WORLD BANK LATIN AMERICAN AND CARIBBEAN STUDIES

Latin American Entrepreneurs

Many Firms but Little Innovation

Daniel Lederman, Julián Messina, Samuel Pienknagura, and Jamele Rigolini

OVERVIEW

SKU 32814 FM_main_ENTinLAC_i-xvi.indd 2 11/21/13 5:30 PM Latin American Entrepreneurs i

OVERVIEW Latin American Entrepreneurs

Many Firms but Little Innovation

Daniel Lederman, Julián Messina, Samuel Pienknagura, and Jamele Rigolini This booklet contains the Overview of the forthcoming World Bank book, Latin American Entre- preneurs: Many Firms but Little Innovation. To order copies of the full-length book, published by the World Bank, use the form at the back of this booklet or order online at www.worldbank.org /publications.

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Foreword...... v

Acknowledgments...... vii

Contents of Latin American Entrepreneurs: Many Firms but Little Innovation ...... viii

Abbreviations...... ix

Entrepreneurship is a driver of development ...... 1 Entrepreneurship is vibrant—but growth is weak...... 4 The region has many entrepreneurs but little innovation...... 7 Few companies enter export markets...... 10 Even large multinational corporations in the region are insufficiently innovative...... 13 How can policy enable innovative entrepreneurs?...... 16 Notes...... 19 References...... 20

iii

Foreword

or almost a decade, emerging market rate than the United States and, more import- economies, including several countries ant, were unable to take advantage of their Fin Latin America and the Caribbean relative underdevelopment by catching up to (LAC), were regarded by analysts and inves- the United States and other developed econo- tors as new engines of growth. Their growth mies that became the sources of technologies before the global financial crisis sparked that are now commonplace around the globe. enthusiasm that, after a short pause during LAC did not need to invent, just to imitate the 2008 crisis, was cemented by vigorous and adopt technologies, as some economies recoveries in 2009 and 2010. A new story line in East Asia were able to do. seemed to dominate: thanks to deep struc- All this is not to say that the recent enthu- tural changes, both domestic and global, the siasm for LAC’s emerging markets was potential of emerging market economies had unwarranted. The enthusiasm was justified finally arrived. by the substantial and unprecedented social In the past few months, enthusiasm for progress in the region during this recent emerging markets appears to have soured. growth spurt, as documented in a previous A notable slowdown has cast doubts on the regional flagship report, Economic Mobility sustainability of their high growth rates of the and the Rise of the Latin American Mid- past decade and revived old fears of macro­ dle Class. That report provided evidence of economic and financial turbulence. Phrases remarkable progress: such as “submerging economies” have become common in financial periodicals. • Nearly 70 million people were lifted The truth is that major LAC economies out of poverty in the past decade. experienced lackluster growth for decades • Approximately 50 million people before the boom of the 2000s. At the begin- entered the ranks of the middle class ning of the 20th century, a simple aver- between 2003 and 2009. age of the region’s gross domestic product • Income inequality, as measured by the per capita was about 38 percent that of the Gini coefficient, fell steadily, dropping United States. By 2012, that ratio was about from its peak of 0.58 in 1996 to the 35 percent. lowest level ever recorded in the region, The change implies that over 110 years, 0.52, in 2011, a decline of more than the large economies of LAC grew at a slower 10 percent.

v vi Foreword

• About one-third of the poverty reduc- • Improving logistics and infrastructure. tion was the result of social policies Modernizing ports, transport, and that transferred incomes to the poor, customs can add a competitive edge but labor market income during the to products from the region. The cur- boom years accounted for the remain- rent infrastructure deficit also needs to ing two-thirds. In other words, growth be addressed in order to end capacity is required to sustain poverty reduction constraints that become evident at low and middle class expansion. growth rates. • Enhancing competition. Although the What makes the productivity challenge press- region has globalized, many industries ing is precisely the fact that social progress has remain sheltered from competition. been tied to growth. Thanks to current poli- This protection has the dual negative cies, social programs can be maintained in the effects of reducing productivity growth short term. The risk is that these gains may be in those sectors and handicapping the lost if growth remains low for too long. export sector, which relies on their ser- With global tailwinds receding, the region vices and intermediate goods. will need to rely on its own devices to spur • Improving the contractual environ- growth. Those devices have only one name: ment. Although intellectual property productivity. With scant domestic sav- rights are not the only relevant aspect ings and receding external capital inflows, of domestic institutions that affect pro- income growth can be sustained only by pro- ductivity, innovation is unlikely to take ductivity gains. root without adequate protection. Leaders in the region are fully aware of the importance of boosting productivity. But what With LAC’s recent social gains, growing is this battle about? This report argues that it demands for access to good-quality services is about establishing an enabling environment have increased. Middle classes expect not in which entrepreneurs can emerge, compete, only income gains so that their children will and innovate. It is about building an innova- see even more progress in the future but also tive entrepreneurial class in which top-notch improved public services for the current gen- firms—firms that export goods, services, and eration. With increased productivity, private even capital—no longer look tepid in contrast incomes will rise, increasing public revenues to entrepreneurial superstars elsewhere. and the state’s capacity to invest in service Beyond generalities, the main elements of delivery. In time, if we win the productivity an enabling environment for entrepreneur- battle, we will enter into a virtuous cycle of ship and innovation include the following: stronger public sectors, higher growth, and opportunities for all. • Building human capital. The chal- lenge of raising the quality of education remains, but it goes well beyond test Augusto de la Torre, Chief Economist scores. For example, LAC has a historic Hasan Tuluy, Vice President deficit of engineers, dating at least to Latin America and the Caribbean Region the early 20th century. The World Bank Group Acknowledgments

his report was prepared by a team Schoar. While we are very grateful for led by Daniel Lederman, Julián Mes- the guidance received, these reviewers are Tsina, Samuel Pienknagura, and Jamele not responsible for any remaining errors, Rigolini. Important additional contribu- omissions, or interpretations. Additional tions were made by Paolo Benedetti, Claudio insights from Pablo Acosta, Tito Cordella, Bravo-­Ortega, Maggie Chen, Paulo Correa, Leonardo Iacovone, Mariana Iootty de Ana Paula Cusolito, Marcela Eslava, Ana M. Paiva Dias, Esperanza Lasagabaster, Mar- Fernandes, Mario Gutierrez-Rocha, Mary tha Martínez-Licetti, Marialisa Motta, Hallward-­Driemeier, John Haltiwanger, Oltac Unsal, María Pluvia Zuñiga, and Thomas Kenyon, Leora Klapper, William other participants in a workshop that took Maloney, David McKenzie, Yotam Margalit, place on November 15–16, 2012, are grate- Camilo Mondragón, Marcelo Olarreaga, fully acknowledged. We also want to thank Aitor Ortiz, Çag˘lar Özden, Markus Poschke, Mauro Lopes Mendes de Azeredo, Marcela Douglas Randall, Miguel Sarzosa, Murat Sánchez-Bender, and the World Bank’s Latin Seker, Marco Vivarelli, and Lucas Zavala. America and the Caribbean Finance and Pri- The team was ably assisted by Juan Manuel vate Sector Development and International Puyana, Juan Pablo Uribe, and Cynthia van Trade teams for valuable comments. der Werf. The work was conducted under Book design, editing, and production were the general guidance of Augusto de la Torre, coordinated by the World Bank’s Publishing Chief Economist for the Latin America and and Knowledge department under the super- the Caribbean Region of the World Bank. vision of Patricia Katayama and Mark Inge- The team was fortunate to receive advice bretsen. Last but not least, we thank Ruth and guidance from four distinguished peer Delgado and Jacqueline Larrabure Rivero for reviewers: Caroline Freund, Jose Guillerme unfailing administrative support. Reis, Pablo Sanguinetti, and Antoinette

vii Contents of Latin American Entrepreneurs: Many Firms but Little Innovation

Foreword

Acknowledgments

Abbreviations

1 Overview 2 Entrepreneurship, Entry, and the Life Cycle of Firms in Latin America and the Caribbean: Are All Forms of Firm Creation Entrepreneurial? 3 Entrepreneurship by Incumbent Firms: What Explains the Innovation Gap? 4 Export Entrepreneurship 5 Foreign Direct Investment, Multinational Corporations, and Innovation 6 Toward an Enabling Environment for Innovative Entrepreneurs

viii Abbreviations

BEEPS Business Environment and Enterprise Performance Surveys CAFTA Central America Free Trade Agreement CRC Centro Regional de Competencia para América Latina EAP4 Indonesia, Malaysia, the Philippines, and Thailand ECA Europe and Central Asia EPA export promotion agency FTA free trade agreement GDP gross domestic product GIPBP Global Investment Promotion Best Practices HS Harmonized System ICRG International Country Risk Guide ICS Investment Climate Surveys IPA investment promotion agency IPR intellectual property right LAC Latin America and the Caribbean LAC5 Argentina, Brazil, Chile, Colombia, and Mexico MNC multinational corporation PEVC private equity and venture capital PPP purchasing power parity R&D research and development RCA revealed comparative advantage SME small and medium enterprise TFP total factor productivity USPTO U.S. Patent and Trademark Office

