Eastern Europe business: Entrepreneurial laggard

FROM THE ECONOMIST INTELLIGENCE UNIT

Eastern Europe lags behind other emerging regions in terms of entrepreneurship, according to a recent study. In large part this is a result of institutional deficiencies, such as weak property rights and burdensome regulations. However cultural values and popular attitudes are also problems for eastern Europe: the region’s young people have low levels of confidence in their own abilities, see few opportunities for entrepreneurship and are in thrall to the fear of failure. Entrepreneurial indicators have weakened over the past year, to the detriment of the region’s long-term economic growth potential.

Despite a surge in entrepreneurial activity in some countries in eastern Europe in the 1990s, entrepreneurship, and the probability of becoming an entrepreneur, still tends to be significantly lower in the east European economies than in comparable economies, two decades after the start of the transition. This is apparent in the latest study of entrepreneurial activity in the Global Entrepreneurship Monitor (GEM), which has four measurements:

* Nascent entrepreneurship rate: the percentage of the population aged 18-64 who are currently actively involved in setting up a business that they will own or co-own and manage.

* New business ownership rate: the percentage of the population aged 18-64 who are currently owner-managers of a new business (between 3 and 42 months old).

* Early stage entrepreneurial activity: the percentage of the population aged 18-64 who are either a nascent entrepreneur or an owner-manager of a new business, as defined above.

* Established business ownership rate: the percentage of the population aged 18-64 who are owner-managers of an established business that is more than 42 months old.

The GEM’s 53-country sample can be divided into four groups: Russia and seven other transition economies in eastern Europe; 17 other middle-income emerging markets (including Brazil, Argentina, South Africa and Malaysia); 19 high-income countries; and 9 low-income countries.

Where the entrepreneurs reside

The relationship between the level of development and entrepreneurial activity is not linear, it is U-shaped. Low-income countries have a large number of small businesses. As income per head rises, industrialisation and economies of scale increase the role of large firms in the economy. This may be accompanied by a reduction in the number of new businesses. At high levels of income, entrepreneurship begins to rise again as more individuals can access the resources necessary to start their own business. There is also a structural shift to services that is associated with increased entrepreneurial entry.

On each measure of entrepreneurial activity, average rates in the transition economies are lower than in the group of other middle-income emerging markets. For most indicators, the averages for other middle-income economies are about double those of the transition economies. Especially striking are the extremely low rates of entrepreneurial activity in Russia, which are among the lowest in the world. The east European averages also tend to be lower than in the developed world, although the average rates for nascent entrepreneurship are the same.

Entrepreneurial activity, 2009
(% of the working-age population)
Nascent entrepreneurship rate New business ownership rate Early stage entrepreneurial activity Established business ownership rate
Bosnia 3.1 1.3 4.4 3.9
Croatia 3.5 2.2 5.6 4.8
Hungary 5.4 3.7 9.1 6.7
Latvia 5.3 5.4 10.5 9.0
Romania 2.8 2.3 5.0 3.4
Russia 1.8 2.3 3.9 2.3
Serbia 2.2 2.8 4.9 10.1
Slovenia 3.2 2.1 5.4 5.6
Transition economies 3.4 2.8 6.1 5.7
Other middle-income economies 7.9 6.3 13.9 9.1
High-income economies 3.4 3.1 6.3 6.8
Low-income economies 10.0 8.9 18.3 7.9
Source: Global Entrepreneurship Monitor, 2009 Global Report

The determinants of entrepreneurial activity

Factors that influence the level of entrepreneurship include individual attitudes to risk, formal and informal institutions, human capital endowments and the development of the financial sector. The institutional environment affects the propensity to start a new business. Potential institutional obstacles to entrepreneurial activity include the strength of legal enforcement, administrative barriers to entry and to business activities, and the lack of market-supporting institutions. The Soviet legacy left a state sector in eastern Europe that typically militates against entrepreneurial activity, both because of high taxation and via state expenditure. In many countries in the region, the state also continues to engage in arbitrary interference in enterprise affairs, to the detriment of new private ventures.

For entrepreneurship, it is also important to have strong property rights. For the majority of transition economies, the protection of property rights is weak. Informal institutions (prevailing norms and values) are as important as formal institutions in shaping the framework for entrepreneurship. Communism left a legacy of values and norms that are not conducive to entrepreneurship. Values that are critical for entrepreneurship remain much weaker in post-communist societies than in comparable countries. The older generation born and educated under communism is far less entrepreneurial than its counterpart in other regions of the world. However, the differences between transition and comparator countries are lower for younger people, who have a much greater capacity to adapt to new conditions and cultural influences.

An individual’s decision to create a new firm is affected by that individual’s confidence in their own skills and willingness to accept the risk of failure. Citizens in transition economies on average display less confidence than citizens in comparator countries in terms of the percentage of respondents who believe that they have the skills and knowledge to start a business. There is exceptionally low confidence in their own business skills in Russia (24% of those aged 18-64) and Romania (27%). The fear of failure variable also generates a distinctive pattern in which transition countries score lower than other economies. A typical respondent in a transition economy is less likely to accept the risks associated with a new venture.

The level of corruption reflects all the institutional weaknesses in an economy, as it results from weak property rights, arbitrariness in state administration, a weak judicial system, and inefficient and non-transparent regulatory frameworks. It also reflects prevailing social norms. It can therefore be treated as a proxy for overall institutional quality. For most transition economies, high corruption is consistent with low scores on levels of entrepreneurship.

The effects of the 2009 recession

The 2009 crisis hit much of eastern Europe disproportionately hard (with Poland being a notable exception). Although crises can sometimes unleash new entrepreneurial energies, and boost necessity-driven entrepreneurship, 2009 is likely to have had a negative impact on entrepreneurship in eastern Europe through a reduction in actual and perceived opportunities and more difficult financing conditions. Some of these longer-term negative consequences will constrain growth.

The crisis and entrepreneurship
(% of population aged 18-54)
Nascent entrepreneurship rate Early stage entrepreneurial activity Perceived opportunities
2008 2009 2008 2009 2009*
Bosnia 6.4 3.1 9.0 4.4 35
Croatia 4.9 3.5 7.6 5.6 37
Hungary 3.8 5.4 6.6 9.1 3
Latvia 3.9 5.3 6.5 10.5 18
Romania 2.5 2.8 4.0 5.0 14
Russia 1.7 1.8 3.5 3.9 17
Serbia 4.0 2.2 7.6 4.9 29
Slovenia 4.1 3.2 6.4 5.4 29
Transition economies 3.9 3.4 6.4 6.1 23
Other middle-income economies 9.3 9.1 15.9 15.8 46
High-income economies 3.6 3.2 6.8 6.0 28
* % of the population aged 18-64 who see good opportunities to start a firm in the area where they live
Source: Global Entrepreneurship Monitor, 2008 and 2009 Global Report

The GEM data show that entrepreneurial activity rates on average declined in eastern Europe in 2009 compared with 2008. The two notable exceptions were Hungary and Latvia, where there were significant increases in activity. These two economies were among those hit hardest by the crisis, suggesting that there was an increase in so-called “necessity-driven” entrepreneurship. In the other middle-income emerging-markets group, the average rates of entrepreneurial activity were almost the same in 2009 and 2008.

Another worrying indicator for eastern Europe is the pervasive pessimism about prospects, linked to the economic crisis, as revealed by the results of the survey on perceived opportunities to start a business in 2009. The share of those who see good opportunities are among the lowest in the world. It is especially striking that only 3% in Hungary saw good opportunities for starting a business.