Financing Entrepreneurship and Innovation in Emerging Markets

Lourdes Casanova, Peter Klaus Cornelius, Soumitra Dutta

• Publisher: Academic Press
• Year: 2017
• Print ISBN: 9780128040256
• eBook ISBN: 9780128040263
• Topic: Negocios y empresa
• Subtopic: Estrategia empresarial

Financing Entrepreneurship and Innovation in Emerging Markets offers an original perspective on the links between macro data on innovation, data on micro-entrepreneurial processes and venture capital supply. The authors synthesize two disparate fields of research and thinking—innovation and entrepreneurship and economics—to illuminate how domestic companies compete and the business environment in which entrepreneurial firms operate. Its broad scope and firm linkages between processes at different levels leapfrogs research topics. For those investigating entrepreneurship and innovation in the early stages of economic development, this book demonstrates how micro and macro foundations of productivity, and hence economic growth and development, are inextricably intertwined.- Combines macro and micro perspectives on innovation processes- Reveals how economic growth and development are inextricably intertwined- Uses case studies to portray the entrepreneurial firm and its role in accelerating the speed of innovation and dissemination of new technologies- Identifies common flaws undermining public venture programs, including poor design, a lack of understanding for the entrepreneurial process and implementation problems

Chapter 1

Introduction

Abstract

This chapter discusses the pivotal role of innovation in sustaining economic growth, the importance of entrepreneurship for technological change, and the need for entrepreneurial firms to have access to external finance. As the chapter shows, there are limited funding sources for entrepreneurs in emerging economies, and unless these constraints are alleviated, there is considerable risk of countries stalling at critical junctures of economic transformation. While a substantial volume of literature explores the nexus between entrepreneurial finance, innovation, and economic growth, much of this research has focused on bank lending and other traditional funding forms. This chapter argues that new, alternative funding pools could combine with rapid advancements in financial technology to have a profound impact on the growth dynamics of emerging economies. The remaining part of the introduction presents the structure of the book and summarizes the key arguments and findings in each chapter.

Keywords

Entrepreneurship; Innovation; Technological progress; Bank credit; Entrepreneurial finance

Most economic historians will remember the Global Financial Crisis of 2008–2009 as the deepest recession since the Great Depression. However, this period is also memorable for another reason: for the first time in history, emerging market and developing economies contributed more to global output as measured in purchasing power parity (PPP) terms than advanced economies (International Monetary Fund, 2017). Since then, emerging and developing economies have further increased their share of world Gross Domestic Product (GDP), and according to the IMF (2017), emerging economies could account for as much as 60% of world GDP by 2020. This process has been led by the four largest emerging economies—Brazil, Russia, India, and China (the BRICs)¹—which together could overtake the combined GDP of the G7—the seven largest advanced economies—by 2035 (Goldman Sachs, 2003).

In most, but not all, emerging economies, rising living standards have accompanied the catch-up process relative to standards of advanced economies. In South Korea, for instance, real GDP per capita in 1980 amounted to only around 17% of the level in the United States (Fig. 1.1). In the subsequent decades, the per capita income gap narrowed progressively, prompting international organizations such as the IMF to reclassify South Korea as an advanced economy.² By 2016, South Korea’s relative level of prosperity reached 67% of the United States’, and IMF projections suggest that this catch-up process could continue in the future. Similarly, while China’s per capita income is estimated to have amounted to just 2% relative to the United States in 1980, in 2016, the country’s level of prosperity reached 27% of the U.S. benchmark.

Fig. 1.1 Per-capita incomes relative to the United States. Note: Per-capita income based on purchasing power parity. (Source: Authors, based on data from IMF WEO database, accessed 4/27/17.)

