A prolific academic once wrote “Getting economic growth and jobs creation from entrepreneurs is not a numbers game. It is about encouraging the formation of high quality, high-growth companies. Policy makers should stop subsidizing the formation of the typical start-up and focus on the subset of businesses with growth potential”.
Entrepreneurship is considered as the magic-bullet for solving many of the Middle East’s most pressing economic challenges. Job creation, unemployment, economic diversification, and competitiveness- the list has become non-exhaustive. Following in the footsteps of economies such as Singapore, South Korea and the United States, new firm formation has become synonymous to driving economic growth and strengthening indigenous innovation capabilities. Middle Eastern entrepreneurs have become heroes straight out of Dr Naif Al-Mutawa’s The 99; showcasing their risk-taking abilities by launching new start-ups and striving to become home-grown success stories that will lead others to follow in their footsteps. Socio-culturally, entrepreneurs are no longer perceived as lone-rangers combatting the system. Finished are the times when the best career option was to become an engineer or a doctor. Today, the Middle Eastern Generation Y want to become entrepreneurs, mirroring the success of Aramex’s Fadi Ghandour, Wamda’s Habbib Haddad, Wild Peeta’s Mohamed and Peyman Parham Al Awadhi and Maktoob’s Samih Toukan.
However, few people question whether the premise that is driving the formation of entrepreneurial economies in the Middle East is an illusion, and that increasing the stock of SMEs may actually hamper economic growth, innovation and job creation. After all, whilst the overall share of SMEs in the Middle East stands at 71% of employment, these businesses contribute only to an estimated 28% of GDP- well below the European standards of 50-60%. These figures become even more alarming when focusing on Gulf Cooperation Council economies. In Saudi Arabia alone, approximately 764,000 firms are considered SMEs under the current national definition, or approximately 95% of all business activity. Whilst SMEs employ around 82% of the total workforce, GDP contribution remains below 16%. Comparatively, Dubai detains 72,000 SMEs, employing 42% of the workforce and generating an estimated 40% of GDP.
Despite the aggressive pursuit by governments to support SMEs in the region, there exists a lack of evidence justifying the flow of resources geared towards supporting the creation of new businesses. In the absence of reliable data, the impact of entrepreneurship and small business policies on stimulating employment and economic value-creation remains opaque. Policies navigate disparately between supporting the growth of existing businesses whilst simultaneously aiming to increase the stock of new start-ups, with the conflicting results of SME versus entrepreneurship policy remaining largely ignored. On one hand, SME policies tend to impact on the aggregate number of firms operating within the given ecosystem, and directly targets existing firms or sectors. SME policy is generally geared towards improving the competitiveness of the environment for SMEs as a whole, enabling them to grow and access more opportunities, having a more perceivable effect on firms in their growth or expansion stages. In contrast, entrepreneurship policy is more inclined towards individuals, and individual behaviour rather than SMEs as firm entities. Such policy aims to increase the supply of competent entrepreneurs and is most effective in the early stages of the entrepreneurial development process, including nascent and start-up phases, simultaneously targeting the development of an entrepreneurial culture throughout all layers of society.
However, when governments intervene to create new start-ups, does it encourage the desired type of new business creation, by the right type of entrepreneurs? Are SME incentives benefitting those ventures and individuals that will contribute positively to the productivity of the economy as a whole, or are they being used as a social net to combat unemployment?
An increase in the rate of nascent start-ups can be attributed to the transition from efficiency-driven to innovation-driven economic activity. An efficiency-driven economy such as Saudi Arabia has an economic structure reliant on a heavy manufacturing and its industrial base. This type of environment has a negative relationship with start-up activity, as the capital requirements for opening a business are high and larger firms are favoured by both governmental institutions and the private sector. Therefore, the high rate of individual establishments is attributed to individuals operating within limited value-added sectors with low barriers to entry and high rates of failure. Their contribution to GDP is below 16% as these types of firms are usually self-employed businesses or employer firms (1 to 2 employees). If they survive, they have limited opportunities for growth and expansion, and will generate sufficient revenue for their owner to derive a salary from.
But this is obviously not the types of start-ups that governmental support schemes are seeking to create. By transitioning to an innovation-driven economy, support shifts to those that detain knowledge. Knowledge becomes the source of capital and creates social wealth and innovation. And entrepreneurs lie at the heart of this transformational process. At least, this is the adage upon which policy-makers in the region today live and breathe by.
