contribution: In interaction with large incumbents, SMEs are even more promising actors in
the Schumpeterian dynamics, esp YICs With their radical innovations young innovative companies create the scene on which
other firms build further, enhancing their breakthroughs and adding to their overall usefulness (Baumol (2002)).
A Schumpeterian look at growth and innovationSMEs are at the hart of the churning process,
constituting most of the entry, exit and fast growth, but
Young Innovative Firms and their contribution to radical innovations
On the basis of 1342 innovation-active companies responding to the German CIS-4 survey YICs defined as <6 age, <250 employees, RDI >15%
(see EC State Aid Rules for Young Innovative Enterprises)
Superior YIC performance confirmed in econometric analysis, even after corrections for firm size, age, sector, R&D inputs
Source: Veugelers (2009) A lifeline for Young Radical Innovators, Bruegel Policy Brief
Problems appropriating the benefits from innovation SMEs, and especially Young Innovative Companies, are
less able to appropriate the surplus created by own and subsequent innovations
Effectiveness of IPR regime Problems accessing finance
Incomplete, imperfect and asymmetric information create financial market failures;
Imperfections in capital markets usually affect small innovators more than large ones (Hall, 2005).
Young radical innovators, lacking collateral, reputation and with high-risk profile, even more affected by imperfections in capital markets
Barriers to innovation for young and small firms
Having SMEs and especially young, highly innovative firms, impeded to play their role may have an important direct and indirect impact
on an economy’s overall innovative and growth performance
Impact of the crisis on the SME-growth nexus
Financial markets for innovation and growth
King & Levine (1993) Better financial services expand the scope and improve the
efficiency of innovation by Evaluating prospective entrepreneurs, funding the most promising
ones and monitor their performance; Aghion (2008)
The growth enhancing effect of financial markets runs mainly through relaxing the credit constraints on small and new firms.
The growth enhancing effect of financial development depends on business cycle
Credit constraints reduce R&D investments especially during recessions
Investments in R&D are long-term and therefore require firm’s survival of SR liquidity shocks.
While necessity entrepreneurship is more pro-cyclical, opportunity entrepreneurship, especially innovative entrepreneurship, is a leading indicator of the business cycle
Firms that have more difficulty to access external financing because of their high risk profile, will be affected disproportionally by a financial crisis
Young radical innovators, have a high risk/bankruptcy profile and are credit constrained
Since the effect of the current downturn is compounded by a severe financial crisis, young, radical innovators currently are getting a double whammy, leaving the economy with a seriously reduced likelihood of getting new radical innovations, that lay the foundations for growth in future.
The impact of the current crisis on the SME-growth nexus:
Assessing the potential of SMEs for driving post-crisis growth in the EU:
Assessing pre-crisis role of SMEs (YICs) in EU growth: structural
weaknesses ?
EU productivity performance pre-crisis European (labour) productivity had been catching up
with the US frontier for 50 years… …but since 1995 US productivity accelerated again
away from Europe, with consistently lower productivity growth rates in the EU Lower contributions of ICT & MFP to EU growth
The contributions of ICT and MFP to growth weaker in the EU than in the US
2000-2005
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
2.5
3.0
United States EU15 (1) United Kingdom France Italy Germany
%
Labour input ICT capital Non-ICT capital Multi-factor productivity
Source: O’Mahoney & Van Ark (2007), The Conference Board
ICT-using services were unable to drive growth in continental EU countries
-0.5
0
0.5
1
1.5
2
2.5
Italy France Germany Japan UK Canada USA
ICT-producing manufacturing ICT-producing services ICT-using services Other activities Residual
1996-2002
Source: O’Mahoney & Van Ark (2007), The Conference Board
Factors behind the low productivity growth: a failing creative destruction process?
The churning process in the EU Gross turnover rate (entry & exit) is higher in the US
EU exit rates between 0.1 and 0.3 of US rates EU entry rates represent between 0.4 and 0.8 of US rates
High positive correlation between entry and exit across sectors in the US (while insignificant in the EU):
Entry size larger in EU than in US
The contribution of churning to growth in the EU The effect of exit on productivity growth is always positive, both in
the US and the EU, confirming that the least productive firms are exiting, but there is less exit in the EU
Low survival rate for very small entrants in the US, but better post-entry performance for successful entrants
post-entry growth at 7 years for manufacturing is in France 6% of the US rate, in Finland 17% and in the UK 60%.
Lower EU post-entry growth than in US
Net employment gains among surviving firms at different lifetimes (net gains as a ratio of initial employment)
Source: “Comparative Analysis of Firm Demographics and Survival”(2003) by E. Bartelsman,
S. Scarpetta,and F. Schivardi, OECD Economics Department WP 348.
Churning differential between US and EU is explained by experimentation
US entrants being more small scale experimental Upon survival, US entrants have a stronger post-entry
growth Exit occurs faster in the US , at smaller scale This entry-experimentation process plays particularly in
high-tech/high IT intensive sectorsRole played by SMEs in the churning process is different in the EU: the
lack of young experimenting enterprises behind the gap in growth performance between the EU and the US;
Source: Aghion, Bartelsman, Perotti, Scarpetta (2008)
What’s wrong with EU SMEs?
