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November 24, 2014

Opinion

Tuesday, April 1, 2014

Latin America can become the start-up continent

By Pablo Sanguinetti
For the Herald

A long time ago, a reporter is said to have asked the Argentine writer Jorge Luis Borges “Who is Borges?” To which the characteristically subtle answer was: “A forgotten man, from a forgotten time, from a forgotten continent.” With economic growth in Latin America having decelerated to 4.6 percent in 2011, to 2.9 percent in 2012, to 2.7 percent in 2013, and with commentators dismissing the growth momentum of the preceding decade as commodity-driven fluke, the region seems indeed on the path to oblivion.

The time is, thus, ripe for a fresh debate around growth and growth drivers in the region. In Corporación Andina de Fomento’s (CAF) Economic and Development Report 2013, we do just this, focusing on the role of entrepreneurship and business productivity growth to bolster aggregate productivity.

Latin America has no shortage of entrepreneurial disposition. On the contrary, based on data from the Global Entrepreneurship Monitor, it boasts a higher rate of business creation than any other region of the world.

The problem is that these businesses do not grow enough. While in Eastern Europe, for example, firms of 26 years of age or older employ 12 times more workers than at birth, in Latin America they employ only seven times more workers than at birth.

As a result, Latin America has too many small firms, sometimes, even one-person firms. While only 68 percent of firms in the United States employ up to 10 employees, this is the case for 91 percent of firms in Latin America.

Obviously this implies that too many people are employed in too small firms. While only 15 percent of the workforce in the United States works in firms with up to 10 employees, this is the case for almost half of the workforce in Latin America.

The region’s diminutive average firm size is bad news: small firms are, on average, less productive. In particular, people employed in firms with more than five employees make almost 25 percent more on average than people working in smaller firms.

So, why are Latin American firms not growing? For one thing, not because of lack of entrepreneurial talent. According to our 2012 survey — which gathered information about those psychological features typically associated with successful entrepreneurship in 17 Latin American cities and a US benchmark — the Latin American workforce scores higher in need of achievement, lower in multi-tasking ability, and similarly in internal locus of control, self-efficacy, and risk tolerance. A virtual tie.

The differences pop up when looking at the entrepreneurial talent of, alas, the very entrepreneurs. A lot of them, precisely those not employing other people, have just as many or less entrepreneurial traits as people with salaried jobs, except for risk tolerance.

These entrepreneurs — in reality just self-employed — are colossally overrepresented in the Latin American labor market. They account for 28 percent of the workforce, compared with only 6.1 percent in the United States. They account for a larger share of the workforce, the poorer the country.

These entrepreneurs, moreover, do not seem to have chosen to start their own one-person, low-productivity businesses for the sake of other non-pecuniary rewards, such as independence and flexibility —they actually report less job satisfaction than employers or employees. They seem, instead, to have been forced into self-employment by lack of better employment alternatives. Actually, seven percent of the self-employed of the region had been unemployed the previous year, compared with only two percent in the United States.

Unfortunately, many of these entrepreneurs are unlikely to ever take off. On average, only six percent of the many self-employed in the region become employers after a year, while 10 percent of the few self-employed in the United States does. And six percent of them go back to joblessness after a year, compared with only three percent in the United States.

Does this mean we should just forget about entrepreneurship support initiatives? Not quite. While 75 percent of the region’s entrepreneurs are in reality micro-entrepreneurs (with less than five employees), it is possible, and advisable, to distinguish among them. Actually close to 25 percent of these micro-entrepreneurs share socioeconomic and psychological attributes similar to those of big employers, suggesting that their businesses have genuine potential to grow. The rest, unfortunately, do resemble salaried employees and would probably be better off as such. Moreover, around 70 percent within them resembles informal employees, speaking for non-negligible employability challenges.

The policy implications are clear. Most of the current micro-entrepreneurs of the region—those who are unlikely to graduate into big firm managers — would be better off as the targets, not of entrepreneurship policy, but of actual social policies that actually target their whole family units, and education and training policies that help them transition to formal, more productive, better-paid jobs.

Entrepreneurship policy as such — programmes designed to relax financial restrictions, improve the business climate, and foster innovation — should target those entrepreneurs who do have the potential to grow.

Incorporating this key distinction into policy design is essential for Latin America to unlock its entrepreneurial potential and become a true “start-up continent” — one that, contradicting Borges’s prediction, can aspire to be kept in mind.

Pablo Sanguinetti is the director of socioeconomic research at the CAF Latin American development bank and a researcher at Torcuato Di Tella University

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