The flip side of the coin is that when countries increase their economic wealth, people are less likely to partake in entrepreneurial activity as the opportunity-cost and risk increases. By strengthening the role and promoting employment expansion within the private sector, this will lead to conflicting outcomes. As the private sector expands, so will the benefit of working as an employee, as this type of organization will offer higher wages, certainty of income and a number of health and social benefits that just can’t be offered by a start-up. The existing talent pool of people who have the traits associated with successful entrepreneurial careers may prefer the certainty associated with being an employee, hence narrowing the available entrepreneurial talent pool. This is known as ‘prosperity-pull’, when transitions to employer and paid employment are prevalent and under economic conditions. The environmental and institutional context is intrinsic to this structural shift. If regulations and incentives do not adequately support and protect high-growth potential entrepreneurs, the risk-reward gap becomes significant. To this effect, policy must be put in place which does not only support the emergence of productive and innovative SMEs, but provide incentives similar to that which would be offered within larger firms to ensure that nascent entrepreneurs are incentivized.
But such incentives come at a cost. The more institutions streamline regulations, provide training and enhance capital availability, the more this is likely to create new business establishments that have little to no economic purpose. Known as ‘recession pull’, start-up policy becomes an active labour market program, particularly when unemployment is rife. By seeking to simultaneously combat unemployment whilst pursuing active new business creation activities, this often results in the unemployed jumping the bandwagon to self-employment, disguised as ‘entrepreneurship’. Promises of higher job satisfaction, flexible hours and the possibility to gain the acclamation of being an ‘entrepreneur’ are as much motivating factors as seizing a potential business opportunity.
Examples of shifts from unemployment to self-employment resulting as an outcome of entrepreneurship policy have been prevalent in the EU and USA. Policy-makers focus on business start-up rates as an indicator for net firm creation, and therefore as an indicator to measure entrepreneurial activity. However, no satisfactory empirical evidence has demonstrated that an increase in the incidence of self-employment has led to job creation, innovation or for that matter, economic growth. In fact, numerous studies have found that in the USA, despite the Start-up Act and other seminal small business policy measures, the vast majority of small businesses do not want to innovate, do not grow in size and do not want to expand. The Kauffman Foundation and one of the ‘godfather’s’ of entrepreneurship research, William Baumol, also confirmed this in a recent study, highlighting that the only type of entrepreneurial businesses are those that bring to market new innovations in products, processes and ideas. The rest, labelled as ‘replicative entrepreneurs’ predominantly respond to local demand and a wealthier population. They are therefore symptoms of a growing economy, rather than the root cause of economic growth.
In parallel, rather than attracting true entrepreneurs, government policy and support schemes stimulate people to start businesses in sectors with low barriers of entry. A low barrier of entry means highly competitive industries, which in turn induces a disproportionate amount of business failures. Taking as an example the recent digital tech boom that has gripped the GCC and Levant region, what is the true opportunity for success and expansion? A nascent technology start-up is born immediately within a highly turbulent and fast-moving market. Whilst initial capital requirements for an online based business are relatively low; pre-entry experience, timing and product technology strategies and processes are crucial to its survival. To add to this, digital entrepreneurship is highly consumer-centric and customer-dependent- one change in consumer trends and the business no longer exists. As the wave of digital start-ups increase, normal barriers to entry will continue to be eradicated and the market-place becomes even more competitive. Only those start-ups who demonstrate an ability to scale and adapt their business models to create fundamental advantages over their competitors will survive the initial digital gold rush.
The sad reality is that by stimulating people to become entrepreneurs, policy-makers in the region are also stimulating a huge amount of business failures, one of the many outcomes of Schumpeter’s creative destruction process. As industries become more competitive, firms that are unable to innovate fail, and predatory firms feed on the weak. In truth, this process is an economic necessity for regions and industries to be competitive, but provides a false sense of security to those potential entrepreneurs lured by the idea of wealth, job satisfaction and recognition. Numerous studies primarily conducted in the US have shown that small businesses detain an average life-cycle of two years before failing. If they do not grow into gazelles or if they survive beyond this point, such SMEs typically do not expand. Whilst the true entrepreneurs who may have witnessed failure will use their experience to reinvest their resources into exploiting a new business opportunity, the vast majority of wannabe-entrepreneurs will return to paid employment.
