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Entrepreneurship, Small Firms and Self-employment

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Entrepreneurship, small firms and self-employment

David Audretsch (University of Indiana)

Maria Callejon (Universitat de Barcelona)
Mari Jose Aranguren (Universidad de Deusto)

August 2002

Introduction
The role of entrepreneurship in society has changed drastically over the last half
century. During the post-World War II era, the importance of entrepreneurship and business
seemed to be fading away. While alarm was expressed that small business needed to be
preserved and protected for social and political reasons, few made the case on the grounds of
economic efficiency. This position was drastically reversed in recent years.
In the post-war era, small firms and entrepreneurship were viewed as a luxury, perhaps
needed by the west to ensure a decentralization of decision making, but in any case obtained
only at a cost to efficiency. Certainly the systematic empirical evidence, gathered from both
Europe and North America documented a sharp trend towards a decreased role of SMEs during
the post-war period.
Thus, it was particularly startling and a seeming paradox, when scholars first began to
document that what had seemed like the inevitable demise of SMEs actually began to reverse
itself starting in the 1970s. Loveman and Sengenberger (1991) and Acs and Audretsch (1993)
carried out systematic international studies examining the re-emergence of SMEs and
entrepreneurship in North America and Europe. Two major findings emerged from these studies
– first, the relative role of SMEs varies systematically across countries, and secondly, in most
European countries and in North America, SMEs began increasing their relative importance
starting in the mid-1970s. In the U.S. the average real GDP per firm increased by nearly two-
thirds between 1947 and 1989, from $150,000 to $245,000, reflecting a trend towards larger
enterprises and a decreasing importance of SMEs. However, within the subsequent seven
years it had fallen by about 14 percent to $210,000, reflecting a sharp reversal of this trend and
the re-emergence of SMEs (Brock and Evans, 1989). Similarly,. SMEs accounted for one-fifth of
manufacturing sales in the U.S. in 1976, but by 1986 the small-firm share of sales had risen to
over one-quarter (Acs and Audretsch, 1990).
The reversal of the trend towards large enterprises towards the re-emergence of SMEs
was not limited to North America. In fact, a similar trend was found to take in Europe as well.
For example, in the Netherlands the business ownership rate fell during the post-war period,
until it reached a trough of 0.085 in 1982. But this downward trend was subsequently reversed,
rising to a business ownership rate of 0.10 by 1998 (Audretsch et al., 2002a). Similarly, the
small-firm employment share in manufacturing in the Netherlands increased from 68.3 percent
in 1978 to 71.8 percent in 1986; in the United Kingdom from 30.1 percent in 1979 to 39.9
percent by 1986; in (West) Germany from 54.8 percent in 1970 to 57.9 percenty by 1987; in
Portugal from 68.3 percent in 1982 to 71.8 percent in 1986; in the North of Italy from 44.3
percent in 1981 to 55.2 percent by 1987, and in the South of Italy from 61.4 percent in 1981 to
68.4 percent by 1987 (Acs and Audretsch, 1993).. An EIM study documents how the relative
importance of SMEs in Europe (19 countries), measured in terms of employed shares has
continued to creased between 1988 and 2001 (EIM, 2002).
Only recently have scholars begun to try to find an empirical link between
entrepreneurship and growth. The results have been fraught with ambiguities. While some
studies find a positive relationship between entrepreneurship and growth, still others find either
no relationship or even a negative one. Thurik (1999) provided empirical evidence from a 1984-
1994 cross-sectional study of the 23 countries that are part of the Organization for Economic
Co-operation and Development (OECD), that increased entrepreneurship, as measured by
business ownership rates, was associated with higher rates of employment growth at the
country level. Similarly, Audretsch et al. (2002b) and Carree and Thurik (1999) find that OECD

1
countries exhibiting higher increases in entrepreneurship also have experienced greater rates of
growth and lower levels of unemployment.

