Institutions Are Key To Successful Entrepreneurship

Each year INSEAD and WIPO team up to produce the Global Innovation Index, which aims to rank nations according to their innovative capacity and outputs. At the heart of the rankings are various institutions and institutional factors that the researchers believe underpin good innovation. The index ranks nations according to things such as political stability, government effectiveness, regulatory quality, the rule of law and the ease of starting a business.

While the Global Innovation Index includes a wide range of factors in ranking each nation and doesn’t apply greater weight to one factor over another, there is growing evidence that institutional quality is fundamental to both innovation and entrepreneurship. Research from the University of Texas-Rio Grande Valley underlines this point. The researchers found that after examining 70 countries between 2005 and 2015, there is a clear link between the quality of institutions in a country and both the quality and quantity of entrepreneurship.

Rules of the game

The importance of institutions was famously described by Joseph Schumpeter in Capitalism, Socialism and Democracy, where he described not only their importance but also their enduring qualities.

“Social structures, types and attitudes are coins that do not readily melt,” he wrote. “Once they are formed they persist, possibly for centuries, and since different structures and types display different degrees of this ability to survive, we almost always find that actual group and national behavior more or less departs from what we should expect it to be if we tried to infer it from the dominant forms of the productive process.”

Their importance in an entrepreneurial context was further underlined in a 1990 paper by William Baumol, who argued that every society has its fair share of entrepreneurs, but both the way those entrepreneurs express themselves, and the success of their efforts, are largely dependent upon the institutions in each society.

Baumol suggests that no amount of entrepreneurship can flourish if the institutions don't exist to support entrepreneurs, thus resulting in a huge number of "lost Einsteins". The Texas study looked at six formal and informal institutional dimensions (availability of debt and venture capital, regulatory business environment, entrepreneurial cognition and human capital, corruption, government size, and government support), and found that the impact of institutional improvements can be especially pronounced in developing countries, with this boost seen in both the quantity and quality of entrepreneurship.

The institutional conditions in a country were a major determinant of the quantity and quality of entrepreneurship, with successful entrepreneurs then taking the opportunity to subsequently influence institutions and either create new institutions or transform existing ones in a virtuous circle of improvement.

Starting from a low base

This is not easy, however, when countries have weak institutions to begin with. For instance, the Global Innovation Index ranked Pakistan a lowly 99th in terms of the quality of its institutions, with the country scoring particularly poorly for the regulatory and political environment in the country. Indeed, the Global Entrepreneurship Development Institute ranks the country a lowly 122nd out of 137 countries. This compares to neighboring India, which ranks 69th. With the World Bank also rating the country 136th out of 190 in its ease-of-doing-business rankings, the problems facing potential startups are all too evident.

One approach would be to develop "one-stop shops" for registering a business and paying taxes. Such an approach has already been adopted by around 80 countries globally so it is a tried and tested method that should represent reasonably low-hanging fruit.

There is also much the country could do to improve the infrastructure that underpins entrepreneurship. For instance, the Global Innovation Index ranks the country just 117th in terms of ICT usage, with the general infrastructure ranked even worse. Similarly, there are evident challenges in terms of market sophistication, with the country ranking 123rd in terms of ease of getting credit and general access to finance.

While there are evident challenges, the country produces around 290,000 graduates per year, with 315,000 additional graduates from vocational-training institutes. Couple this with an enormous population of some 140 million people below the age of 30, and there are clear opportunities for the country.

The emphasis on institutional voids, as well as the concept of ‘‘distance’’ between rules and norms of countries, often obscure the considerable organizational and institutional innovations occurring in emerging economies, and overlook how the catch-up challenge shapes the different ways in which public and private actors can reconfigure their innovative capacities. States vary in the configuration of their industrial support and corporate governance institutions, which in turn, greatly shape the competitive advantages of the embedded firms and the insertion or adaptation challenges of foreign firms. Institutions (in the North’ian sense) also play an inordinately large role in shaping the competitiveness of a nation’s industries.

States shape knowledge flows through the imposition of formal institutions such as laws and regulations, although relationships between actors within an innovation system are governed just as much by informal institutions.. States matter, not only as enforcers and creators of institutions but also as direct participants in innovation systems through public organizations, such as research institutes and universities, and as orchestrators of industrial and innovation policy state intervention through institutions or through direct participation can facilitate skills development and knowledge creation programs or services. This may include public investments in R&D and new technologies that individual firms find too risky to undertake on their own, as well as the training in practices and standards ‘imported’ from advanced economies.

Distributed entrepreneurship

The potential for entrepreneurship to invigorate economies is evidenced by the growing democratization of the field. Whereas historically high-growth startups tended to cluster in a few hubs, the 1,000 or so unicorns are now scattered across nearly 300 cities. This is a marked change from a decade ago, when around three-quarters of all unicorns were based in the United States and only four countries were host to any at all.

While places like San Francisco, Beijing and London continue to play an outsized role in global entrepreneurship, half of global capital now flows outside of the United States. Hubs around the world have sprung up off the back of deep pools of tech talent, ready access to capital and strong links to the rest of the world.

This distribution has also been fueled by the spread of high-speed internet and the reach of smartphones that allow companies to access global markets at the click of a button. This has been exacerbated by the emergence of cloud computing and a huge array of developer tools that have made setting up a tech business that much easier. Many of the nations that have developed successful clusters have, however, also got robust institutions underpinning them.

For instance, it's notable that Singapore has managed to grow over 3,800 tech-enabled startups while coming 1st in the Global Innovation Index's institutions ranking. This includes an additional S$300mil to catalyze investments and increased its co-investment ceiling to S$4million for early-stage deep tech startups.

Data colonies

The University of Oxford’s Viktor Mayer-Schonberger, and his colleague Thomas Ramge, argue that a key development to fuel both innovation and global development would be greater access to data. The likes of McKinsey have previously suggested that open data across just a handful of industries would yield a multi-trillion dollar bounty globally, and in Access Rules, Mayer-Schonberger cites the United Nations Conference on Trade and Development’s 2019 event on digital development, in which delegates from a number of developing nations made the case for a data access mandate to power innovation and development.

“But the best solution would be for many regions to converge and form a data access coalition to take on the data colonialists,” Mayer-Schonberger argues. “A strategy for creating wealth through accessible data across borders could entail a lucrative offer to many nations: become part of a data access region based on carefully considered and consistently enforced rules; within this region US and Chinese companies will have to grant access to their data if they want to do business.”

The west has already shown what can happen when such access is facilitated, after the breakup of AT&T, and importantly the opening up of the IP held and generated by Bell Labs, provided an enormous boost to the computing and internet developments that were to come over the following 70 years.

“Entrepreneurial innovation touches virtually all industries – including those sectors that are the foundations of economic growth,” says Stasia Mitchell, EY Global Entrepreneurship Leader. “From agriculture to telecommunications, education to finance, entrepreneurs in developing countries often tackle some of the most important infrastructural challenges a nation or community can face, and, in many cases, alter the country’s economic trajectory in the process.”

Entrepreneurship can play a crucial role in the development of any nation, but it's clear that institutional support and stability are crucial to allow that to take place. As Baumol explains, it is beholden to policymakers to ensure the rules of the game are such that entrepreneurship is invigorated. This could be via fairly old-fashioned institutions, but it could also be via new regulations that encourage startups to stay independent or to ensure that data access is democratized.

*this article was co-written with Muneeb Sikander