Innovation And Entrepreneurship In Developing Countries

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www.wider.unu.edunumber 1, 2011OverviewHow does innovation impact on devel opment? How, and under what condi tions, do entrepreneurs in developingcountries innovate? And what can bedone to support innovation by entre preneurs in developing countries? Thispolicy brief addresses these questionsand explains the relationship betweenentrepreneurship, innovation and devel opment. Policy lessons are drawn fromhistorical, cross-country and individualcountry experiences.Written by Wim Naudé, AdamSzirmai and Micheline Goedhuys United Nations University, 2011ISBN 978-92-808-3093-4ISSN 1814-8026Licensed under the Creative CommonsDeed “Attribution-NonCommercialNoDerivs 2.5”The views expressed in this publicationare those of the authors and do notnecessarily reflect the views of theUnited Nations University.Innovation and Entrepreneurshipin Developing CountriesNobody can be left in any doubt as to thei mportance of innovation for prosperity upon reading that “people living inthe first decade of the twentieth century did not know modern dental and medicalequipment, penicillin, bypass operations, safe births, control of genetically transmitted diseases, personal computers, compact discs, television sets, automobiles,opportunities for fast and cheap worldwide travel, affordable universities, centralheating, air conditioning . . . technological change has transformed the quality ofour lives.” 1Despite this, most of the work on understanding the process of innovation andits relationship to public policy has been conducted in economies at more advancedstages of development. Several authors have even downplayed the importance ofinnovation for developing countries. In a similar fashion, there has been a resurgence of interest in the role of entrepreneurship in innovation, employment creation and economic growth, but here the primary focus has been on the advancedeconomies. In this Policy Brief we deal with these relatively neglected issues andargue for a better understanding of the roles that entrepreneurs can play in innovation in even the world’s poorest countries. We focus in particular on theentrepreneurship–innovation nexus in the context of development and refer to thefindings contained in the book Innovation, Entrepreneurship and Economic Development edited by Adam Szirmai, Wim Naudé and Micheline Goedhuys.DefinitionsThe discipline of entrepreneurship generally studies the why, when and how ofopportunity creation, recognition and utilization for providing goods and servicesthrough the creation of new firms (start-ups) and within existing firms for bothprofit and non-profit purposes. Not all opportunity creation will necessarily be insociety’s best interest. The reward structure of a society can also lead to a destructive allocation of entrepreneurial talent. We focus here on productive entrepreneurial activity. This consists of the creation, recognition and utilization of positiveopportunities in such a way that involves “innovation”—or the provision of “newcombinations”—of products and/or processes.Innovation and Entrepreneurship in Developing Countries1