The renewed literature has stressed the relevance of entrepreneurship for growth (Audretsch
and Thurik, 2001; Thurik and Wennekers, 1999; OECD, 1998). Audretsch et al (2002b) have
argued that the better growth performance of United States over the European Union in recent
years has to do with the strong entrepreneurial vitality in United States. At the same time the
empirical tests of the link between entrepreneurship and growth have been blurred (Reynolds et
al. 2001) by the difficulties at finding a good definition for entrepreneurship with empirical
relevance allowing to identify observable variables. Although scholars generally agree that new
businesses are an important, if not the main agent of entrepreneurship, it seems also clear that
not all new businesses are entrepreneurs able to make an impact on growth and innovation.
One of the limitations involving both research and policy is the heterogeneity inherent in
entrepreneurship. An important research challenge is to decompose at least some of the
different types of behavior and incentives that characterise entrepreneurship and distinguish it
from other businesses forms.
The purpose of this present study is to contribute to the analysis of entrepreneurship by
examining whether some forms of registered businesses are less likely to behave as
entrepreneurs. The answer to this question is important because it will shape what is both
understood to be entrepreneurship as well as the impact of entrepreneurship on performance
measures. In particular, in the empirical part of this paper we focus on distinguishing the
behavior and performance of the self-employed without employees from those firms with
employees. Although we can find reports where self-employment is virtually equated to
entrepreneur (Gallup Europe, 2000), academic approaches take a more restrictive vision
(Audretsch, Carree and Thurik, 2001). The incentives that drive one agent to be self-employed
(no paid job opportunities, niche, preference for independence, professional career) are not the
same of an entrepreneur as we will discuss below. The self-employed with 0 employees
represent more than half of all business units in the European Union (Figure 1). It is a
considerable proportion and it makes sense to analyse if they can be treated as other small
firms in analysis concerned with the measure and the effect of entrepreneurship.

Table 1. Enterprises in the EU — Breakdown of enterprises, employment and turnover by employment size
class. 1996.

Average
Average turnover
Employment size Total number of
Enterprises Turnover per enterprisese
classes employment persons
(€1000)
employed
0 50.4 10.0 1.2 3.8 71.0
1-9 42.7 24.4 3.5 14.1 310.0
10-49 5.9 18.8 19.3 16.8 2686.0
50-249 0.8 13.1 93.9 19.5 21732.0
250+ 0.2 33.8 1043.8 45.8 219905.0
Total SMEs 99.8 66.2 4.0 54.2 511.0
Source: Enterprises in Europe, 6th Report. 1991

What follows in this paper is organised in two main parts and conclusions. The first part deals
with the conceptual framework of entrepreneurship including theory and discusses the nature of
entrepreneurship, its measurement aspects, the impact of entrepreneurship on growth and
welfare, its relationship to industry structure and dynamics, and some policy issues. The second
part is empirical and shows how the behaviour of the self-employed, and specifically solo-self-
employed, is different from small business. The distinct behavioral patterns between these two
groups leads us to conclude that many of the standard measures of entrepreneurship which
have combined firms with no employees and firms having employees are too heterogeneous of
a group to result in unambiguous results and findings.

2
The nature of entrepreneurship

The notion of Entrepreneurship, typically understood as involving the business activities