ix

Overview

Entrepreneurship is a driver of development and was greatly strengthened by the seminal work of Joseph Schumpeter—­is that creative Successful entrepreneurs are individuals who entrepreneurs are not just byproducts of the transform ideas into profitable commercial development process but important drivers of enterprises. This process often requires special such a process. Entrepreneurs are key actors talents, including a capacity to innovate, to in the transformation of low-­income societies introduce new products, and to explore new characterized by low productivity and often markets. It also requires an ability to manage subsistence self-­employment into dynamic others, to assign priorities to tasks to increase economies characterized by innovation and a the efficiency of production, and to make the rising number of well-­remunerated workers. best use of available resources. But these tal- To the extent that causal links from entre- ents are not enough. Successful entrepreneurs preneurship to productivity growth are at thrive in favorable economic and institutional work, there is room for using policy levers to environments that enhance the expected quicken the development process by improv- returns of innovation. When an enabling ing the incentives and supportive institutions environment exists, entrepreneurs take risks that facilitate innovation by entrepreneurs. and invest in innovation, spurring productiv- These analytical and policy issues motivate ity gains through the dynamics of firm entry this report, which explores the challenges and exit and innovation by incumbent firms, faced by potential high-­growth, transforma- thus fostering economic development. tional entrepreneurs in Latin America and Why should policy makers care about the Caribbean (LAC). entrepreneurs, who tend to be among the Figure 1 depicts the transition from self-­ better off in the population? The answer is employment toward wage employment that simple: entrepreneurship is a fundamental tends to go hand in hand with economic driver of growth and development. Indeed, development. It shows that up to a gross the basic premise of this report—­one that is domestic product (GDP) per capita of about shared by most economists since Adam Smith $2,000 (adjusted for purchasing power

1 2 Latin American Entrepreneurs

FIGURE 1 Type of employment, by GDP per capita This stylized fact is shared across coun- tries, albeit with less intensity in the more 100 advanced economies. It is not attributable to observable differences in the distribution of 80 workers’ skills or education across firms of different sizes. 60 Medium-­size and large firms, which are typically run by the most dynamic entrepre- neurs, are also more likely to engage in vari- 40 Workers (%) ous forms of innovation. They are more likely to export to foreign markets, obtain patents, 20 invest in research and development (R&D), introduce new products, improve produc- 0 tion processes, cooperate on innovation with 300 500 1,000 2,500 5,000 10,000 25,000 50,000 GDP per capita other firms, import new technologies, and All agricultural workers Nonagricultural wage and salaried export capital to establish affiliates in foreign Nonagricultural employer Nonagricultural own account markets (figure 2). Nonagricultural unpaid Research on entrepreneurship in LAC may deepen our understanding of the region’s Source: Gindling and Newhouse 2012. lagging productivity growth. Although LAC Note: Employment shares are calculated based on data from household surveys. GDP = gross domestic product. experienced remarkable growth in the first decade of the new millennium—­especially parity), agricultural workers make up most compared with its own past and growth in of the labor force, followed by the nonagri- the advanced economies—­there are reasons cultural self-­employed; wage employment to doubt the long-­term sustainability of such outside agriculture comes only third. The high growth rates. A significant part of the incidence of wage employment rises gradually recent growth spurt appears to be related to thereafter, becoming the most important type the commodity boom. Productivity growth of employment at a GDP per capita of about remains modest (Busso, Madrigal, and $5,000. In countries such as Canada and the Pagés-Serra 2012), particularly in the non- United Kingdom, more than 85 percent of tradable services sector (Pagés-Serra 2010), employment consists of salaried employees which through the natural process of struc- (Gindling and Newhouse 2012). tural transformation is attracting a growing The transition from self-­employment to share of the LAC urban workforce. wage employment is part and parcel of the Measuring entrepreneurship is not an easy development process, in which entrepreneurs task, however, because it is related to the play a crucial role. Creative entrepreneurs individual talents and characteristics of a few are typically behind the most dynamic and elite businesspeople. Following Schumpeter productive firms—­the ones that innovate, (1911), this report adopts a broad definition expand production, and generate jobs at a of entrepreneurship that focuses on what is comparatively rapid pace. These firms not new for the market.2 Entrepreneurship thus only create employment opportunities, they includes firm entry into new or existing also create better employment. For a given markets (both domestic and foreign), the set of skills, across the world, more pro- introduction of new products to the mar- ductive firms, which tend to be the larger ket, and organizational improvements that ones, pay higher wages. In LAC, for exam- enable firms to improve the quality or price ple, medium firms (with 5–­25 employees) of their products or achieve more efficient pay 20–­40 percent higher wages than small modes of production. The report adopts var- firms, and large firms (with more than 25 ious terms to refer to this type of innovative employees) pay 30–­60 percent higher wages.1 entrepreneurship, including “high-growth,”­ Overview 3

“high-­end,” and Lerner’s and Schoar’s (2010) FIGURE 2 Innovation edge of medium and large firms over small “transformational” entrepreneurship. The firms in Latin America and the Caribbean, 2010 important point is to differentiate entrepre- neurs with high growth potential from small firms and self-­employed individuals with low Labor productivity growth potential. Exporter The report uncovers some bright spots. It finds that LAC is a region of entrepreneurs, Exports share as evidenced by the large number of busi- ness owners per capita relative to countries Invested in R&D with similar incomes per capita. Moreover, Patent abroad the large number of entrepreneurs is not—­as often believed—­mainly a reflection of a large Patent, trademark, informal sector in which low-­productivity or copyright firms are constantly emerging and dying. The New or signi cantly improved process share of business owners with formally reg- istered firms is also relatively high in several Patent in country LAC economies. New products introduced At the top end of the entrepreneurial Medium firms spectrum, LAC experienced impressive Technology from a foreign- owned company Large firms export entrepreneurship activity during 95% confidence 2004–­09. Stimulated by global tail winds Cooperates on innovation interval and augmented by comparative advantage, recently implemented trade agreements, and 0 10 20 30 40 50 Marginal eect (%) well-­targeted export promotion policies, the region saw impressive survival rates by Source: World Bank, based on data from 2010 Enterprise Surveys. exporters. It also witnessed the emergence Note: Bars represent the marginal effect of a medium and large dummy variable in a regression controlling for firm, sector, and country characteristics. Small firms have ­50,0– medium firms of multinational enterprises—­multilatinas—­ 51–­100, and large firms more than 100 employees. Robust standard errors were calculated. Each which are increasingly extending their country has the same weight in the regional average. R&D = research and development. influence beyond their countries’ borders, particularly into neighboring countries. productive than similar multinationals from These bright spots notwithstanding, the other regions. report identifies a glaring weakness in LAC’s The rest of this overview is structured as entrepreneurship landscape—­namely, the follows. The next section documents the sur- low level of innovation. Firms in the region prising vibrancy of entrepreneurship in the suffer from a chronic and substantial inno- region, as measured by the large number of vation gap relative to comparator countries enterprises. It highlights the crucial distinc- and regions. This gap exists not only in terms tion between “small” and “young” firms. of R&D and patenting but also in terms of Businesses that grow rapidly and become product and process innovation. Innovation employment poles are more likely to be young gaps are found among small and large firms firms, but they are not necessarily small. The alike. Indeed, even the region’s superstar third section documents the acute shortfall entrepreneurs—­exporters and multilatinas—­ in innovation that characterizes LAC entre- lag in important dimensions of innovation. preneurship—­in product innovation, pat- Entry rates into exporting activities by LAC ents, R&D, and managerial practices. The firms have been particularly low, although fourth section examines various stylized facts incumbent exporters did become more about export entrepreneurship in the region, innovative under duress during the global including low entry rates coupled with solid financial crisis of 2008–­09. Multilatinas are survival rates and strong responsiveness to less innovative, less well managed, and less adverse circumstances. The fifth section 4 Latin American Entrepreneurs

examines the performance of multilatinas in fundamental policy question. Addressing it the broader context of multinational corpora- requires a change in policy paradigm from tions in LAC, with a focus on their low level the current emphasis on supporting small of innovation. The last section discusses pos- firms toward an emphasis on supporting sible links between entrepreneurship, innova- start-­ups and young firms. tion, and structural features of the enabling Figure 3 captures both the vibrancy of the environment in LAC. entrepreneurial environment and some of its deficits. It shows that in many countries in the Entrepreneurship is vibrant—­ region, the share of (nonagricultural) employ- but growth is weak ers in the population is much larger than in countries at similar levels of economic devel- In contrast to commonly held views, LAC opment (panel a). However, these employers is characterized by vibrant entrepreneur- do not generate sufficient wage employment, ship, as measured by the number of firms as the share of own-­account workers in the per capita. The share of entrepreneurs in population is also above the expected levels the population is higher than in compar- (panel b). This characteristic is linked to the ator countries and regions. Perhaps more large informal sectors that constitute a devel- surprisingly, the incidence of formal busi- oping country hallmark. nesses is also high. This fact suggests that Entry into the higher end of the formal the enterprise sector is much more than a sector, measured by registration of new large informal sector. However, the region limited liability firms, remains low in many lags in the nature of the businesses created. LAC countries3 relative to their level of eco- Firms in LAC tend to be smaller (in terms of nomic development. Figure 4 (panel a) dis- the number of employees) at birth than firms plays the relationship between firm entry in other regions at similar levels of develop- (measured by the average annual number ment, and the growth process fails to com- of new limited liability firms registered per pensate for the initial gap in employment. 1,000 working-­age people during 2004–­11) Even the largest firms in LAC create fewer and the level of economic development (mea- jobs than the largest firms in other regions. sured by the average per capita income for How to address the gap in firm growth is a the same period) across 129 countries. Entry