www.unu.eduAbout this Policy BriefThis Policy Brief is the resultof a joint UNU-MERIT andUNU-WIDER initiative andaccompanies the book Entre preneurship, Innovation, and Eco nomic Development edited byAdam Szirmai, Wim Naudé andMicheline Goedhuys (2011,Oxford University Press).“I learnt a lot from this book.Innumerable books discuss inno vation and entrepreneurship, onthe one hand, and specific prob lems of developing countries, onthe other, but connecting themin Schumpeter’s and Gerschenk ron’s spirit is rare. The volumeedited by Szirmai, Naudé, andGoedhuys stands above the literature with its thoroughresearch, clarity of discussion,and relevance of conclusions forsociety.”János Kornai, Professor of Eco nomics, Emeritus, Harvard Univer sity and Collegium Budapest2Three main conceptual approachesto entrepreneurship are found in theliterature. The first—a functionalapproach—is concerned with thedynamic actors that make key decisionson investment, production, innovation,location, research and development.From this perspective, entrepreneurship is a psychological trait referring todynamism, creativity and originality.This approach also includes managersof multi-national firms, state enterprises or non-profit organizations, anda variety of dynamic entrepreneurswithin organizations. The secondapproach focuses on the firm as thekey economic actor. The firms includedhere are owner- operated firms, incorporated joint stock companies,state-owned firms’ joint ventures andsubsidiaries of multi nationals. Thesefirms are the units that make the keydecisions on investment, on branchinginto new activities or sectors, or relocating to other countries. There exists alarge literature on firm-level behaviourin developing countries which examinefirm characteristics, including theireconomic performance, innovative performance, capabilities and businessstrategies.2 The third conceptualapproach focuses on owner-operatedenterprises. Within this approach, theentrepreneur is the person who is bothowner and is actively involved in running the business. This relates tomainly small and medium-sized enterprises (SMEs), start-ups and selfemployment.As stated in the Oxford Handbookof Innovation,3 the concept of innovation refers to the putting into practiceof inventions. A narrow, strictly- technological approach focuses specifically on product and processinnovations, or technological innovation, which is often said to be the resultof technology entrepreneurship. Abroader approach refers to innovationas not only the development of newproducts, new processes and newsources of supply, but also to the exploitation of new markets and thedevelopment of new ways to organizebusiness.Innovative performance has beenmeasured in a variety of ways: usingpatents, trademarks, R&D inputs andother secondary indicators such as publications or citations. Since the1980s, increasing use has been made ofinnovation surveys amongst firms.Starting with the European Community Innovation Surveys (CIS), innovation surveys have since spread to thedeveloping world (in particular toLatin America, but also to Asia andsouthern Africa). In innovation surveys, firms are asked whether theyhave introduced innovations. Themain focus in most innovation surveysis on technological innovations resulting in new products or new productionprocesses.Innovation, Stages of Developmentand Lessons from DevelopingCountriesDifferent types and degrees of innovation may take place across differentstages of development. For example,Acz and Szerb4 recently made arenewed case for Michael Porter’s distinction between factor-driven, efficiency-driven and innovation-drivenstages of development. In the factordriven stage, high rates of unemployment results in a large informal sectorand a high rate of small business startups; at this stage low-cost and resourcebased production dominates.Innovation may account for only fiveper cent of economic activity in factorbased economies. In the efficiencystage, the rate of start-ups will start todecline as capital and other productionPolicy Brief

www.wider.unu.edufactors are used more efficiently, raisingtheir rate of return. As a result, firmsbecome larger and start to exploit economies of scale. In this case, innovationbecomes more important and poten-disregards the fact that the conditionsunder which developing countriesembark upon catch-up change overtime and that past patterns are notrepeated unchanged. There used to be a“Rapid economic catch-up depends on countries’ entrepreneursbeing able to absorb and creatively adapt internationaltechnological knowledge.”tially contributes to around 10 per centof economic activity. Finally, in theinnovation stage, knowledge becomesthe driver of growth as countriesalready on the production possibilitycurve try to shift this out. In this scenario, innovation can contribute tomore than 30 per cent of economicactivity.Though these distinctions are useful, they understate the importance ofinnovation by entrepreneurial innovation in the early stages of development.One reason is that differences betweenincremental innovations and more radical innovations need to be distinguished. The former is often importantin advanced economies where competition is intense and where many firmsare already producing on the production-possibilities frontier. In developingcountries which are in the process ofcatching up, incremental innovationmay be more important. It is alsoimportant to distinguish between innovation that is new to a country or firm,and innovation that is new to theworld. The former type of innovation iscalled imitation and involves developingcountry entrepreneurs adopting newproducts or processes from other partsof the world. Such innovation can playan important role in technologicalupgrading, and increasing the utilization and the efficient allocation of production factors. Finally, stage theoryclear distinction between traditionalsectors such as beverages, agriculture,and textiles and shoemaking, and hightech sectors such as aerospace, IT,pharmaceuticals and electronics; but,in the modern global economy, all sectors are technology-driven, creatingan innovation challenge for developingcountries.In an increasingly unequal worldeconomy, several developing countrieshave experienced rapid economic catchup, including Chile, China, Korea andTaiwan. These countries were able toabsorb and creatively adapt international technological knowledgeand, thus, achieve accelerated growth.Gerschenkronian and evolutionarygrowth theories argue that latecomereconomies may profit from the advantages of technological backwardness.They can benefit from a global diffusion of technology and can access newtechnologies without bearing all thecosts and risks of investment in newknowledge. Such technological adoption goes beyond mere imitation; it isan example of creative and innovativebehaviour.What Kind of Entrepreneurs DriveInnovation?An important question in the developing-country context is whothe innovative firms are. Are theylarge domestic firms, subsidiaries ofInnovation and Entrepreneurship in Developing CountriesAbout the AuthorsWim Naudé is Professor ofDevelopment Economics andEntrepreneurship at the Maastricht School of Manage ment, The Netherlands. He isformer Senior Research Fellowat UNU-WIDER where hedirected the project “PromotingEntrepreneurial Capacity”.Adam Szirmai is Professorial Fellow at UNU-MERIT and Professor of Development Economics at the MaastrichtGraduate School of Governance,Maastricht University, The Netherlands.Micheline Goedhuys is ResearchFellow at UNU-MERIT and atMaastricht University, The Netherlands.3