of those agents that seek to introduce a new idea, product or service in the market, has long
been recognized to be a fundamental vector of economic growth and social development. There
are certainly exceptions to this view, such as the conception represented by the classic
Aristotelic philosophic school, but the predominant view within economics has considered the
entrepreneurial function as serving as an agent of change. The most prevalent and compelling
views of entrepreneurship focus on the perception of new economic opportunities and the
subsequent introduction of new ideas in the market. Entrepreneurship is about change, just as
entrepreneurs are agents of change; entrepreneurship is thus about the process of change.
This corresponds to the definition of entrepreneurship proposed by the OECD, “Entrepreneurs
are agents of change and growth in a market economy and they can act to accelerate the
generation, dissemination and application of innovative ideas….Entrepreneurs not only seek out
and identify potentially profitable economic opportunities but are also willing to take risks to see
if their hunches are right” (OECD, 1998, p. 11). Because this change adds value to economic
welfare it is generally regarded as a desirable behaviour for the wealth of nations.
At the same time the task of producing clear and relevant empirical evidence on the
determinants and effects of entrepreneurship present significant difficulties. In this aspect the
phenomenon of entrepreneurship is not different from most dynamic economic processes,
where empirical testing is systematically burdened with significant measurement difficulties.
At least one part of the difficulties in matching concepts and evidence might be due to the
ambiguous and elusive elements in the available theories of entrepreneurship. Models oscilate
between a conception of the entrepreneur as a special individual or a more general vision
where incumbent firms or organizations generate the new or entrepreneurial activities. This fact
does not facilitate the identification of observable variables that might give account of the
quantity and quality of entrepreneurs and allows comparison among different studies. Not least,
another part of the problem is the endemic scarcity of relevant data; a situation at which Solow
(1997) has pointed out as the main general barrier to the testing of economic theories.
Many authors have observed that the conventional theory of the firm, the theory of the firm
embedded in traditional industrial organization, does not account for entrepreneurship. Baumol
(1968) observed that in neoclassical analysis “the theoretical firm is entrepreneur less. Explicitly
or implicitly the firm is taken to perform a mathematical calculation which yields optimal (i.e.
profit maximizing)”.
The concept and the phenomenon of entrepreneurship have been approached outside and in
parallel to the field of industrial organization but from different - although related - perspectives.
Audretsch (1995) has maintained that the theory of the behaviour of new firms should take the
individual as unity of analysis. According to the different classical approaches the entrepreneur
is understood as the agent that (i) experiments and discovers (Hayek); (ii) innovates
(Schumpeter), (iii) bears uncertainty (Knight) or risk. And in all cases the entrepreneur is an
agent that fosters economic development.
Hayek (1948) did not produce an explicit theory of the role and nature of entrepreneurship but
his conception of the process of economic development relies in fact on agents that scan all
new market possibilities with the incentive of making a profit. Each agent browses only an
infinitesimal part of the economic reality, but collectively all alternatives are put into proof.
Implicitly Hayek presents entrepreneurship as a type of behaviour that many individuals adopt
spontaneously under free political and social institutions. In some way Hayek transfers the idea
of biological Darwinian evolution to the economy in a process that involves also the
entrepreneurship activity. In a society under the rule of individual freedom and were the
allocation of resources is performed fundamentally through a competitive market, no business
opportunity will pass unnoticed by one or another individual seeking to make a profit.
“….the method [of production] which under given conditions is the cheapest is a thing
that has to be discovered anew, sometimes almost from day to day, by the
entrepreneur, and that, in spite of the strong inducement, it is by no means regularly the
established entrepreneur, the man in charge of the existing plant, who will discover what

3
 is the best method. The force which in a competitive society brings about the reduction
of price to the lowest cost at which the quantity saleable at that cost can be produced is
the opportunity for anybody who knows a cheaper method to come in at his own risk
and to attract customers by underbidding the other producers” (Hayek, 1948, p.169).
Although Hayek acknowledges that individual rationality is imperfect and limited, and most
undertakings will not be accepted by the market and fail, those business initiatives that are
socially valuable and are able to generate enough demand will succeed. In that way free
individual initiative coupled with overall coordination by the market will ensure that all
imaginable innovation possibilities will be tested and only those business initiatives “best fit” will
be able to survive in the process of competition and contribute to produce the highest economic
progress and rate of growth. In other words, the outcome of the selection process is that
resources are optimally allocated in a dynamic context. Although this image somehow reminds
us of the Panglossian world where “tout va pour le mieux dans le meilleur des mondes”, it is a
good way to illustrate the process of dynamic competition. Hayek does not intend to explain
entrepreneurship by itself but its effects on the general performance of the economy under a
political regime of individual freedom. Entrepreneurs enter as the elemental unit of economic
growth. Recently Carlsson and Eliasson (2001) have proposed a model that they call
“experimental selection” with similar parameters.
One aspect of Hayek’s model that may have interesting implications and links to modern
selection theories like Jovanovic’s (1982) is that in his outline all initiatives are tested. Hayek’s
model presents also the attractive feature that it can account for the high turbulence of firm’s
demography, while models that suppose some kind of entrepreneurial rationality have more
difficulties to match empirical evidence. If the decision to enter was fully based on rationality
grounds the rate of gross entry probably would be lower and would vary much more across
industries and over the product cycle.
In Schumpeter’s approach the entrepreneur is an innovator. The entrepreneur is the element
that provides the creative response of the economic system, while conventional business
people present adaptative responses. The list of innovative activitities (new good, new method
of production, new market, new source of supply, new forms of organization of an industry like
the creation of a cartel or trustification or, inversely, the breaking up of a monopoly position)
does not include only strictly technological innovations. The relevant aspect, for the purpose of
this paper is that Schumpeter distinguishes between two different technological regimes of
innovation and the nature of the entrepreneur is also different in each one. In Schumpeter Mark
I regime (1912) innovation is afforded by many small firms that use the “public basin” of existing
knowledge (Soete and Weel, 1999). This is the place for entrepreneurs. In Schumpeter Mark II
regime (1942) innovative activities are conducted by incumbent large firms which are usually
monopolist of the innovation and are able to appropriate most economic rents. In this second
scenario it is more difficult to see a role for the entrepreneur as individual although it would be
possible to maintain the existence of entrepreneurship.
Schumpeter’s entrepreneur does not bear the risk, the banker does. In Frank Knight’s theory of
entrepreneurship (1921) if not risk (to which there is associated a probability calculated with
actuarial methods) the entrepreneur bears uncertainty. A feature of all new entrepreneurial
initiatives is the lack of previous occurrences, it is unique and its probability of success is not
known.
Is predisposition to entrepreneurship a psychological characteristic? Starting with Schumpeter
most authors seem to consider that entrepreneurship is a psychological characteristic and
individuals vary in their endowment of it. If this was the case it would be possible to hypothesise
that all human societies – independently of the country – would have the same proportion of
potential entrepreneurs, although the actual proportion would depend upon idiosyncratic or
country-specific institutions and social rules and values. This seems compatible with Hayek’s
views although Hayek himself does not seem to view entrepreneurs as special characters
(Kirzner, 1997).
Baumol (1968) feels also attracted by the psychological explanations of the entrepreneur,
particularly his capacity for “leadership” and his particular motivations, which would be not
simply to earn money and maximize profit, but the need for “achievement”. Baumol also
observes that from a policy perspective the crucial aspect is not the nature of entrepreneurs but
the conditions that influence the supply of entrepreneurship and the means that can be used to