Figure 3 Relationship between type of employment and GDP per capita, 2010

a. Nonagriculture, employer b. Nonagriculture, own account

8 40 HTI

6 CRI DOM 30 COL ECU VEN VEN PRY SLV 4 MEX HND PER GTM SLV URY BOL URY PER ECU 20 PRY BOL JAM

Percent CHL HND COL Percent CHL CRI JAM GTM MEX 2 DOM 10

HTI 0 0 6 7 8 9 10 11 6 7 8 9 10 11 Log of GDP (PPP) per capita Log of GDP (PPP) per capita LAC countries Non-LAC countries

Source: World Bank, based on data from Gindling and Newhouse 2012 and World Development Indicators. Note: Curves shows quadratic fitted values. GDP = gross domestic product. LAC = Latin America and the Caribbean. PPP = purchasing power parity. Overview 5

FIGURE 4 Relationship between size and formal firm entry

a. Entry rates and GDP per capita b. Average workers by rm age 20 300

250 15 200

10 150

100 Entry density (%) 5 Number of employees 50 0 0 6 7 8 9 10 11 1–4 5–9 10–19 20–29 30–39 40+ Log of GDP per capita LAC countries Non-LAC countries LAC High-income ECA EAP4 countries

Sources: Panel a: World Bank, based on data from World Development Indicators and World Bank Group Entrepreneurship Snapshots (WBGES). Panel b: World Bank, based on data from 2006–­10 Enterprise Surveys. Note: Panel a: Each point represents the average between 2004 and 2011. Curve shows quadratic fitted values. GDP = gross domestic product. LAC = Latin America and the Carib- bean. Panel b: ECA (Eastern Europe and Central Asia): Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, Georgia, Kazakhstan, Latvia, Lithuania, FYR Macedonia, Moldova, Romania, Russian Federation, Serbia, Turkey, Ukraine, and Uzbekistan. EAP4: Indonesia, Malaysia, the Philippines, and Thailand. High income: Croatia, the Czech Republic, Hungary, Poland, the Slovak Republic, Slovenia, and Spain. LAC: Latin America and the Caribbean. The most recent survey available for each country was used. Each country has the same weight in the regional averages. Size at birth above 10,000 was replaced by “missing.”

is positively associated with GDP per capita, business declined steadily in the 2000s. LAC and in many LAC countries entry rates are was no exception, exhibiting stronger dereg- below the expected level. However, there is ulation among countries that started with the substantial heterogeneity within the region, highest levels at the turn of the millennium. with some countries located above the bench- However, the significant reduction in entry mark. The most salient example is Costa barriers has not made a visible dent in the Rica, with an entry rate of almost 16 new region’s entry rates of limited liability firms, firms per 1,000 working-­age people—­four which lie at the high end of the formal sector. times the international benchmark. Argen- This failure could be interpreted as an indica- tina and Mexico, by contrast, exhibit rates of tion that the effects of changes in entry bar- entry substantially below those suggested by riers come with a considerable lag. A more their GDP per capita. plausible interpretation may be that either The fact that on average LAC displays entry barriers are not the most binding con- uninspiring rates of entry of formal limited straint to formal entry in LAC or that reduc- liability firms has led many observers to sin- ing entry barriers alone, without achieving a gle out entry barriers as the main culprit. critical mass of complementary reforms, is In the last decade, however, LAC countries insufficient to spur entry. made significant progress in reducing such Another salient feature of LAC entrepre- barriers. The burden imposed by red-­tape neurship is that new firms do not grow as entry-­related regulations is still higher in LAC much as firms in other regions and thus tend than in comparator regions. But the time to to remain small. Panel b of figure 4 plots set up a business, for instance, was halved in the average age of firms against the average less than a decade (World Bank 2013). number of employees for different regions. Moreover, the variance across countries It shows that LAC has the smallest new in the number of procedures, length of time, firms (in terms of number of employees) of and costs associated with setting up a new any region.4 Even the largest new firms (the 6 Latin American Entrepreneurs

90th percentile of the size distribution of new importance for the design and effectiveness firms) are about half the size of new firms in of SME support programs. other regions.5 Moreover, differences in size The empirical basis for emphasizing this widen as firms age: LAC firms that are 40 or distinction is illustrated by a detailed analysis more years old are on average half the size of of the dynamics of (formal) manufacturing firms the same age from high-­income coun- firms in Colombia by Eslava and Haltiwan- tries and Eastern Europe and Central Asia ger (2013), as well as by research on firm (ECA) and one-­third the size of firms in the dynamics in the United States. Figure 5 pres- middle-­income countries of East Asia and ents some of the results on the importance of Pacific (EAP4)—­Indonesia, Malaysia, the firm size versus firm age for the generation Philippines, and Thailand. of employment in Colombia. Panel a focuses Policy makers in LAC have typically tried on “continuers” (that is, firms that remained to address the lackluster growth of firms by alive throughout the sample period) and focusing on smallness per se. Together with therefore abstracts from firm entry and exit. a concern about employment, this focus has Growth increases with size and declines with taken the form of a myriad of government-­ age, as stands to reason (that a firm that sponsored programs that support small and did not expand quickly during its youth or medium enterprises (SMEs). Eligibility for middle-­age years is arguably less likely to accessing support depends largely on size, enjoy a growth spurt in old age). However, typically measured by the number of employ- differences in growth rates are much more ees. The evidence in this report casts doubt marked along the age dimension than along on this overemphasis on smallness and points the size dimension. Firms of all sizes grow to the need to shift the focus toward young fastest in their early years, especially their (rather than small) firms. Most young firms first four years. are small, but a relatively large share of small Even more interesting is the fact that the firms are not young—­a distinction this report average growth rates of firms in their early highlights as having potentially critical years increase rapidly with size—­that is, firms

FIGURE 5 Employment growth in Colombia, by firm size and age

a. Continuers b. All establishments

0.6 0.10

0.4 0.05 0.2

Growth rate 0 Growth rate 0

–0.2 –0.05 Small Medium Large Small Medium Large Size of rm Size of rm

Age of rm: All 0–4 years 5–9 years 10–14 years 15+ years

Source: Eslava and Haltiwanger 2013. Note: Small: fewer than 50 employees; medium: 51–­200 employees; large: more than 200 employees. Growth rates are defined as in Davis, Haltiwanger, and Schuh (1996). They are the change in employment between two consecutive periods divided by the average employment between the two periods. Overview 7

that are young and large grow the most, mak- abilities of private agents, and using risk-­ ing the largest contribution to job creation. sharing arrangements to align incentives This fact contradicts the popular belief that could help governments try to pinpoint firms most employment generation occurs among worthy of public sector support. small firms. The confusion stems from the failure to distinguish between the stock of The region has many firms and their growth dynamics. Even if at entrepreneurs but little any point in time small firms were to account innovation for most of the jobs in the economy, it does not follow that all small firms (independent There are many potential reasons why LAC of age) are equally responsible for employ- firms grow as slowly as they do. One is the ment generation over time. Rather, it appears lack of innovation. Entry is just the beginning that job creation comes from young firms, of the story. In order to grow, or even survive, regardless of their size. firms need to continuously innovate. When all firms in the Eslava-­Haltiwanger It is in this domain of entrepreneurship sample (not just firms that stayed alive during that businesses in LAC score relatively badly. the sample period but also firms that were LAC firms introduce new products less fre- created or died during that period) are exam- quently than firms in otherwise similar econ- ined, the picture changes in an important omies, high-­end entrepreneurs tend to be far respect (panel b of figure 5). Although young away from global best practices in the man- firms continue to be the main contributors agement of their enterprises, firms’ invest- to employment growth, the role of size is ment in R&D is low, and patent activity is reversed, with small firms dominating. The well below benchmark levels. average employment growth rate of small Some of the most successful LAC firms firms up to four years old jumps from 4 per- have managed to grow out of their national cent for continuers to 53 percent for all firms. boundaries during the last decade and are This result stems from the fact that the vast now competing on world markets. The suc- majority of entrants are small, and by con- cess of high-­end companies such as Vale, struction the growth rates of newly created Embraer, and CEMEX notwithstanding, firms are highest. innovation in LAC is limited, with even some Hence, the evidence on firm dynamics in of the giant multilatinas underperforming Colombia suggests that young rather than their peers from other countries. Many for- small firms are the main employment cre- mal firms in the region are engaged in some ators. This evidence is consistent with recent form of innovation, but the intensity of findings for the United States (Haltiwanger, innovation tends to be low or poorly suited Jarmin, and Miranda 2013). Further research to raise productivity. Figure 6 shows the could determine the role of young firms in percentage of firms that developed or intro- employment generation across LAC. duced a new product (product innovation) in However, increasing the effectiveness selected countries between 2006 and 2010. of programs aimed at supporting firm (and The LAC countries are bunched toward the employment) growth may call not just for a low end of the scale.6 On average, firms in shift of emphasis from small to young firms. the region are 20 percent less likely to have A deeper understanding of the characteristics introduced a new product than the middle-­ of young firms of all sizes that enable them income countries in ECA—­and the picture to survive and thrive in market economies appears even grimmer for most of the Carib- is also necessary. Unfortunately these char- bean, where the likelihood of introducing acteristics of young dynamic firms remain a new product drops to half that of firms unknown, thus making policy making in this in ECA. area complicated. Coordinating efforts with Figure 6 measures the share of firms the private sector, leveraging the screening involved in innovation activities, which is 8 Latin American Entrepreneurs

