Barriers to Entrepreneurship - World Bank

Barriers to EntrepreneurshipLeora Klapper(World Bank)Luc Laeven(World Bank and CEPR)Raghuram Rajan(IMF and NBER)World Bank, January 10, 2005

Motivation• Little is known about the business environments that promotenew firm creation. This is an important concern forpolicymakers, who are trying to implement policies that willfoster entry.• What is the role of entry regulations, especially bureaucraticregulations on setting up limited liability companies, inexplaining variations in patterns of firm entry?• The early debate on entry regulations emphasized the possibilitythat crooks might register with little capital and dupeunsuspecting investors or consumers. According to this view,entry regulations serve the public interest by preventing fraud.• Others describe regulations as devices to protect private interestsof industry incumbents or the regulators.2

Contribution• We first show that entry regulations do affect entry.• Next we study the consequences of preventing free entry for thegrowth of incumbent firms.• A cross-country regression of firm entry against regulations maysuffer from a causality problem – that in countries with generallylow entry, people are not sufficiently motivated to press for therepeal of regulations that impede entry.• To address this sort of problem, we focus on cross-industry, crosscountryinteraction effects. In particular, we test whether entry isrelatively lower in “naturally high entry” industries when they arein countries with high bureaucratic restrictions on entry.3

Data• Our primary source of firm-level data is the Amadeus databasewith information on >5 million firms in 34 European countries.• It improves upon previously used datasets in that it includes a largenumber of private firms and all industrial sectors.• We measure entry as the share of new firms, calculated at thecountry and industry level.• Proxies for natural propensity to enter and other industrycharacteristics from a variety of sources, all based on U.S. data• Proxies for entry barriers and other regulations from a variety ofsources.4

Entry Regulations HamperEntrepreneurship• We find that entry regulations hamper entrepreneurship, especiallyin industries that naturally should have high entry.• Relative entry into industries with high entry in the U.S. isdisproportionally higher in countries with low entry costs.• The effect is generally present in all countries and industries.• The results are robust to using alternative measures of the naturalpropensity to enter, including U.S. exit rates, SME shares, andaverage firm size and scale variables.• Both the availability of private (bank) credit and of trade creditaids entry in financially dependent industries.5

Causality• There could be omitted variables that jointly drive the propensity toenter and the degree of bureaucratic entry barriers: but the resultshold when we instrument entry regulation with legal origin.• Perhaps countries with large “high natural entry” industries have astrong entrepreneurial culture and select low entry regulation: butthe results hold when we restrict the sample to industries that arerelatively small. These industries are unlikely to be responsible forentry barriers since they have limited political clout.• Countries with more untrustworthy populations may erect higherbureaucratic barriers so as to screen would-be entrepreneurs morecarefully. If such barriers were meant to screen entry efficiently,we should expect them to be particularly effective in low-income/high-corruption countries relative to high-income/low-corruptioncountries. We find they are not. Entry regulations have adverseeffects primarily in countries that are more developed/less corrupt.6

Are Entry BarriersSocially Harmful or Beneficial ?• If entry barriers screen appropriately (public interest view), weshould find that incumbent older firms in naturally high entryindustries should grow relatively faster in countries with highentry regulations. We find the opposite (private interest view).• The value added by naturally “high-entry” industries grows moreslowly in countries with high entry barriers. The effect isprimarily seen for older firms suggesting that entry barriers mutethe disciplining effect of competition.7

Conclusions• Taken together, these results suggest that entry regulations areneither benign nor welfare improving. These regulations seempurposefully intended to protect incumbent firms.• We do not imply all regulations inhibit entry. Regulations thatenhance the enforcement of property rights or lead to a moredeveloped financial sector do lead to greater entry in industries thatdo more R&D or industries that need more external finance.• Our paper suggests that competition has disciplinary effects thatoutweigh any possible screening benefits from entry restrictions. Ifso, moves to reduce bureaucratic entry regulations will helpcountries.8

What Next ?

Future Research• Need more and better data on small and new firms, even for theUnited States.• Measuring firm creation requires data on redeployment of assets,mergers and acquisitions, spin-offs, re-registrations, etc.• Need to (re)define “firm entry” and “entrepreneurship”.• Is the United States a useful benchmark for natural entry rates andindustry structures more generally ? Not if U.S. bankruptcysystem is inefficient ?• Need to study the life cycle of firms, tracking firms over time, andsimultaneously look at entry, exit, and industry structure.• Political economy of entry: formal and informal barriers created bygovernment and incumbents.10