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Placing your bets: Subsistence or Transformational Entrepreneurship

Morten Seja's picture

The importance of dividing entrepreneurs into two distinct categories: transformational and subsistence was the topic of an inspiring talk of MIT Professor of Entrepreneurship and Finance, Antoinette Schoar at the World Bank. In crude terms, subsistence entrepreneurs are solely concerned about their survival,  and are tiny businesses and unlikely to grow or create new jobs. However, it needs to be said that they remain an important economic pillar, especially for developing countries. Contrarily, transformational entrepreneurs, the considerably smaller group of the two, strive for growth, are generally larger business owners, and provide relatively secure employment opportunities for others. They are the catalysts of innovation, job creation, productivity, and competitiveness.  This leads to a crucial question for development – should we target our policies towards entrepreneurs with transformational qualities even though they may not be the poorest of the poor since these are the ones that create more, sustainable and (often) productive employment?

Transformational entrepreneurship must be considered separately from subsistence entrepreneurship to allow for astute policy decisions.  
Identifying entrepreneurs who foster economic and employment growth should be critical in defining what policy approach should be taken, and how a regulatory framework should be designed. The most pressing question is how can we identify, in a cost-efficient way, who has the potential to be a successful entrepreneur?

Just a week before at another event at the World Bank named “Identifying Gazelles” Professor Christopher Woodruff from the University of Warwick provided some evidence that can help us identify entrepreneurs who are likely to prosper. Using different methods of determining potentially successful entrepreneurs, there are (often costly) ways of gaining a good overview of which entrepreneurs are successful. Identifying transformational spirit in entrepreneurs comes from attitude and aptitude. Attitude can be identified by the debriefing of entrepreneurs on their vision of their business. The simplest and cheapest ways of testing aptitude are intelligence tests, such as a “digit memory test” – a test to see how many digits in a row one can remember.
Evidence from Ghana suggests that combining these two characteristics can provide a good proxy to identify potentially successful entrepreneurs who will increase employment in the labor market.

Bottlenecks, such as underdeveloped management capacity, are a cause for the lack of transition from subsistence to transformational entrepreneurs and therefore growth.
Along with managerial talent and good governance, Professor Schoar argues that the policy dimensions of regulation of labor and product markets and access to capital are barriers to transformational entrepreneurship.  She cited evidence from Ardanga and Lusardi (2008) that a heavily regulated labor and product market plays a disproportionately strong role in excluding transformational entrepreneurs from the economy. Given the myriad articles and policies that cite access to finance as a key component to entrepreneurial development, the access to capital dimension seems to be generally accepted by now and becomes intuitively a constraint to development.

A change in the regulatory environment in providing a safety net attracts more entrepreneurs – successful ones!

Providing incentives to become an entrepreneur (or take away the disincentives) attracts successful entrepreneurs to the market and allows for “creative destruction.” A recent case from France provides impressive evidence for this. According to research conducted by Homber, Schoar, Sraer and Themsar (forthcoming), a regulatory change allowed self-employed workers transitioning from a salaried position to entrepreneurship to keep unemployment benefits in case their business fails or has low returns. This provision of downside protection for entrepreneurs removed disincentives to engage in entrepreneurial activity – which is synonymous to the creation of a new firm. The results are staggering: the number of firms created in France increased by 40% after the introduction of the new policy. Three years after starting a company these firms have the same likelihood of survival as the established firms and even create more jobs with higher wages. On the flipside there is evidence for a crowding-out effect.
The entrepreneurs who enter the market tend to be college educated and many of those have the desire to grow into transformational entrepreneurs.  In France, these entrepreneurs do not have to deal with strong impediments that hinder the transition of many entrepreneurs in developing countries, such as the lack of adequate financial tools, resources, networks and a safety net. After all, an enabling environment is a necessary, albeit not sufficient condition for successful entrepreneurship.

More research on entrepreneurs is needed.
Understanding that there are different types of entrepreneurs is pivotal in designing successful strategies and implementing programs supporting entrepreneurs. However, much more research is needed to target the right people with the right policies that will have the biggest impact on the poor and society as a whole.
At this point it is clear that there can be no one size fits all approach. Different regions with diverse backgrounds require commensurate interventions. For example, interventions can be targeted towards micro-entrepreneurs to create employment that can then be integrated into the formal economy and create a functioning economic eco-system in which the state should be an astute, capable and responsible stakeholder for the economy’s well-being. Interventions should also be targeted to the creation of an enabling environment in middle income countries to catch up with the cutting edge research of technological centers. There is clearly a need to diversify the approaches taken towards entrepreneurship and successfully pursue the vision of eradicating poverty and promoting shared prosperity.  

Photo credit: burgermac, Flickr Creative Commons