Problem of EU SMEs is not their number. But underperformance in terms of: Average productivity
relative to large firms, SMEs have lower labour productivity (57% for manufacturing in the EU). This is more marked for the EU than for the US.
Growth post-entry growth at 7 years for manufacturing is in France 6% of the US rate, in Finland 17% and in
the UK 60%. Innovation
relative to large firms: less R&D intensive, less innovation intensive, less cooperation active relative to US SMEs: EU SMEs less R&D intensive (average R&D intensity of SMEs is 0.34% in EU,
0.53% in US)
Composition problem: we are missing the experimental type of SMEs: young, highly innovative enterprises, esp in high-tech, high-growth sectors: ICT services
Some evidence on Europe’s missing young firms among leading innovators
The graph is based on a sample of 226 companies, obtained from matching firms in the FT Global 500 (2007) with the 2007
EC-IPTS Top 1000 R&D scoreboard companies. Leading Innovators are thus
defined both by the size of market capitalization and R&D expenditures. The
US has 80 companies in the sample, Europe 86 and other countries 60.
Young is defined as founded after 1950; US has 24 young leading innovators in sample, Europe 7;
The total is the sum of all 226 leading innovators in the sample.
Source: Bruegel Policy Brief: A lifeline for Young Radical Innovators, Veugelers (2009)
What the US has but the EU lacks: YolliesYollies = Young Leading Innovators created after 1975
There are fewer EU-based than US-based Yollies
Sources: Bruegel/European Commission JRC-IPTS on the basis of the EU IndustrialR&D Investment Scoreboard (European Commission, 2008).
Why missing Yollies matter
The lower R&D intensity of EU Yollies is the largest factor responsible for the total EU-US R&D intensity gap (55%)
Sources: Bruegel/European Commission JRC-IPTS on the basis of the EU IndustrialR&D Investment Scoreboard (European Commission, 2008).
Risk-taking financial markets Segmented product markets
Early users/lead markets (Re-)entry & exit costs Flexible labour markets Insufficient linking in “innovation system”
Industry science links Large incumbents and small new entrants Public Private partnerships
Government policy Funding Procurement Competition policy
IPR regime
Why Europe is missing Yollies?
Well known stories
Cost of patenting: EU vs US
European (EPC - European Patent Convention), US and Japanese patent costs Firm size Total cost (€2000)
Large 49 900 EPC (typical application, 8 Member States)
SME 49 900
Large 10 330 US SME 8 015
Large 16 450 Japan SME 12 450
Note: The US has a 50% reduction of fees for SMEs. This concerns only official fees (does not apply to agent's and translations fees). Japan has also reduced fees, but with conditionality (e.g. proven lack of funds, R&D dedicated SME)
A role for government intervention? How?
Despite incomplete knowledge, what can be said about?
Policy Do’s Policy Don’ts
Policy Don'ts
Keeping ailing firms in ailing sectors alive: exit barriers Protectionism for SMEs: no shielding from market
discipline Creation of thresholds in legislation with “lock in” effects
for SMEs growth “Ad-hoc” solutions to claimed SME problems not
reflecting a market failure. Risk of government failure
Policy Do's Financial Markets Restructuring Framework Conditions
more efficient market functioning: more integrated and more contestable
reform of bankruptcy law: faster, cheaper exits and not preclude new starts
integration of capital markets, particular emphasis on venture capital,
improvement of Europe’s IPR systemReduction of administrative burdens
Targeted Innovation Policy
How to design innovation instruments for young innovators
Since young innovators need to find a symbiotic overall innovative environment to interact with in ‘co-optition’, a specific policy must be part of an overall innovation and growth policy.
A specific policy approach should tackle the specific barriers faced by young highly innovating firms, at least those rooted in market failure and where governments can redress these without inflicting new barriers Getting the target right: Young Radical Innovators A specific policy implies first and foremost dealing with the
financial constraints. Subsidy programmes for young radical innovators must
be carefully designed in order to reward the risk-taking inherent in radical innovations.
Increasing the efficiency and reducing the cost of intellectual property (IPR) protection is also essential for young radical innovators.
Given that we still know very little of which ‘cures’ work, more emphasis should be put on evaluation of policy initiatives.
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Thank You For Your Attention
Veugelers, R., 2008, The Role of SMEs in Innovation in the EU: A Case for Policy Intervention?, Review of Business and Economics, 53, 3, 239-262.
Veugelers, R. and M. Cincera, 2010, Europe’s Missing Yollies, Bruegel Policy Brief 2010/06, Bruegel Brussels
Veugelers, R., 2009, A lifeline for Europe’s Young Radical Innovators, Bruegel Policy Brief, 2009/01, Bruegel Brussels.
http://www.econ.kuleuven.be/msi/members/veugelers.htmhttp: //www.bruegel.org