FIGURE 6 Percentage of firms in selected uninformative about the quality and intensity countries introducing a new product, 2006–10 of innovation, two factors strongly associ- ated with high-­productivity firms. Datasets St. Lucia exploring these fundamental factors in a Dominica comparable way across countries are of poor Jamaica Antigua and Barbuda quality. The few available indicators suggest Nicaragua that the quality of innovation in LAC may be Venezuela, RB Mexico as much of an obstacle to firms’ growth and Guyana productivity as the quantity. Trinidad and Tobago St. Kitts and Nevis Figure 7 shows aggregate investment in Ecuador R&D. Panel a compares regional averages St. Vincent and the Grenadines Malaysia as a percentage of value added in manufac- Dominican Republic turing (the sector where most R&D takes El Salvador Uzbekistan place). Panel b benchmarks R&D against Uruguay the average of countries at similar stages of Guatemala Romania development.7 Average R&D investment in Spain the five largest LAC economies is two-­thirds Bolivia Honduras that of China when expressed as a percentage Costa Rica of manufacturing value added and one-­third Chile Paraguay when expressed as a percentage of GDP. For Colombia the remaining LAC countries, R&D invest- Greece Peru ment is about a third that in China when Turkey expressed as a percentage of manufacturing Argentina Suriname value added and a tenth that of China when Bulgaria expressed as a percentage of GDP. These Korea, Rep. Azerbaijan innovation gaps are worrisome. Grenada A second feature that distinguishes LAC Kazakhstan Germany from China and high-­income countries is the Croatia preponderant role the public sector plays in Ireland Ukraine R&D (the public sector also accounts for a Hungary large share of R&D in ECA) (Pagés-Serra Georgia Poland 2010).8 This is not to say that the public sec- Moldova tor in LAC invests excessively in R&D: as a Slovak Republic Macedonia, FYR percentage of GDP, it invests much less than Russian Federation China or high-­income countries. The finding Thailand Serbia rather reflects how little private LAC firms Czech Republic invest in innovation. Albania Latvia The extent to which lower levels of R&D Armenia are likely to translate into lower productiv- Bosnia and Herzegovina Slovenia ity and economic growth is, of course, influ- Lithuania enced by many factors. But panel b of figure 7 Belarus indicates that economies that experienced 0 20 40 60 80 100 Percent periods of sustained growth often had bursts LAC countries Other countries of R&D investments that placed them well above their peers (relative to the blue line).

Source: World Bank, based on data from Seker 2013 and 2006–­10 Enter- LAC’s low levels of R&D, and the fact that prise Surveys. little of it is conducted by the private sector, Note: LAC = Latin America and the Caribbean. appears to be one of the main culprits behind the region’s well-­documented history of low productivity growth. Overview 9

FIGURE 7 Investment in research and FIGURE 8 Number of patents per capita granted by U.S. Patent development (R&D) in selected country groups, and Trademark Office, actual and benchmarked, by inventor’s 2008–10­ country or place of residence

a. R&D by region Uzbekistan LAC countries Haiti Bolivia Other countries Other LAC Paraguay or economies Albania El Salvador Benchmark Indonesia ECA Honduras Kazakhstan Bosnia and Herzegovina LAC5 Guatemala Peru Azerbaijan Colombia China Ecuador Macedonia, FYR Dominican Republic High-income Philippines countries Ukraine Turkey 0 2 4 6 8 10 12 14 16 Venezuela, RB Serbia R&D/manufacturing value added (%) Belarus Georgia Business enterprise Government Oman India Higher education Private nonpro t Thailand Armenia Foreign Mexico Jamaica b. R&D by level of GDP Brazil Uruguay 5 United Arab Emirates Argentina Israel Saudi Arabia Latvia 4 Poland Chile Russian Federation Finland Korea, China 3 Trinidad and Tobago Rep. Portugal Slovak Republic Lithuania 2 St. Kitts and Nevis Greece

R&D (% of GDP) China Croatia Brazil Costa Rica 1 Costa Bulgaria Rica Kuwait India Uruguay Antigua and Barbuda Colombia Argentina Czech Republic 0 Mexico Malaysia Guatemala Hungary 100 1,000 10,000 100,000 Spain Slovenia GDP per capita (PPP) Italy New Zealand Ireland France Sources: Panel a: World Bank, based on data from World Development Norway Indicators (WDI) and UNESCO. Panel b: Updated from Lederman and Belgium Maloney 2003 using WDI. United Kingdom Australia Note: For countries and economies included in each group, see note 4. Austria GDP = gross domestic product. PPP = purchase power parity. R&D = Hong Kong SAR, China research and development. The blue line is a regression-fitted line esti- Singapore mated with data from 1996 to 2011 covering 119 countries. Netherlands Denmark Canada Germany Sweden A similar picture emerges from data on Finland Korea, Rep. patents. Figure 8 shows the number of pat- Switzerland Israel ents per million people that inventors from Japan different countries received from the U.S. Pat- 1 10 100 1,000 10,000 ent and Trademark Office (USPTO) between Patents per 1 million people 2006 and 2010. No LAC country exhibits a Source: World Bank, based on data from USPTO 2012 and World Development Indicators. level of patents that approaches that of high-­ Note: Dots represent predictions from a multivariate regression analysis that includes the log of patents income countries, and most LAC countries per million people on the log of gross domestic product (GDP) (adjusted for purchasing power parity), the log of population, and the log of merchandise exports to the United States. They indicate where each country stands with respect to countries with similar levels of GDP, population, and merchandise exports to the United States. The regression used all countries and economies for which data were available; the figure presents only comparator countries. Data are averages for 2006–10. LAC = Latin America and the Caribbean. 10 Latin American Entrepreneurs

received fewer patents than their middle-­ by the training and ability of LAC managers income country peers. Brazil, for instance, and entrepreneurs. Factors external to the registered only 5 patents per million people firms, such as the business environment and between 2006 and 2010, half the number per other country characteristics, are also likely capita of China (10) and slightly less than a to explain the region’s deficit in managerial quarter the number per capita of Bulgaria practices and hence process innovation. (22). To be sure, part of these differences can be explained by lower levels of economic Few companies enter development and lower exports to the United export markets States (which imply fewer incentives to apply for patents from the USPTO). But even after Accessing new markets through trade is controlling for per capita income, population arguably a salient manifestation of transfor- size, and exports to the United States, the pat- mational entrepreneurship. Barring firms that ent intensity in most countries in the region benefit from high rents, only firms with supe- remains below their benchmark, including rior performance can thrive in export mar- Brazil (figure 8). kets. In fact, most new entrants into export R&D and patenting are proxy measures of markets do not survive beyond one year. the intensity and quality of innovation. They This report documents a number of styl- indicate only indirectly how firms perform in ized facts that characterize LAC exporting terms of process innovation. An additional firms. In particular, although entry rates dimension is the quality of management into exporting activities remain significantly practices, which can be assessed following below those in (poorer) comparator coun- the methodology developed by Bloom and tries, the survival rates of the few firms that Van Reenen (2007). attempt to export tend to be at or slightly Figure 9 compares management prac- above benchmark levels. Moreover, analysis tices of manufacturing firms across different of the contraction of foreign demand during dimensions for a number of high-­income and 2008–­09 suggests that exporting entre- LAC countries as well as China and India (the preneurs respond well to pressure: in the sample of comparator countries is dictated face of the crisis, they nimbly opened new by countries in which management surveys exporting firms and developed new export were conducted). LAC countries other than products, in the process penetrating new Mexico score toward the bottom of the dis- export markets. Thus, it seems that the old tribution, with management practices closer adage “necessity is the mother of invention” to those of Chinese and Indian firms than to applies to export entrepreneurship. The high-­income countries. Given that LAC firms report also provides evidence that export face higher labor costs than firms in China promotion policies that help entrepreneurs and India, poor management practices in the surmount certain barriers to entry by pro- region pose a more severe competitive disad- viding information about global markets. vantage for them. Research conducted for this report bench- Part of the LAC “management gap” can marked entry and survival rates in the be explained by firm characteristics. Firms region using a new firm-­level database, the in high-­income countries have a larger share World Bank’s Exporter Dynamics Database of employees with college degrees, are larger, (figure 10).9 and are more likely to be multinationals than The results are striking: virtually all LAC firms in LAC. These firm characteristics countries in the sample show export entry explain at most a third of the management rates that are below the benchmark. In con- gap between the median firm in LAC and the trast, in Asia, the Middle East, and even United States, however. Part of the remain- Africa, entry rates of firms into exporting ing two-­thirds of the gap could be explained activities are above the benchmark. LAC Overview 11