4
expand it. Recently a strong concern for policies that foster; or do not impede, entrepreneurship
is found in Audretsch et al (2002a).
If the theory of entrepreneurship is of special interest it is because we can distinguish two
approaches depending upon the adoption of a broad or a restrictive concept of
entrepreneurship. According to the broad, inclusive, concept an entrepreneur is someone that
take decisions about the co-ordination of the production activity and the allocation of resources.
But the academic tradition generally takes the more restrictive option of the entrepreneur as an
innovator or front runner like in Schumpeter or Baumol. In this second sense it is assumed that
entrepreneurship and management is not the same thing. Neither in motivation, nor in effects.
Baumol (1968) expresses this widely shared conception by specifying that the management
function consists on taking the firm to its production possibility frontier, and the entrepreneurial
function is to locate new ideas and to put them into effect, that is, to push the frontier further out.
The adoption or one or another, broad or strict, concept involves deep analytical consequences.
While innovative entrepreneurship is generally considered to impact positively on the level of
competitiveness and the growth rate, management activities are supposed to imply also positive
but less intense effects.

Measures of entrepreneurship activity

Operationalizing entrepreneurship for empirical measurement is difficult (Storey, 1991).
The degree of difficulty involved increases exponentially when cross-country comparisons are
involved. Studies focusing on a single country, either in a cross-sectional or time series context,
have deployed a variety of proxy measures, spanning self-employment rates, business
ownership rates, new-firm startups (births), as well as other measures of industry demography,
such as turublence (turnover), or the extent of simultaneous births and exits and net entry. An
ideal measure would incorporate each of these different measures reflecting a different aspect
of entrepreneurship. However, systematic measurement conducive to cross-country
comparisons is limited.
The different contexts and organizational forms involving entrepreneurship account for
the paucity of measures used to reflect entrepreneurial activity. Measures of self-employment
reflect change that is occurring at least for the individual starting a new business. That very little
of this change is projected onto the larger industry, nation or global market has long resulted in
the criticism of self-employment as a measure of entrepreneurial activity. That is, what is new
and different for the individual may not be so different for the industry or global market. As
Aldrich (1999) has shown, even for a developed country such as the United States, only a very
small faction of new startups are really innovative. Still, measures of self-employment are
widely used to reflect the degree of entrepreneurial activity, largely because they are measured
in most countries, and measured in comprehensive facilitating comparisons across countries
and over time (Blau, 1987).
Audretsch, Carree, van Stel and Thurik (2002a) and Carree, van Stel, Thurik and
Wennekers (2001) use a measure of business ownership rates to reflect the degree of
entrepreneurial activity. This measure is defined as the number of business owners (in all
sectors excluding agriculture), divided by the total labor force. There are a number of important
qualifications that should be emphasized when using and interpreting this measure. First, it
lumps together all types of a very heterogeneous activity across a broad spectrum of sectors
and contexts into a solitary measure. This measure treats all businesses as the same, both
high-tech and low-tech. Second, it is not weighted for magnitude or impact. Again, all
businesses are measured identically, even though some clearly have a greater impact than
others. Third, this variable measures the stock of businesses and not the startup of new ones.
Still, this measure has two significant advantages. The first is that, while not being a direct
measure of entrepreneurship, it is a useful proxy for entrepreneurial activity (Storey, 1991).
Second, it is measured and can be compared across countries and over time.
Other measures of entrepreneurship focus more on change that corresponds to
innovative activity for an industry. Such measures include indicators of R&D activity, the
numbers of patented inventions, and new product innovations introduced into the market
(Audretsch, 1995). These measures have the advantage of including only firms that actually
generate change at the industry level, that is at a level beyond the firm itself. However, such

