Transcript Crisis policies and medium

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:
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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?
A Schumpeterian look at growth and innovation
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;
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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
SMEs are at the hart of the churning process,
constituting most of the entry, exit and fast growth, but
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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

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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)).
Young Innovative Firms and their contribution to
radical innovations
Source: Veugelers (2009) A lifeline for Young Radical Innovators, Bruegel Policy Brief
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
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
Barriers to innovation for young and small firms

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

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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
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
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Evaluating prospective entrepreneurs, funding the most
promising ones and monitor their performance;
Aghion (2008)
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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.
The impact of the current crisis on the SMEgrowth nexus:

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
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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.
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
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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
Labour input
ICT capital
Non-ICT capital
Multi-factor productivity
%
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
-1.0
United States
EU15 (1)
United Kingdom
France
Italy
Germany
Source: O’Mahoney & Van Ark (2007), The Conference Board
ICT-using services were unable to drive growth
in continental EU countries
ICT-producing manufacturing
ICT-producing services
ICT-using services
Other activities
Residual
1996-2002
2.5
2
1.5
1
0.5
0
Italy
France
Germany
Japan
UK
Canada
USA
-0.5
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
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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

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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 postentry 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 hightech/high IT intensive sectors
Role 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?
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Problem of EU SMEs is not their number. But underperformance in terms of:
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Average productivity
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Growth
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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
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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.
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: Yollies
Yollies = 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 Industrial
R&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 Industrial
R&D Investment Scoreboard (European Commission, 2008).
Why Europe is missing Yollies?
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Risk-taking financial markets
Segmented product markets
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Early users/lead markets
(Re-)entry & exit costs
Flexible labour markets
Insufficient linking in “innovation system”
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Industry science links
 Large incumbents and small new entrants
 Public Private partnerships
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Government policy
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Funding
 Procurement
 Competition policy
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IPR regime
Well known stories
Cost of patenting: EU vs US
European (EPC - European Patent Convention), US and Japanese patent costs
Firm size
Total cost (€2000)
EPC
Large
49 900
(typical application, 8 Member
SME
49 900
States)
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
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Policy Don'ts
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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
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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 system
 Reduction of administrative burdens
Targeted Innovation Policy
How to design innovation instruments for
young innovators

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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
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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.htm
http: //www.bruegel.org
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