www.unu.edumultinationals, owner-operated SMEsor micro enterprises?Alice Amsden suggests that largeprivately-owned enterprises (POEs) arethe innovative firms in developingcountries.5 She argues that POEs aremuch more flexible and innovative thanmore advanced production techniques.In another chapter, BascavusogluMoreau8 argues that Turkish growth inthe last decade has relied heavily onSMEs, whose dynamism derives fromprofitability and flexible labourmarkets. Elsewhere in the book, Stam“Private indigenous-owned enterprises in East Asia explain theeconomic success of this region as compared to theforeign-dominated economies of Latin America.”the subsidiaries of foreign-owned firms(FOEs) and that the strength of privateindigenous-owned enterprises in EastAsia explains the economic successof this region, as compared to theeconomies of Latin America which aremore dominated by multinationalenterprises. The importance of large,dynamic domestic firms is also statedelsewhere and has also been suggestedas being valuable in places such asIndia.6Elsewhere in the book Innovation,Entrepreneurship and EconomicDevelopment, the authors emphasizethe importance of SMEs both inadvanced economies and developingcountries. SMEs employ a substantialnumber of people in developingcountries across the globe. Most smallscale entrepreneurs, however, aresurvival entrepreneurs who arehampered by weak infrastructure, lackof finance and a lack of capability. Thesystems of innovation are often notproviding the best incentives forentrepreneurs to become moreinnovative. However, Jaap Voeten andco-authors7 provide an encouragingcase study of innovative behaviouramongst clusters of handicraftenterprises in Vietnamese villageswhich are being transformed throughthe development of new products or4and van Stel9 even go so far as tosuggest that small owner-operatedfirms will be the prime movers in theprocess of structural change indeveloping countries and transitioneconomies.The mix of types of entrepreneurship will vary from country to countryand region to region. A tentativeconclusion one might derive from thisinteresting debate is that absorptivecapacity and capacity for upgradingdepends on some kind of appropriatebalance between privately-owned andforeign-owned enterprises. Whereforeign-owned firms predominate andlarge privately-owned indigenousenterprises and entrepreneurs are weakor absent, the country may behampered in its technological andeconomic development. Furthermore,it is not only the large firms, but alsoa dynamic sub-set of firms in theSME sector which can make positivecon tributions to innovation and catchup.Policy ImplicationsMarket DevelopmentPromoting innovation by entrepreneursacross the stages of development therefore seems justified, but how? Answering this question first necessitatesPolicy Brief

www.wider.unu.eduraising another question: Why doentrepreneurs innovate? This questionhas been answered long before JosephSchumpeter’s important contributionsto entrepreneurship. The answer is:They are driven by profit motives.Adam Smith’s important insight was tothe reasons why trade functions as anengine of growth. Where markets arerestricted by inappropriate regulationsor strangled by predatory governmentsor monopolies, there is little incentivefor entrepreneurs to introduce innovations that are new to the firm. And“The degree to which the entrepreneur will engage in technicalinnovation and specialization depends on the size and functioningof the market.”realize that although entrepreneurs actin pursuit of their own profits, theymay generate benefits to the broadersociety in the process. The degree towhich the entrepreneur will engage intechnical innovation and specializationdepends on the size and functioning ofthe market. Markets can thus be seenas important drivers of growth anddevelopment.In the poorest developing countries,markets unfortunately fail to fulfil thisrole. They are hamstrung in a variety ofways, many of which are analysed byAdam Smith in his Wealth of Nations.Developing-country markets are oftensmall, fragmented and imperfect due tolack of infrastructure, low per capitaincomes, misguided policies and institutional constraints. The politicalstability, predictability and transparency, peace and other institutional prerequisites for the functioning ofmarkets are often absent. With fragmented, small and uncertain marketsthere is often insufficient incentive forentrepreneurs to innovate. Where markets are restricted because of barriersto trade (either natural barriers such aslack of infrastructure or man-madebarriers) it is difficult for innovations tospread. Through the ages, internationaltrade has exposed entrepreneurs to newideas and technologies. This is one ofwhere inappropriate property rightsand contract enforcement makes anyreturns on innovative activity risky,there will be little incentive for entrepreneurs to invest in innovations newto the domestic market or new to theworld.Capacity BuildingWhile the broadening of the marketmay be one of the necessary conditionsfor innovation, it will often not be sufficient. The reason is that innovation isincreasingly knowledge- and skillintensive. Because of the positive externalities inherent in investment inknowledge, technological advance andhuman capital, public policy has animportant complementary role to playin fostering entrepreneurial innovation.Innovation requires not only highlyknowledgeable, experienced and skilledentrepreneurs, but also highly-skilledlabour. Thus, educational policies andcapability-building are important public policies.Recognizing the importance ofthese complementary policies, and theneed for appropriate incentives forentrepreneurs to innovate allows one toidentify why well-meaning donor anddevelopment organization policiesoften fail to encourage innovation. Forexample, trade liberalization is oftenInnovation and Entrepreneurship in Developing Countries5