5
measures must always be qualified by their failure to incorporate significant types of innovative
activity and change not reflected by such measures (Griliches, 1990).
Similarly, other measures of entrepreneurial activity focus solely on the criterion of
growth. Firms exhibiting exceptionally high growth over a prolonged duration are classified as
gazelles. For example, Birch (1999) measures the number of gazelles to reflect
entrepreneurship. Such measures of entrepreneurship must also be qualified for their narrow
focus not only on a single unit of observation – enterprises – but also on a single measure of
change – growth.
Lundstrom and Stevenson (2001) followed the precedent of the Global
Entrepreneurship Monitor (GEM) study (Reynolds et al., 2000) by defining and measuring
entrepreneurship as “mainly people in the pre-startup, startup and early phases of business”
(Lundstrom and Stevenson, 2001, p. 19). This definition has a tilt toward incipient
entrepreneurs and startups because, “these are the targets for entrepreneurship policy
measures.” An obvious limitation of this approach is that it restricts entrepreneurial activity to the
process of the firm startup. While an important manifestation of change and innovation is no
doubt reflected by the process of starting a new business, at the same time there is a
considerable amount of change and innovation contributed by incumbent enterprises of all
sizes, or what is sometimes referred to as intrapreneurship. Lundstrom and Stevenson (2001, p.
19) justify their emphasis on pre-startup and startup as well as the incipient and early stages of
business ownership because, “These are the targets for entrepreneurship policy measures and
we propose that entrepreneurship policy measures are taken to stimulate individuals to behave
more entrepreneurially. It is our position that this can be done by influencing motivation,
opportunity and skill factors. Therefore, our aim is to see what types of policy actions are taken
towards individuals in the pre- and early stages of idea and business development.”
The above discussion makes it clear that while entrepreneurship is a heterogeneous activity
encompassing a broad spectrum of disparate organizations and types of activities, many of the
conventional definitions and measures are, in fact, remarkable for reflecting entrepreneurship as
a homogeneous activity. In the context of developing countries such a narrow definition and
measure of entrepreneurship must be qualified.
In sum, one of the main imperfections of the measures of entrepreneurship most often
employed is that they cannot discriminate between Schumpeterian entrepreneurship or self-
employment and other routinary business initiatives. To progress in the empirical test of the
theory and policy of entrepreneurship it is convenient to try to identify and measure the relevant
variable. This paper attempts a modest contribution by signalling some groups of firms that
could be safely not included.

Entrepreneurship and growth

Although entrepreneurship has been considered almost universally as the vehicle for
innovation, the beginning of specific research on its mechanisms is recent. The program of
research developed by Acs and Audretsch (1987, 1988, 1990, 1993 and 2001) is rooted in a
dynamic approach and has provided evidence that innovative entrepreneurship in small firms is
at the base of economic growth. The connection between entrepreneurship and growth is robust
and has been found across several units of observation; at the level of the firm, the city or
region, and across countries.
According to the approaches of dynamic industrial economics and evolutionary theory the
enhanced role of small firms is a consequence of structural change, and specially the shift in the
predominant industrial regime following the path of what Piore and Sabel (1984) have called the
“second industrial divide”. Audretsch and Thurik (2000 and 2001) have pointed how since the
late 70’s the United States has experienced changes of industrial structure and technological
regime that imply a shift of industrial dominance from the big conglomerates and mass
production technologies to the small innovative specialized firms.
In the United States (Birch, 1989).observed that the creation of new firms increased from
around 90.000 in 1950 to 700.000 at the end of the 80’s. The same author signalled that in the