FIGURE 9 Management practices in selected economies

a. Overall management practices b. Operation management c. Performance monitoring

United States United States Sweden Japan Germany United States Germany Sweden Germany Sweden Japan Canada Canada Canada Japan United Kingdom Australia France Italy New Zealand United Kingdom France Italy Mexico Australia France Italy Mexico United Kingdom Australia Poland Greece Portugal Northern Ireland Argentina Poland New Zealand Portugal New Zealand Portugal Mexico Argentina Republic of Ireland Northern Ireland Chile Argentina Chile Brazil Chile Republic of Ireland Northern Ireland Greece China Republic of Ireland China Poland Greece Brazil Brazil China India India India 2.0 2.5 3.0 3.5 2.0 2.5 3.0 3.5 2.0 2.5 3.0 3.5 Mean score Mean score Mean score

d. Target management e. Talent management

Japan United States Germany Canada United States Japan Sweden Germany Italy United Kingdom Canada Poland France Sweden Australia Northern Ireland United Kingdom Italy Poland Mexico Mexico Australia New Zealand Republic of Ireland Northern Ireland China Portugal France Republic of Ireland Chile Argentina New Zealand Brazil Greece Greece Argentina China Portugal Chile India India Brazil 2.0 2.5 3.0 3.5 2.0 2.5 3.0 3.5 LAC countries Other countries Mean score Mean score or economies

Source: Maloney and Sarrias 2012. Note: Surveys sampled manufacturing firms with 100–­5,000 employees recorded in Orbis. LAC = Latin America and the Caribbean. 12 Latin American Entrepreneurs

FIGURE 10 Average entry and one-­year survival rates in selected However, exporting entrepreneurs tend countries (differences with respect to baseline) to display a significant capacity to adapt to and cope with adverse circumstances, which suggests that greater competitive pressures Chile could be an antidote to the dearth of inno- El Salvador vation among high-­end export entrepreneurs Costa Rica in LAC. The agility of incumbent exporters Colombia Bulgaria is illustrated by their reactions to the drop Mexico in foreign demand in 2008–­09. During Guatemala this period, average LAC export growth Macedonia, FYR by incumbent exporters was negative. But Peru their sales of new products raised exports Ecuador Jordan by 3 percent on average, and their sales to Morocco new destinations raised exports by 4 percent Mauritius (Fernandes, Lederman, and Gutierrez-­Rocha South Africa 2013). Furthermore, the contribution of Dominican Republic new exporters (entrants) to national export Mali Senegal growth increased when the global crisis hit Nicaragua in 2008, even though entry rates did not rise. Bangladesh During the steady growth period (2005–­ Kenya 07), incumbent exporters played a dominant Burkina Faso role in explaining export growth in both Tanzania Pakistan LAC and non–­LAC countries, among all Cameroon types of exporters (natural resource based, Iran simple processing, and diversified manu- Cambodia factures) (panel a of figure 11). In contrast, Malawi new exporting firms were an important con- Niger Uganda tributor to exports in LAC during 2008–­09. Export growth in LAC during the global cri- –0.3 –0.2 –0.1 0 0.1 0.2 0.3 0.4 Log of GDP per capita sis would have declined more sharply than Average entry rate Average 1-year survival rate of new entrants it did if exports by new entrants had not compensated for the exit of incumbent firms (panel b of figure 11) and incumbent export- Source: Estimations by Ana M. Fernandes and Daniel Lederman (World Bank), based on data from the World Bank’s Exporter Dynamics Database, World Development Indicators, and World Inte- ers had not found new markets. grated Trade Solution (WITS) database. Export promotion services also appear to Note: Figure shows estimates of each country’s dummy variable from an econometric model that also includes (the log of) GDP per capita (adjusted for purchasing power parity), the Vollrath (1991) increase entry and survival rates and there- index of revealed comparative advantage at the six-­digit level of the Harmonized System (HS) clas- fore overall export activity. The economic sification, industry dummies, and year dummies. The industry dummies are defined at the two-­digit level of the HS. The excluded benchmark country is Albania. Data are for 2005–­09. justification for export promotion is often based on some form of information failure, related to the public good nature of infor- mation that leads to its underproduction by countries fare better in the survival dimen- private firms. For instance, existing exporters sion, with survival rates of the (relatively small have no incentives to share information about number of) firms that enter into exporting foreign market conditions and opportunities markets above the benchmark. However, no with potential competitors after incurring the LAC country appears to be an overachiever costs of discovering how to export profitably on the survival front when compared to most (Hausmann and Rodrik 2003). of the other developing countries included In research conducted for this report, in the database, as shown in figure 10, after Lederman, Olarreaga, and Zavala (2013) use controlling for GDP per capita. firm surveys from seven LAC countries from Overview 13

FIGURE 11 Sources of export growth in selected countries, 2005–­07 and 2008–­09

a. Decomposition, 2005–07 b. Decomposition, 2008–09 Chile Ecuador Peru Costa Rica Ecuador Peru

Natural Colombia

resources South Africa Natural Costa Rica resources Chile Nicaragua South Africa Bangladesh Cambodia Cambodia Bangladesh Guatemala Nicaragua Dominican Republic Guatemala El Salvador Dominican Republic Simple processing El Salvador Simple processing Egypt, Arab Rep. Brazil Egypt, Arab Rep. Mexico Brazil Mexico Manufacturing Manufacturing

LAC countries LAC countries of LAC Average countries of LAC Average –0.1 0 0.1 0.2 0.3 0.4 countries –0.2 –0.1 0 0.1 0.2 0.3 Export growth rate Export growth rate Incumbents Exiters Entrants

Source: Fernandes, Lederman, and Gutierrez-Rocha 2013, based on data from the World Bank’s Exporter Dynamics Database. Note: Figures for Ecuador in panel a are for 2006–­07. LAC = Latin America and the Caribbean.

2006 and 2010 to analyze the effectiveness transitional dislocations. Although the elim- of export promotion services. They find that ination of inefficient local firms may not ulti- firms that used export support services have mately be bad for a country’s economy, in the a significantly higher probability of entering short term it may adversely affect workers and surviving in export markets. and create social and political tensions. This report provides evidence that multi­ Even large multinational national corporations have had significant corporations in the region are net positive impact in LAC economies in insufficiently innovative recent years: the positive impacts from tech- nology transfers, knowledge spillovers, and Under the right business environment and linkages have overwhelmingly dominated contractual conditions, multinational corpo- the negative impacts from greater competi- rations can be good for the local economy. tion in product and factor markets. The full They tend to be more productive and to use potential of multinational corporations has the latest technologies; through their engage- not been fully realized, however, because ment with and support of local suppliers, they multinational affiliates in LAC behave like can transfer knowledge and better technol- local firms, investing very little in innovation. ogies to the local economy, which raise the Thus, either LAC is not attracting the most quality of inputs and the productivity of firms innovative multinationals or the obstacles (Moran 2001; Javorcik and Spatareanu 2005). that local firms face to innovate also act as At the same time, they can have nega- barriers to innovation for foreign firms oper- tive impacts: by competing in local product ating in the region. and factor markets, they can drive less effi- The recent emergence of multilatinas cient local firms to exit, thereby generating has not changed this picture. On average, 14 Latin American Entrepreneurs

multilatinas conduct less research than their 5 percentage points higher (figure 12). Mul- peers from other regions. The large major- tinationals are also more likely than local ity of their business is concentrated in Bra- firms to apply for a patent, trademark, or zil, Mexico, and Chile. They therefore miss copyright; collaborate for innovation pur- the opportunities presented by greater inte- poses with other institutions; invest in R&D; gration, both regionally and globally. When and adopt foreign technologies. The differ- multilatinas expand abroad, typically to ences are even larger for efforts to improve neighboring countries, their affiliates often the quality of products. Multinational corpo- operate in the same sector as the parent com- rations are 21 percentage points more likely pany, suggesting that these firms are driven to engage in quality-­improving investments by the search for larger markets and the and 25 percentage points more likely to have desire to diversify country risk rather than international quality certifications than local the desire to establish linkages and clusters, firms, perhaps because they are more likely thereby deepening their involvement in pro- to export. ductive networks and global value chains. Figure 13 quantifies the relative impor- The higher productivity and more innova- tance of the competition and knowledge tive behavior of multinational corporations transfer channels, in order to assess the relative to local firms in LAC are reflected impact of the entry of multinational cor- in many dimensions. Everything else equal, porations on firm-­level and aggregate pro- the probability that a firm introduces a new ductivity. The estimations use a sample of product is about 11 percentage points higher manufacturing firms from 60 countries, for a foreign-­owned firm operating in LAC 5 of which are in LAC (Argentina, Brazil, than for domestic firms, and the probabil- Chile, Colombia, and Mexico). The results ity of introducing a new process is about are striking: other things equal, doubling the number of multinational corporations in LAC would increase aggregate productivity Figure 12 Innovation edge of foreign multinational corporations over local firms in Latin America and the Caribbean Figure 13 Predicted productivity gains from entry of new multinational corporations in Has an international quality certication selected country groups, countries, and economies Invested to improve quality control or obtain certication 4.0 Uses foreign technology 3.5 New or signicantly improved product 3.0 Invested in research and development 2.5 New or signicantly improved process 2.0