www.unu.eduprescribed for small developing countries as a development strategy, assuming that knowledge will automaticallyand without friction flow to thesecountries, but not taking into accountthe need for absorptive capacity.Another example is in to be found indonors’ private-sector developmentprogrammes, where the promotion of competition is seen as important tostimulate market development. However, under too much competition,there may be little opportunity forentrepreneurs to recoup investments ininnovative activities, particularly ifdomestic financial markets are underdeveloped and the entrepreneur hasto finance innovation out of profits.Thus, in the absence of careful government interventions and policies, theoperation of markets may result inRelated UNU PublicationsNaudé, W.A. (ed.) (2011) Entre preneurship and Economic Devel opment. Basingstoke: PalgraveMacmillan.Naudé, W.A. (2010) “PromotingEntrepreneurship in DevelopingCountries: Policy Challenges”,UNU Policy Brief No. 4.Naudé, W.A. (ed.) (2010) SpecialIssue of Small Business EconomicsJournal devoted to Entrepreneur ship, Developing Countries andDevelopment Economics, 34(1).Minniti, M. and W.A. Naudé (eds)(2010) Special Issue of the European Journal for DevelopmentEconomics Research devoted toFemale Entrepreneurship acrossCountries and in Development,22(2).6under-investment in knowledge andinnovation. Nowadays, “innovationpolicy” and “national innovation systems” have become a standard partof the economic growth discourse inboth advanced economies and developing economies.National Systems of InnovationIn developing countries, the benefits ofinnovation by entrepreneurs depend onthe characteristics of the system ofinnovation within which they areembedded. The better the system ofinnovation, the more able a developingcountry will be to tap into global technology. Knowledge will circulate betterwithin the domestic economy and theeconomy will embark on the processof technological upgrading more rapidly. The weaker the system of innovation, the less the efforts of individualentrepreneurs will contribute to accelerated economic development andcatch-up.The interplay between marketdevelopment, systems of innovationand government science, technologyand innovation policies is an importanttheme of the book Innovation, Entrepreneurship and Economic Development.10In Chapter 9, Sunil Mani11 discussesthe innovation system that gave rise torapid growth in technological entrepreneurship in India. He identifies five relevant broad facilitating factors; namely,1. the liberalization of the economythat created many new market opportunities; 2. the general increase infinancial resources for innovation andentrepreneurship, including in particular venture capital; 3. more governmentsupport programmes and public–private partnerships; 4. the emergence ofprivate institutions and initiatives tocomplement government support programmes for innovation; and 5. theincreased availability of skilled labouressential for high-tech products andservices.Many developing country governments have in recent years attempted toimprove the national system of innovation by supporting business incubators.These business incubators are increasingly being adopted in order to overcome some of the weaknesses ininstitutional environments.

key economic actor. The firms included here are owner-operated firms, . in the modern global economy, all sectors are technology-driven, creating an innovation challenge for developing countries. In an increasingly unequal world economy, several developing countries have experienced rapid economic catch-up, including Chile, China, Korea and Taiwan. These countries were able to absorb and .

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