Some thoughts on promotion of entrepreneurship

Here is the challenge with entrepreneurship. India has too many of the wrong type of subsistence entrepreneurs, micro-entrepreneurs in the informal sector, and too little of the right kind of job creating entrepreneurs, small entrepreneurs in the formal sector.

Ejaz Ghani et al define entrepreneurship as presence of formal establishments which are less than 3 years old, measured in terms of number of such establishments per 1000 workers in formal sector. Evidence shows that jobs get created when firms which start small and formal, grow into medium sized ones. Accordingly, areas (both at state and sub-state region levels) with high levels of new enterprises have been found to generate higher employment growth. Further, as Andrei Shleifer and Rafael La Porta have argued “informal firms stay permanently informal, they hire informal workers for cash, buy their inputs for cash, and sell their products for cash, they are extremely unproductive, and they are unlikely to benefit much from becoming formal”.

This means that the primary objective should be to promote the establishment of formal small enterprises, instead of trying to move informal firms to formality. 

In India, the two most consistent factors that predict overall formal entrepreneurship, in both manufacturing and services, are local education levels and the quality of local physical infrastructure. These relationships have been found much stronger in India than in the US. Liberalized labour regulations and household banking quality in the districts concerned are also important predictors. Further, in manufacturing, agglomeration economies (Chinitz effect) in the district arising from supportive incumbent industrial structures for input and output markets (common labour needs or have customer-supplier relationships with the city's incumbent businesses) too contribute to new entrepreneurship. 

Despite these correlations, even in case of developed economies, identification of policy levers that drive entrepreneurship and incubation of new enterprises has proven elusive. The mainstream discussion on entrepreneurship focus on three types of policies – trainings, clusters, and deregulations. However, there is little evidence that entrepreneurship trainings work or economic clusters materially increase the level of overall entrepreneurship within a city. In fact, there is no example of validated successes with entrepreneurship training anywhere in the world, developed or developing. Though deregulation has not been found to increase entrepreneurship, it is likely that excessive regulation may prevent the growth of firms.

So, what are the policy responses available? A first order takeaway may be to eschew policies that seek to create entrepreneurs or directly promote entrepreneurship. Also avoid too much focus on trying to roll back informal sector. 

Instead focus on creation of conditions for enterprise entry and growth. These conditions can be divided into two broad categories – physical and enabling. 

The former involves improvements in infrastructure, access to credit and skilled labour at competitive terms etc. Unfortunately, there is limited progress possible in the short-run and only so much that can be done even in the medium-term. 

This leaves us with the latter as the focus of all policy action. They involve broadly business development and enabling regulatory environment. Numerous studies have shown that productivity can be improved by 25-35% by merely introducing simple management practices like monitoring, setting targets, personnel incentives, inventory management etc. Such business development services should become quasi-public goods, to be subsidized by governments. This should be complemented with regulatory enablers. Deregulation, limiting interface with government, extensive use of IT work-flow automation, and so on are some possible steps in this direction.