Projections such as Goldman Sachs Group Inc’s study on “Dreaming with BRICs,” which received huge attention in both the investor community and policy circles, are based on the assumption that emerging economies will continue to enjoy rapid productivity growth. This growth will require continued technological progress, which, as we know from Abramowitz’s (1956) and Solow’s (1957) seminal contributions to the economic growth literature, explains the lion’s share of economic growth. As these and subsequent studies have shown, today’s advanced economies would not have been able to achieve their high income levels without rapid technological change.³ Their experience suggests that today’s emerging economies will be unable to narrow and eventually close their per-capita income gaps vis-à-vis richer countries unless they continuously innovate.

While it is generally accepted that countries that rely primarily on increasing the number of inputs will fail to achieve sustained economic growth, there is considerable debate about the underlying drivers of innovation (Furman et al., 2002). This debate centers around the various influences on the pace of technological change and the changing role innovation plays as developing countries catch up and achieve higher levels of economic prosperity. Similarly, while few would dispute the importance of entrepreneurship as a driver of technological progress, most of what we know in this area is based on research on developed markets. The extent to which this knowledge applies to rapidly growing emerging economies is an open question. Finally, there is substantial evidence that lack of financial resources is a significant impediment for entrepreneurship and innovation in advanced economies and to an even greater extent in emerging markets. While this evidence concentrates on traditional sources of funding, especially bank lending, research is struggling to keep pace with rapidly evolving forms of finance, such as angel investing, crowdfunding, accelerators and incubators, and venture capital (VC).

The main objective of this book is to shed more light on the nexus of technological change, entrepreneurship, and the finance of innovation in emerging economies. What determines the innovative process in emerging economies and hence the speed at which they can grow? What role do entrepreneurial startups play in this process, and what does the cross-country analysis tell us about the conditions under which entrepreneurship can thrive? And to what extent could new funding sources and new forms of financial intermediation alleviate the constraints startup entrepreneurs in emerging economies often fail to overcome? The answers to these questions will inform the perspectives of all players involved—innovators and entrepreneurs, financiers, and policy makers.

We are under no illusions that any discussion of these critical issues can be more than preliminary, as we are severely handicapped by the limited availability of data. Reliable data about entrepreneurial finance and its role for innovation is already hard to come by in the United States and other advanced economies, and much harder to track and analyze in emerging economies. These difficulties should not excuse neglecting one of the most profound challenges facing emerging economies as they catch up to richer countries. In fact, echoing Roger Leeds (2015), the “… formidable data gaps provide additional motivation for writing this book,” which could hopefully serve “as a catalyst for better data collection and encourages others to pursue similar research.”

In this sense, this book should be seen as an effort to summarize what we believe we know. As the saying goes, without data, you are just another person with an opinion. Due to the limitations of the data, many of our observations and conclusions are preliminary and remain subject to important changes as more and better data become available. As long as this book helps to shift—no matter how little—the balance from unsubstantiated opinions to a more evidence-based analysis, we feel we have succeeded.

The rest of this chapter proceeds as follows: First, we provide a brief introduction to the key issues we shall discuss in this book—the dynamic process of innovation as a function of a country’s stage of economic development, the role of transformational entrepreneurs in driving innovation, and the challenges entrepreneurs face in financing innovative startups. In the latter section, we provide a brief summary of each chapter of the book.

1.1 Technological Progress and Economic Development

Technological progress as it affects innovation is often associated with radically new products and production processes, a view that is largely U.S.- or OECD-centric.⁴ However, as Porter (1990) argues, a broader concept of innovation is needed to understand how emerging economies, which operate far away from the global technology frontier, grow and narrow their income gap against advanced economies. Porter distinguishes three development phases, each of which exhibits different competitiveness drivers. In the initial phase, economic growth is based on a country’s factor endowments, primarily unskilled labor and natural resources (factor-driven stage). As wages rise in the development process, companies must begin to develop more efficient production methods and increase product quality. At this stage, sustaining economic growth increasingly hinges on a country’s technological readiness, that is, the ability of firms to harness the benefits of existing technologies and innovate by adopting new technologies from abroad and improving on them (efficiency-driven stage).