Cooperates on innovation with others 1.5 Percentage points Percentage 1.0 Filed for patent, trademark, or copyright 0.5 0 5 10 15 20 25 0 Additional likelihood by MNC a liates High-income China ECA LAC5 (percentage points) economies Signicant at 10% Not signicant at 10% Knowledge spillover Market reallocation

Source: World Bank, based on data from 2010 Enterprise Surveys. Source: Alfaro and Chen 2013. Note: Figures are for the manufacturing sector only. Bars are the coefficients of a dummy variable tak- Note: Figures are for the manufacturing sector only. Bars represent total ing the value 1 if the firm is foreign owned in a regression of innovation variables. Additional controls productivity gains from doubling the probability of multinational cor- include country and industry fixed effects. Standard errors are clustered at the industry level. MNC = poration entry, estimated though a structural model. For countries and multinational corporations. economies included in each group, see note 4. Overview 15

by 3.8 percent. This number is six times Figure 14 Spending on research and development (R&D) in Latin higher than in ECA or high-­income econo- America and the Caribbean mies and seven times higher than in China. Moreover, in contrast with other regions, a. R&D spending by foreign b. R&D spending by multinational knowledge spillovers run the entire show in a liates of U.S. multinationals, corporations, by home region LAC: they explain almost all the estimated 1998 and 2008 aggregate productivity gains from entry of 100 30 multinational corporations. 90 25 Alas, the full potential of productivity 80 70 gains from knowledge spillovers from mul- 20 tinational corporations in LAC is not being 60 fully realized, in part because of very low 50 15 levels of R&D by foreign companies oper- Percent 40 10 ating in LAC and multilatinas. The share of 30 R&D in LAC accounted for by U.S. multi- 20 5 national corporations, for instance, is only 10

0 US$ of R&D per thousand revenue 0 about one-­fifth the share of R&D done by 1998 2008 ECA the same companies operating in Asia. More- Europe and Canada Africa China EAP4 LAC5 India over, trends are not encouraging: the share of Middle East Asia High-incomeeconomies R&D performed by U.S. multinational cor- LAC porations in LAC fell 1.2 percentage points, to just 3.9 percent of total R&D, between Sources: Panel a: National Science Board 2012; panel b: World Bank, based on data from Orbis. 1998 and 2008 (panel a of figure 14). Note: Panel a covers only the manufacturing sector. For countries and economies included in each group in panel b, see note 4. The emergence of multilatinas, welcome as it is, has not fundamentally changed the innovation picture. To be sure, the number of FIGURE 15 Sectoral position of foreign subsidiaries relative to multilatinas is still small, and they are con- headquarters in selected country groups, countries, and economies, centrated in three countries (Brazil, Chile, 2010–11 and Mexico). But despite towering over other LAC companies in size, they are not sufficiently innovative. On average, multi- 60 latinas from the manufacturing sector invest 50 only $0.06 per $1,000 of revenue on R&D (panel b of figure 14). This figure stands in 40 sharp contrast with R&D intensity in high-­ income economies and even China and the 30 four economies of EAP4. For example, mul- 20 tinationals from EAP4 invest $1.70 in R&D for every $1,000 of revenue—­almost 30 10 times the R&D investment of the average subsidiaries (%) of foreign Share 0 multilatina. LAC China and EAP4 High-income ECA A partial explanation for the low level of India economies innovation of multilatinas may be found in Location of headquarters their motives for sending capital abroad. Mul- Upstream (relative to parent) Horizontal tilatinas appear to set up operations abroad Downstream (relative to parent) mainly to expand the markets in which they Source: World Bank, based on data from Orbis. sell and to diversify country risk rather than Note: The sectoral position was calculated using the input-­output matrix for the United States. to integrate into global value chains. A subsidiary is defined as downstream if the parent company’s sector is a net supplier of the sub- sidiary’s sector. A subsidiary is defined as upstream if the subsidiary’s sector is a net supplier of the Figure 15 divides the subsidiaries of multi- parent company’s sector. For countries and economies included in each group, see note 4. LAC = national corporations from different regions Latin America and the Caribbean. 16 Latin American Entrepreneurs

into three groups: companies operating in achievements on the macroeconomic and the same sectors as headquarters (horizon- financial stabilization fronts. tal activity), companies providing inputs to Pinpointing the enablers of innovative headquarters (upstream activity), and com- entrepreneurship is complex, however, panies obtaining inputs from headquarters because of the intricate interactions and inter- (downstream activity). Almost half of foreign dependencies between the various dimen- subsidiaries of multilatinas operate in the sions of the enabling environment that matter same sector as their headquarters compared for innovation. These components include the with 30–­40 percent for other regions. Sub- clarity and reliability of legal rights (includ- sidiaries of multinational corporations from ing intellectual property rights) and the other regions are thus more likely to establish judicial process, the quality of information vertical (upstream and downstream) link- disclosure and accounting standards, regula- ages with their headquarters. The implica- tions and policies (including procompetition tion is that many multilatinas fail to transfer policy) that affect industry and commerce, knowledge to the home economy through access to suitable financial services, the qual- their involvement in global value chains. This ity of human capital (education and skills), lack of integration may be exacerbated by the and programs and policies that promote fact that most of the cross-­border activity of or support business development or R&D. multilatinas takes place in large countries in Complexity also arises because both entre- the region (Brazil, Chile, and Mexico jointly preneurial innovation and its possible deter- account for 70 percent of total multilatinas’ minants may be affected by common factors revenues); less than 15 percent of multilati- and hence jointly determined. For instance, nas’ revenues comes from outside LAC. an economy’s contractual environment may simultaneously affect both access to credit How can policy enable and innovation. innovative entrepreneurs? Some areas where policy action may be most fruitful can nevertheless be identified In a tribute to innovation as the key to by highlighting some of the dimensions of the growth, Yale University’s Robert Shiller enabling environment that are vital to inno- (2013) recently asserted that “capitalism is vation and on which LAC countries signifi- culture. To sustain it, laws and institutions cantly underperform. are important, but the most fundamental role Competition is a first and highly plausi- is played by the basic human spirit of inde- ble candidate. To be sure, the relationship pendence and initiative.” But where should between competition and innovation may policy makers look for remedies to cure the follow an inverted U-­shape, as Aghion and low growth and low innovation of LAC enter- others (2005) compellingly argue: too much prises if not in the laws and institutions that competition may weaken the incentives to shape the enabling environment for entrepre- innovate for firms that lack basic capabilities neurs? The answer surely lies well beyond the and are far from the technological frontier, traditional concern with laws and regulations whereas too little competition may not pro- that impose barriers to entry per se. vide sufficient incentives to invest in innova- The main policy challenges seem to be tion. The evidence suggests, however, that related to deeper structural features of the LAC suffers from too little rather than too enabling environment for innovative entre- much competition, particularly in the mar- preneurship, including not only laws and kets for inputs and nontradable services. This institutions but also endowments such as lack of competition undermines the incen- infrastructure and the quantity and qual- tives to innovate, as enterprises can remain ity of human capital. These elements of the profitable by dint of their market power enabling environment are likely to be even rather than their innovative efforts. Without more important for growth as LAC con- a perceived necessity to innovate, the private tinues to consolidate their hard-­earned sector may not give birth to invention. Overview 17