What does this mean for the GCC region? Firstly, data has to be collected to not only account for the start-up activity rate, but for firm death rates. In turn, employee size and business expansion indicators are paramount to understanding shifts and sector transitions. Without this type of data made available, institutions will continue to waste resources into businesses and sectors that have a higher rate of failure and limited contribution to economic productivity. Secondly, the ‘one-size fits all’ policy and entrepreneurial support scheme must be eradicated. Programs and funds must be sector specific, and target those ventures with high-growth potential. A clear vision of which industries will form the pillar of economic growth is crucial, and entrepreneurship and SME policy built around sector-specific industrial strategies must be prioritized to ensure efficient allocation of public resources and the identification of commercially viable innovations. Coupled with workforce nationalization strategies, reinforcing the absorptive capacities of the private sector will become a necessity to absorb the workforce that has failed in their entrepreneurial endeavours. Finally, SME policy that promotes the expansion of existing businesses should be given as much, if not more attention than entrepreneurship policy, as economies can act in developing the value chains of already competitive and productive industrial sectors.
But what about job creation- aren’t new ventures responsible for a disproportionate amount of new jobs?
The fact that new businesses create new jobs is non-debateable. Since Birch’s seminal study in 1987 demonstrated that from 1981-1985 in the USA 82% of employment growth was attributed to firms with fewer than 20 employees, policy-makers have positioned small businesses as the solution to any contraction in employment. What policy-makers failed to mention, was that the firms surveyed in Birch’s work and ensuing studies were in fact in majority firms operating within the manufacturing sector who contributed to the employment boom. Using data from the US Census Bureau, a recent study by the Kauffman Foundation found that small businesses that have survived their nascent stage have contributed to job creation, but have done so at a far lower pace than since 2002 despite policy stimulus. In 2002, a typical start-up would employ 10.8 people within the first two years of its lifecycle, but data from 2010 has shown that this has fallen to eight employees. Another study conducted by the World Bank shows that across 47,745 SMEs surveyed in 99 countries, firms with 5-250 employees contributed to 66.7% of full time employment. However, firms younger than two years old contributed to a negligible median of 4.78% of employment.
What does this tell us? Implicitly, this demonstrates that it is not new entrepreneurial firms that contribute the most to new job creation, but SMEs. Small firms older than 10 years of age, if they are able to expand, contribute much more to creating new employment opportunities than young firms. Job growth created by new firms typically come within the first year, and then from each year one loses more jobs though company failure than it adds through company expansion. Hence, by supporting new business creation, governments are actively stimulating job destruction. In addition, the result of the World Bank study supports the SME share data in the GCC, as it finds a negative correlation between SME GDP contribution, and a positive correlation towards total share of employment.
There are of course exceptions to this trend, infamously alluded to as gazelles or high-impact firms. These firms grow at a disproportionate rate, and accounted for around 58% of employment created by small firms. However, these types of SMEs are not new start-ups. In fact, their average age is 25 years old, with fewer than 3% of the smallest high-impact firms younger than four years old.
The implications of these findings are enormous towards shaping small business policy in the GCC and wider Middle Eastern region. Whilst the quest for a potential high-growth, high-impact firm should not be brushed aside, intervention should be geared towards supporting the growth and expansion of existing SMEs if job creation is the objective. Both start-ups and SMEs are able to bring innovation and knowledge capital to the table if they are able to operate within an environmental context which enables them to do. Young new ventures are more likely to bring new innovative products, processes and ideas that contribute to the innovation ecosystem, whilst existing SMEs are more likely to contribute to employment and GDP creation.
True forms of entrepreneurial activity should be stimulated, and this can be found in both start-ups and SMEs. However, those young firms benefitting from resources should be done through industry-specific programs and funds to enhance their chances of survival and growth. Simultaneously, existing SMEs form an incremental part of the private sector, and measures to enhance their labour absorption rate and innovation capabilities should be prioritized. As the GCC region benefits from a strong manufacturing base, this clearly demonstrates that new venture creation should be sought within this sector. If this is not developed within an implementable long-term vision, the search for immediate ROI and short-termism will only prove to be detrimental to the ecosystem as a whole and lead to business failure and job destruction.
Tatjana de Kerros, 2012 ©
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