In the final (technology-driven) stage of economic development, higher wages and the associated standard of living can be sustained only if companies are able to compete through innovation, producing new and different goods using the most sophisticated production processes. According to Porter (1990), successful economic development may thus be understood as a process of successive upgrading, in which businesses and their supporting environments coevolve, to foster increasingly sophisticated production and competition. Countries that fail to manage the wholesale transformation of dimensions involving both the public and private sectors usually got stuck at critical junctures of economic transition—between the factor-driven and efficiency-based stages, or between the efficiency-based and innovation-driven stages. There are several examples of countries that enjoyed significant economic progress for a period but then appeared to stall in their development. Few countries have reached the innovation-driven stage, suggesting that this transition is particularly critical.

As countries progress through the different developmental stages, their companies are likely to incorporate technical and design specifications as well as performance features into their products and services that are closer to those of the most advanced in the global market, perhaps eventually matching products that are on or near the international product technology frontier (Bell and Figueiredo, 2013). At the same time, companies within those countries improve their capability to generate and manage change in the use of technologies. This allows developing countries to move from positions of technology imitation to modest forms of innovation, potentially proceeding further to engage directly and creatively in innovation activities at the international frontier.⁵ Finally, companies may employ growing innovation capabilities to create unique competitive positions in low-income markets on the basis of “new” products that are less technologically complex than equivalent products produced by firms in advanced countries.

Reflecting the changing role of technology in different stages of development, the Organisation for Economic Co-operation and Development (2005) Oslo ManuaĽs definition is much broader than research and development (R&D)-driven inventions. Instead, the OECD’s definition of innovation encompasses the implementation of a new or significantly improved product (good or service) or process, a new marketing method, or new organizational method in business practices, workplace organization, or external relations. While all innovation must contain a degree of novelty, according to the Manual an innovation can be (i) new to the firm, (ii) new to the market, or (iii) new to the world. The first concept covers the diffusion of an existing innovation that may already have been implemented by other firms to a new firm. Innovations are new to the market when the firm is the first to introduce the innovation on its market. An innovation is new to the world when the firm is the first to introduce the innovation for all markets and industries.

The Oslo ManuaĽs definition of innovation provides the basis for the Global Innovation Index (GII), the world’s most comprehensive attempt to rank a large sample of countries according to their innovative capacity and identify particular strengths and challenges in individual economies. The GII aims to determine where countries stand in their development process relative to their peers and in which areas particular attention is required to foster innovation and the resulting economic growth. As an invaluable source for policy makers and companies alike, the GII represents the natural starting point for this book, which, combined with special case studies on individual countries and companies within these countries, provides important insights into the role of technology and innovation in economic development.

1.2 Innovation and the Role of Transformational Entrepreneurship

Innovation and creative destruction require entrepreneurs who develop new technologies, introduce more efficient production processes, and push out unproductive incumbents. Creative entrepreneurs are typically behind the most dynamic and productive companies, which innovate, expand production, and create employment opportunities at a comparatively rapid rate. To be sure, not every new small business is entrepreneurial or represents entrepreneurship according to this definition. Is a person who opens another delicatessen store or another Mexican restaurant in the American suburb an entrepreneur? Drucker argues against such a definition (Drucker, 1985). Although that business owner takes a risk, they create neither a new satisfaction nor new consumer demand. In contrast, in Drucker’s assessment, McDonald’s was highly entrepreneurial. While burgers had been known for a long time, McDonald’s Corp. applied new management concepts and techniques, standardized the products, and designed a new process and tools, thus dramatically increasing yield from resources and creating a new market that could se...

Table of contents

• Cover image
• Title page
• Table of Contents
• Copyright
• In Praise of Financing Entrepreneurship and Innovation in Emerging Markets
• Foreword
• Acknowledgments
• Chapter 1: Introduction
• Part I: Global Innovation Competitiveness
• Part II: Financing Entrepreneurship
• Index