Figure 16 benchmarks LAC countries FIGURE 16 Actual and benchmarked index of competition in in terms of revealed market concentration 17 nontradable industries in selected countries or economies in industries that are arguably not subject to international competition.10 Most LAC United States LAC countries Bulgaria countries appear at the upper end of the dis- Romania Other countries Poland or economies tribution of the (nontradable) market con- Canada Hungary Benchmark centration index, and all but two (Colombia Russian Federation and Brazil) exhibit average levels of market Lithuania Czech Republic concentration well above their international Norway Colombia benchmarks. Hence, competition should Latvia Korea, Rep. remain at the top of the policy agenda in Japan Portugal most LAC economies. United Kingdom A second fundamental factor behind the Switzerland Macedonia, FYR lack of innovation in LAC seems to be its China Italy human capital gap, particularly in the edu- Ireland Germany cation quality dimension. The region lacks Croatia Serbia the type of human capital—­engineers and Belarus scientists—­that is likely to produce inno- Thailand Spain vative entrepreneurs. A country’s stock of Sweden Austria human capital is often measured by average Finland Netherlands years of schooling of the labor force and by Argentina the quality of education, assessed through Greece Denmark standardized scholastic test scores. LAC Brazil Bosnia and Herzegovina countries underperform international com- Singapore Australia parators on both measures, especially quality Belgium Turkey (Ferreira and others 2013). However, human Mexico capital for entrepreneurship and innovation France Philippines only partially overlaps with general curric- Malaysia Moldova ula and is probably badly captured by gen- Israel New Zealand eral schooling attainment or achievements. Kuwait Hong Kong SAR, China Hence, it is worth also examining the region’s Ecuador chronic shortage of scientific and engineering Kazakhstan Indonesia training. Chile Peru LAC has long suffered from a dearth of Albania Saudi Arabia engineers: despite higher income per capita, India Uruguay Argentina, Chile, and Mexico all had lower Dominican Republic densities of engineers than Spain and Portu- Oman Guatemala gal in 1900 (figure 17). Such historical gaps Bolivia Jamaica appear to be important. Maloney and Valen- United Arab Emirates Paraguay cia Caicedo (2012) find a positive association Venezuela, RB Trinidad and Tobago between engineering density in the 1900s Nicaragua and per capita income in the 2000s. El Salvador Costa Rica LAC countries still have fewer engineers Honduras than the median country and fewer than 0 0.2 0.4 0.6 0.8 would be expected given their current level Her ndahl index of development (figure 18). Even the larger Source: World Bank, based on data from World Development Indicators and firm-­level data from Orbis. and more advanced countries in the region Note: Bars show the average Herfindahl index of concentration of revenues across a selection of (Brazil, Chile, Colombia, and Mexico) have two-­digit nonfinancial services sectors for which data were available for more than 80 countries. A value of 1 represents a market captured entirely by a single firm (the highest level of concen- relatively few engineers. tration); lower values indicate less concentration. Revenues were averaged across 2007–­10. Dots LAC students may be inclined toward represent a benchmark predicted value from a regression for each sector with (log of) population and GDP (adjusted for purchasing power parity) as explanatory variables. The regression model was nonscientific studies for at least two potential estimated for each of 17 sectors separately; the dots are the averages of all sectors. The regression used all available countries. The figure presents only comparator countries. LAC = Latin America and the Caribbean. 18 Latin American Entrepreneurs

FIGURE 17 Income and engineering density in FIGURE 18 Number of engineers per million selected economies, 1900 people in selected countries

180 Honduras LAC countries United States, north Guyana Other 150 Uruguay countries El Salvador Benchmark 120 Brazil Argentina 90 United States Indonesia Colombia 60 United States, south Mexico Venezuela, RB Serbia 30 Portugal Spain Chile Saudi Arabia Engineers per 100,000 male workers Brazil Colombia Mexico Argentina Chile 0 Peru 6.0 6.5 7.0 7.5 8.0 8.5 9.0 Turkey Log of GDP per capita (US$ in 1900) Hungary Netherlands Source: Maloney and Valencia Caicedo 2012. Armenia Note: GDP = gross domestic product. Norway United States Latvia reasons. First, for historical reasons, LAC Croatia universities have long emphasized the Sweden humanities; law; and social, economic, and Bulgaria political fields of study, possibly constraining Belgium their ability to educate more engineers and Greece scientists. Switching their emphasis would Germany require very aggressive public policy, such as Denmark the United States adopted when it developed Japan mining and engineering studies in the early Malaysia 20th century. Second, young people may be Portugal attracted to fields of studies that are relevant Austria to pressing problems faced by their societ- Lithuania Poland ies, which may explain why LAC may have Slovenia formed many sociologists and more macro Switzerland than micro economists. Given the progress Spain the region has made in taming macro insta- Czech Republic bility, there may be more incentives for stu- New Zealand dents to embark on scientific careers. That Slovak Republic said, a big push to expand engineering and Ireland scientific education at the secondary and ter- Finland tiary levels may be required to accompany Ukraine rising demand for such careers. Thailand Factors that affect firms’ economic perfor- 0 10 20 30 mance may also adversely affect innovative Engineering graduates per million entrepreneurship, although the nexus may inhabitants, ages 15–24 not be as straightforward as often believed. Source: World Bank, based on data from World Development Indicators Despite substantial reform, business regu- and UNESCO 2013. Note: Bars show average number of engineering graduates per million peo- lations may still hamper innovative behav- ple ages 15–­24. Dots are a benchmark predicted by a regression with (the ior. Which specific regulations bite and how log of) population and GDP (adjusted for purchasing power parity) as the explanatory variables. The regression uses all the available countries. The much damage they cause, however, remain figure presents only comparator countries. Data are averages for 2008–­10. questions for future research. LAC = Latin America and the Caribbean. Overview 19

Although the region underperforms in FIGURE 19 Actual and benchmarked index of intellectual property terms of financial services, such as long-­ rights in selected countries or economies, 2005 term credit and venture capital, young firms in LAC are not necessarily more credit con- Guyana LAC countries Thailand Other countries strained than young firms in other regions. Indonesia This potential link requires careful research, Dominican Republic or economies Costa Rica Benchmark but prima facie, it is difficult to categorically Paraguay Haiti state that lack of access to finance is a sig- Nicaragua nificant cause of the region’s innovation gap. Saudi Arabia Honduras To be sure, as documented in the report on Grenada Financial Development in LAC (de la Torre, Guatemala Venezuela, RB Ize, and Schmukler 2012), the region’s gap in Peru Jamaica bank credit is significant and has been grow- Uruguay ing over the past 15 years. However, much Bolivia El Salvador of this gap appears to be explained by LAC’s Malaysia Brazil turbulent macro and financial history and by Ukraine the shortage of promising productive projects Russian Federation Colombia (that is, a shortage of innovation) rather than Ecuador by credit rationing and credit supply-side Trinidad and Tobago Hong Kong SAR, China constraints per se. Moreover, the constraint India Mexico that seems to be most relevant for bank credit Argentina supply in LAC is weaknesses in the contrac- Lithuania Turkey tual (rather than the informational) envi- New Zealand ronment, which can undermine both credit China Israel supply and entrepreneurial innovation. Australia Norway The role of the contract enforcement envi- Romania ronment in the region’s innovation deficit is Philippines Poland also nuanced. Insufficient intellectual prop- Slovak Republic Singapore erty rights may be an issue (figure 19), and Chile other weaknesses in the contractual environ- Greece Switzerland ment may also hinder innovation. But indexes Spain of contract viability and the risk of expro- Austria Czech Republic priation do not indicate that LAC countries Korea, Rep. Portugal systematically underperform relative to com- Germany parators in other regions. More research is Hungary Bulgaria therefore needed to understand the subtleties Sweden of, and complex interactions and interdepen- United Kingdom Belgium dencies between, the fundamental underpin- France Canada nings of LAC’s peculiar combination of many Italy entrepreneurs and little innovation. Japan Finland Ireland Denmark Netherlands Notes United States 1. World Bank calculations based on data 2 3 4 5 from 2010 household surveys from 15 LAC Park index (as of 2005) countries. 2. Schumpeter (1911) defines entrepreneurship Source: World Bank, based on data from World Development Indicators and Park 2008. Note: The Park index is the sum of five components: coverage of patents in eight industries; partici- as “(1) The introduction of a new good … or pation in five international property rights (IPR) treaties; duration of protection (relative to a global of a new quality good. (2) The introduction standard, such as 15–­20 years for patents); the existence of up to three enforcement mechanisms; of a new method of production…. (3) The and the existence of up to three types of restrictions on patent rights. Bars show the 2005 Park index for each country. Dots show the predicted percentage of firms from a regression that includes opening of a new market…. (4) The conquest (the log of) population and GDP (adjusted for purchasing power parity) as explanatory variables. of a new source of supply of raw materials or The regression used all available countries. The figure presents only comparator countries. LAC = Latin America and the Caribbean. 20 Latin American Entrepreneurs

