EU reform strategies to promote entrepreneurship and growth must consider that countries have different conditions

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By Selin Dilli (UU) and Niklas Elert (IFN):

Europe’s economic problems have led many policymakers to recognize that institutional reforms to foster entrepreneurship and economic growth are needed in the 28 member countries of the European Union. To be successful, reform strategies must be informed by a sound understanding of the diversity of European capitalism and the institutional structures that drive these differences.

A common reform approach is to identify a country that appears to be performing well in a particular institutional dimension and to promote this institution in other countries. This kind of best-practice-approach ignores the fact that each country has developed its unique bundle of institutions, which complement each other. Reform strategies that ignore such institutional complementarities risk doing more harm than good. This challenge may explain, for example, why European imitation of policies aimed at stimulating venture capital has been unsuccessful (e.g., European Commission 2013).[i]

Institutions are complementary if the presence or efficiency of one institution increases the returns from or efficiency of the other. Institutional complementarities imply that viable policy changes must be compatible with the existing institutional composition. We know from the literature that there may be more than one institutional form that can result in good economic outcomes.

Our study covers 21 European countries and includes the United States as a point of comparison because it is considered successful in terms of entrepreneurship. We analyze countries’ entrepreneurial climate, and institutions relevant to this climate, based on data from 2000 onwards. We include indicators on informal institutions (norms and attitudes), political and economic institutions, labor market institutions and social protection systems, as well as the institutions that underpin knowledge and education.

In order to examine whether and how these institutions support each other various statistical techniques are employed, namely principal component analysis to produce a minimum number of uncorrelated and orthogonal principal components, and cluster analysis to identify how countries group along these dimensions. We find six different country clusters and each cluster has a distinct bundle of entrepreneurial and institutional attributes.

Six country clusters

Our results are in part consistent with previous typologies proposed in the literature, but with several important differences. A first cluster consists of the US, UK, and Ireland. These countries combine good legal systems with an emphasis on small government, prioritize investment funds, have low pension replacement rates, high governmental expenditure on education and moderate school enrollment, and value individualism, long-term orientations, and masculinity. However, the three countries differ with respect to their entrepreneurial regimes: the United Kingdom has little necessity-based new ventures and moderate opportunity entrepreneurship in new and established activities, whereas Ireland has high necessity-based nascent activity, and the United States has a large amount of both.

The Nordic countries form another group and are similar in terms of all the institutional dimensions and entrepreneurial regimes. This group has good legal systems and large governments, prioritizes investment funds, has high governmental expenditure on education and pension replacement rates. Countries in this group have relatively little necessity-based nascent entrepreneurship and moderate levels of opportunity-entrepreneurship in new and established businesses.

Switzerland, the Netherlands, and Austria are a group with an entrepreneurial regime akin to the Nordic model but with a different bundle of institutions. They have high-quality legal systems, high governmental expenditure on research and education, and value individualism, long-term orientation, and masculinity. Belgium and France are similar in all dimensions and therefore form a separate group. These two countries have low levels of nascent necessity-based entrepreneurship and opportunity entrepreneurship in new and established businesses. They have low pension replacement rates, high government expenditure on education and modest school enrollment, a preference for uncertainty avoidance, and a high-quality legal system.

Germany is grouped with the Mediterranean countries as a result of its entrepreneurial regime with low levels of opportunity entrepreneurship while it shows similarities to Continental Europe in terms of its institutional structure. The Eastern European countries are relatively similar in terms of all the dimensions and form a final group. They have moderate to low-quality legal systems and high social spending, especially on health. This group is characterized by necessity-based nascent activity (though in Slovenia this is less obvious).

We, thus, highlight the existence of different institutional structures and entrepreneurial regimes in Europe. This implies that one-size-fits-all reform strategies are likely to fail. Member countries in different clusters must instead follow various reform strategies on how best to promote entrepreneurship and economic growth. It may, for example, be reasonable to use the United States as a reference point when formulating reform strategies for Ireland and the UK, but the reforms for the countries of the other groupings must be based on strategies that are tailored to them. For instance, since 2014, Danish Growth Capital, a government investment fund, has aimed to improve access to risk capital for entrepreneurs and SMEs by using pension funds (OECD 2015).[ii] This model could be a strategy for financial institutions of the other Nordic countries to follow.

Our study, however, provides a snapshot of institutions over a limited time period. It is important to differentiate between slow moving institutions and more rapidly changing ones for better reform strategies. The history of institutional evolution has been far from unidirectional, and institutional reversals are common throughout history. In the future, the FIRES project hopes to explore these historical contingencies in more detail.

This blog is written based on a research carried out by Dilli and Elert (2016). Further information on this research is available at Dilli, Selin and Niklas Elert. (2016) “The Diversity of Entrepreneurial Regimes in Europe.” SSRN Scholarly Paper. Rochester, NY: Social Science Research Network, March 21, 2016.

[i]European Commission (2013). Entrepreneurship 2020 Action Plan: Reigniting the Entrepreneurial Spirit in Europe. Brussels: Commission of the European Communities.

[ii] OECD (2015a). Financing SMEs and Entrepreneurs 2015. Paris: OECD.

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