EIB Working Papers 2018/07 - Young SMEs: Driving Innovation in Europe?

European Investment Bank, European Investment Bank

• Publisher: European Investment Bank
• Year: 2018
• ISBN:
  9789286138256
• Topic: Business
• Subtopic: Finanza
• Index: Business

Using the EIB Investment Survey, this working paper categorises EU firms according to their involvement in R&D and other innovation activities. It explores why young innovators are not more engaged in innovation, examining the role of credit constraints and public grants.

1. The role of (young) SMEs in economic performance and innovation

There is an on-going debate in policy and academic circles about which firms matter most for job creation and growth, with answers ranging from a few large stars versus the glitter of many small firms (for an overview of the different positions, see e.g. Haltiwanger, Jarmin and Miranda, 2010, and Calvino, Criscuolo and Menon, 2016). The interest in small firms for economies’ growth performance is of no surprise. SMEs are not only a large part of the economy but also, almost by definition, are at the heart of the Schumpeterian process of creative destruction, since most new firms entering are small (as are most of the exiting firms) (see e.g. Bravo-Biosca, 2017).

However, high shares of SMEs and entry and exit do not by themselves guarantee a functioning Schumpeterian growth process. What is needed is the right type of churning, where the successful entrants can grow out of SME status to become large incumbents and the failing firms restructure or exit. There are concerns that this churning process may be hampered in the EU. Bravo-Biosca (2017) shows that EU countries have a larger share of static firms – i.e. firms that do not grow or shrink – compared to the US and that this correlates with lower aggregate productivity growth for EU economies.

The heart of the growth potential of a Schumpeterian business fabric lies in the presumption that small entrants bring to the market new and better processes or products, displacing firms with older and/or less efficient products or technologies. Innovation is at the core of the Schumpeterian growth process and young small firms are the most promising actors in the Schumpeterian dynamics, as they are considered to have a key role in creating new ideas and developing them into successful innovations. Joseph Schumpeter in his first contributions emphasized the role of new entrepreneurs entering niches of markets. By introducing new ideas and by innovating, these entrepreneurs challenged existing firms through a process of “creative destruction”, which he regarded as the engine behind economic progress (Schumpeter, 1939). This was later labeled as Schumpeter’s Mark I model (Malerba and Orsenigo, 1995). In later contributions, Schumpeter (1942) shifted attention to the key role of large incumbent firms as engines for economic growth, as these firms can thrive on their accumulated non-transferable knowledge in specific technological areas and markets: Schumpeter’s Mark II (see also Ortega-Argiles, Vivarelli and Voigt, 2009).

The advantage of small new firms holds particularly for more radical innovations that disrupt existing positions – for which incumbent firms are more reluctant to be engaged in, avoiding the cannibalization of their existing profits and being trapped in incumbent expertise (e.g. Henderson, 1993). A lack of small new innovators may thus reduce particularly the introduction of radical breakthrough innovations, which lay the foundations of completely new markets. Missing small new innovators may also reduce the innovativeness of incumbent firms, lacking the challenge to adopt the latest innovations to escape competition and lacking the opportunity to acquire small firm ideas to further improve on (e.g. Colombo et al., 2017).

Concerns abide that the creative destruction Mark I model is less at play in the EU innovation landscape, with a larger share of innovation activities concentrated in older firms and sectors. Missing a concentration of innovators in new sectors and new firms, particularly in digital technologies, goes a long way to explain the persistent business R&D deficit gap of the EU compared to the US (e.g. Cincera and Veugelers, 2014).

There are also concerns that the adoption of latest innovations may be hampered in Europe. For instance, Andrews, Criscuolo and Gal (2016) show an increasing divide in productivity performance between leading and following firms, consistent with a lack of incentives or capabilities to adopt the latest innovations by non-leading firms.

Although innovating firms face a myriad of obstacles, the most frequently discussed explanation for the differences in dynamic structure between Europe and the US is a greater willingness on the part of US financial markets to fund the growth of new companies with more radical projects (O’Sullivan, 2005). With innovation investments typically invoking large and uncertain sunk costs, availability of internal and external finance is a critical issue for innovating firms (e.g. Czarnitzki, 2006). Small and young firms with less collateral and less reputation will face more financial barriers. A large literature confirms the importance of access to finance as the major hampering factors for innovation; for all types of firms, but more for small than for large firms (e.g. Hall, 2002; Beck and Demirguc-Kunt, 2006) and more for young highly R&D intensive firms, which are introducing more radical innovations (e.g. Schneider and Veugelers, 2010; Gaspar et al., 2009, Revest and Sapio, 2012).

The contribution of this paper is to use recent large scale survey evidence to characterize the Schumpeterian creative destruction process in Europe, whether it is more of Mark I or Mark II and with which type ...