half-manufactured­ goods…. (5) The carrying a company that participates in the market. out of the new organization of any industry….” Companies can be publicly owned, blurring 3. The LAC region comprises the following the distinction between “private” and “pub- countries: Antigua and Barbuda, Argentina, lic” R&D. In this report, as in others, such as Bolivia, Brazil, Chile, Colombia, Costa Rica, Pagés-Serra (2010), the term private is used to Dominica, Dominican Republic, Ecuador, characterize “productive-sector”­ R&D. El Salvador, Grenada, Guatemala, Guyana, 9. This exercise took into consideration cross-­ Honduras, Jamaica, Mexico, Nicaragua, Par- country differences in GDP per capita, sec- aguay, Peru, St. Kitts and Nevis, St. Lucia, St. toral composition, and year-­specific effects Vincent and the Grenadines, Suriname, Trin- (such as the global recession of 2008–09).­ idad and Tobago, Uruguay, and República 10. The distinction between tradables and non- Bolivariana de Venezuela. tradables is important. Domestic market 4. Throughout this overview we use the follow- concentration could be high in the sense that ing groups of economies unless otherwise few domestic firms participate in an industry, noted: LAC5 includes Argentina, Brazil, Chile, but if domestic firms compete with imports, Colombia, and Mexico. Other LAC includes domestic market concentration would be a Bolivia, Costa Rica, the Dominican Republic, poor proxy for competition. Ecuador, El Salvador, Guatemala, Honduras, Nicaragua, Paraguay, Peru, Uruguay, and References República Bolivariana de Venezuela. Carib- bean includes Antigua and Barbuda, Cuba, Aghion, Philippe, Nick Bloom, Richard Blun- Dominica, Grenada, Guyana, Haiti, Jamaica, dell, Rachel Griffith, and Peter Howitt. 2005. St. Kitts and Nevis, St. Lucia, St. Vincent and “Competition and Innovation: An Inverted U the Grenadines, Suriname, and Trinidad and Relationship.” Quarterly Journal of Econom- Tobago. ECA (Eastern Europe and Central ics 120 (2): 701–­28. Asia) includes Albania, Armenia, Azerbaijan, Alfaro, Laura, and Maggie Xiaoyang Chen. 2013. Belarus, Bosnia and Herzegovina, Bulgaria, “Market Reallocation and Knowledge Spill- Georgia, Kazakhstan, Latvia, Lithuania, FYR overs: The Gains from Multinational Produc- Macedonia, Moldova, Romania, the Russian tion.” NBER Working Paper 18207, National Federation, Serbia, Turkey, Turkmenistan, Bureau of Economic Research, Cambridge, Ukraine, and Uzbekistan. EAP4 includes Indo- MA. nesia, Malaysia, the Philippines, and Thailand. Bloom, Nicholas, and John Van Reenen. 2007. High-income economies includes Australia; “Measuring and Explaining Management Canada; Hong Kong SAR, China; Israel; Japan; Practices across Firms and Countries.” Quar- the Republic of Korea; Kuwait; New Zealand; terly Journal of Economics 122 (4): 1351–­408. Oman; Saudi Arabia, Singapore; Switzerland; Busso, Matias, Lucia Madrigal, and Carmen the United Arab Emirates; the United States; Pagés-Serra. 2012. “Productivity and Resource and all countries in the European Union not Misallocation in Latin America.” BE Journal included in ECA. The set of economies from of Macroeconomics 13 (1): 1–30.­ each group used in figures throughout this Davis, Steven J., John Haltiwanger, and Scott overview varies according to data availability. Schuh. 1996. Job Creation and Destruction. 5. The typical LAC firm at the 90th percentile Cambridge, MA: MIT Press. has fewer than 25 employees, as opposed to de la Torre, Augusto, Alain Ize, and Sergio 40 in ECA and high-­income countries and L. Schmukler. 2012. Financial Develop- almost 55 in East Asia and the Pacific (EAP4). ment in Latin America and the Caribbean: 6. Grenada is a regional outlier. Its performance The Road Ahead. Washington, DC: World reflects the small number of firms rather than Bank. https://openknowledge.worldbank.org the high incidence of new products. /handle/10986/2380. 7. The OECD (2002) Frascati Manual on R&D Eslava, Marcela, and John Haltiwanger. 2013. statistics, which is used around the world, “Young Businesses, Entrepreneurship, and excludes investments in soil analysis and min- the Dynamics of Employment and Output in eral exploration from R&D activities. Conse- Colombia’s Manufacturing Industry.” Work- quently investments in innovation in agriculture ing paper, CAF, Caracas, Venezuela. and mining tend to be underreported. Enterprise Surveys (database). World Bank Group, 8. R&D data are classified as “productive-­ Washington, DC. http://www.enterprisesurveys sector” R&D when financing comes from .org/. Overview 21

Exporter Dynamics Database. World Bank, Investment and Development. Washington, Washington, DC. http://data.worldbank.org DC: Institute for International Economics. /data-catalog/exporter-dynamics-database. National Science Board. 2012. “Science and Engi- Fernandes, Ana M., Daniel Lederman, and Mario neering Indicators 2012.” National Science Gutierrez-­Rocha. 2013. “Export Entrepre- Foundation, Arlington, VA. neurship and Trade Structure in Latin Amer- OECD (Organisation for Economic Co-­operation ica during Good and Bad Times.” World Bank and Development). 2002. Frascati Manual: Policy Research Working Paper 6413, Wash- Proposed Standard Practice for Surveys on ington, DC. Research and Experimental Development. Ferreira, Francisco H. G., Julián Messina, Jamele Paris: OECD. Rigolini, Luis-­Felipe López-­Calva, Maria Orbis (database). Bureau van Dijk, Amsterdam, the Ana Lugo, and Renos Vakis. 2013. Economic Netherlands. http://www.bvdinfo.com/en-us Mobility and the Rise of the LAC Middle /products/company-information/international Class. Washington, DC: World Bank. /orbis-(1). Gindling, Thomas H., and David L. Newhouse. Pagés-­Serra, Carmen, ed. 2010. The Age of Pro- 2012. “Self-­Employment in the Developing ductivity: Transforming Economies from the World.” Policy Research Working Paper 6201, Bottom Up. Washington, DC: Inter-­American World Bank, Washington, DC. Development Bank. Haltiwanger, John, Ron Jarmin, and Javier Park, Walter. 2008. “International Patent Protec- Miranda. 2013. “Who Creates Jobs? Small tion, 1960–­2005.” Research Policy 37: 761–­66. versus Large versus Young.” NBER Working Schumpeter, J. 1911. Theorie der Wirtschaftlichen Paper 16300, National Bureau of Economic Entwicklung. Leipzig: Duncker & Humblot. Research, Cambridge, MA. Seker, Murrat. 2013. “Innovation Performance in Hausmann, Ricardo, and Dani Rodrik. 2003. Latin America and Caribbean Region.” Back- “Development as Self-­Discovery.” Journal of ground paper for this report. Development Economics 72 (2): 603–­33. Shiller, Robert S. 2013. “Why Innovation Is Javorcik, Beata, and Mariana Spatareanu. 2005. Still Capitalism’s Star.” New York Times, “Disentangling FDI Spillover Effects: What August 17. Do Firm Perceptions Tell Us?” In Does Foreign UNESCO (United Nations Educational, Scien- Investment Promote Development?, edited by tific and Cultural Organization). 2013. Data Theodore Moran, Edward Graham, and Mag- Center, Institute for Statistics. http://stats.uis nus Blomström, 45–­72. Washington, DC: Cen- .unesco.org/unesco/ReportFolders/Report ter for Global Development. Folders.aspx. Lederman, Daniel, and William Maloney. 2003. USPTO (U.S. Patent and Trademark Office). “R&D and Development.” Policy Research 2012. “Patents by Country, State, and Year: Working Paper 3024, World Bank, Washing- All Patent Types.” Washington, DC. http:// ton, DC. www.uspto.gov/web/offices/ac/ido/oeip/taf Lederman, Daniel, Marcela Olarreaga, and Lucas /cst_all.htm. Zavala. 2013. “Export Promotion and Firm Vollrath, Thomas. 1991. “A Theoretical Evalua- Entry and Survival: Evidence from a Panel of tion of Alternative Trade Intensity Measures of LAC Firms.” World Bank, Washington, DC, Revealed Comparative Advantage.” Review of and University of Geneva, Geneva. World Economics 2: 265–­80. Lerner, Josh, and Antoinette Schoar. 2010. World Bank. 2013. Doing Business 2013: Smarter “Introduction to International Differences in Regulations for Small and Medium-­Size Entrepreneurship.” In International Differ- Enterprises. Washington, DC: World Bank. ences in Entrepreneurship, 1–­13. Cambridge, World Bank Group Entrepreneurship Snap- MA: National Bureau of Economic Research. shots (WBGES). World Bank, Washington, Maloney, William F., and Mauricio Sarrias. 2012. DC. http://www.doingbusiness.org/data “What Makes LAC Managers So Bad?” World /exploretopics/entrepreneurship. Bank, Washington, DC. World Development Indicators (database). World Maloney, William F., and Felipe Valencia Bank, Washington, DC. http://data.worldbank Caicedo. 2012. Part II: Engineers, Innovative .org/data-catalog/world-­ development­ Capacity and Development in the Americas. -­indicators. World Bank, Washington, DC. World Integrated Trade Solution (WITS) (data- Moran, Theodore. 2001. Parental Supervi- base). World Bank, Washington, DC. http:// sion: The New Paradigm for Foreign Direct wits.worldbank.org/wits/. Four easy ways to order

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FM_main_ENTinLAC_i-xvi.indd 2 11/21/13 5:30 PM WORLD BANK LATIN AMERICAN AND CARIBBEAN STUDIES

Latin American Entrepreneurs

Many Firms but Little Innovation

Daniel Lederman, Julián Messina, Samuel Pienknagura, and Jamele Rigolini

OVERVIEW

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