6
late 70’s already two-thirds of all net new jobs were created by very small companies with 20 or
fewer employees.
The causes of this change can be found in several combined trends: intensification of global
competition, the increase in the degree of uncertainty, growth in market fragmentation,
technological progress in production processes toward flexible automation that allows shorter
runs and more customised production (Acs and Audretsch, 1993; Carlsson, 1992). According to
this analysis the result is that the industrial regime based on production economies of scale
predominant after the Second World War has evolved to a production base dominated by
flexible production and product differentiation, where static economies of scale are less
important for building competitive advantage.
Audretsch and Thurik (2000), provide more reasons for the structural shift – which is especially
evident in United States. There has been an increase of the labour supply together with some
reduction in wages. The shift is complemented with better education; changes in consumer
tastes for more variety; deregulation that easier entry. Advancing a step further Audretsch and
Thurik (2001) maintain that the shift towards a knowledge based economy is the driving force
behind the move from large to smaller business which becomes the source of a considerable
part of innovative activity. According to this hypothesis it could be said that the present
economic period corresponds to the Schumpeter Mark I regime of creative destruction, and it
follows a period equivalent to Schumpeter Mark II regime of creative accumulation. From the
point of view of governance Audretsch and Thurik maintain that there is a corresponding shift
from the managed economy to the entrepreneurial economy.
The theories that link entrepreneurship with economic growth implicitly or explicitly assume that
entrepreneurs are the agents of innovation and that technological innovation affects positively
total factor productivity. In conformity with this model, Callejón and Segarra (1999) found that
the rates of entry and the rates of turbulence affects positively total factor productivity in Spain
but in this case they favoured an explanation based on the effects of new vintage capital, with
preference to the hypothesis of entry associated to pure innovation.

Simultaneous trends
In recent years, since mid 90’s, the trend towards a greater share of small firms in market
structure seems to have slowed down (Kwoka, 2000) Simultaneously the last years have
witnessed a significant process of concentration in many economic activities. The concentration
process affects not only high-tech industries (pharmacy, aircraft, computers), and industries with
network externalities (software, telecommunications, publishing and media content), but also
more traditional activities (automobiles, financial services, clothing) including retail services
(supermarkets chains, franchising in specialty shops) and hospitality (fast food and traditional
restaurants franchise chains, theatres, hotels), that are also the favourite activities of many
micro entrants. In the theory developed by John Sutton (1998) the present source of scale
economies does not lie in automatization of the production process – like in post World War II -
but in the existence of important sunk costs in terms of R&D, advertising and global marketing,
and also in the presence of dynamic economies of scale, or learning economies associated to
innovation.
The characteristics and real importance of this trend toward a type of concentration different, at
least in part, from concentration due to static economies of scale, still needs much more study.
In some cases the effect of concentration on market power and welfare will be less harmful than
expected, due to the presence of potential competition. In some industries the effective degree
of market concentration will be higher than the measured Gini or Herfindhal index, because
many legally independent firms depend in fact of other bigger firms. For instance, it is being
observed than one part of the self-employed are not really independent firms, except for their
legal form. Anecdotic evidence seems to suggest that many firms substitute contracting out
systems for specialised employment and many former employees become independent legal
business entities. Once again an interesting line of research implies sorting out this type of new
self-employed from pure entrepreneurs.
An interesting aspect in the future might be the relationship of the entrepreneurial regime that
has emerged in the 70’s and 80’s with the more recent concentration trends that, given its
characteristics do not seem to imply a return to what Audretsch has titled the “managed

7
economy” of the old big firms. Apparently present concentration does not correlate closely with
higher market power as in previous periods. As Jovanovic (2001) has signalled the new
economy is one in which technologies and products become obsolete at a much faster rate than
a few decades ago, imitation lags have shrunk and technologies are adopted faster, and small
firms and new firms are well fit for quick response or advanced initiatives. Jovanovic suggests
that we are entering the era of the young firm. So it is not obvious to reach the conclusion that
present concentration trends in some industries or segments of industries will bring a second
move towards a Mark II Regime or, equivalently, a “managed economy”.

Creative destruction, growth and welfare

If innovative entrepreneurship can be associated with growth, a different problem is to identify

the extent to which “creative destruction” leads to higher growth and welfare.
The idea of a dominance of “creative destruction” driven by innovation in the present period is
also explicitly shared by the Reynolds et al. (2001) GEM Report Series where the conceptual
model developed assumes that business churning positively affects growth. But Baumol (2001)
has risen the intriguing question of which is the net effect of innovative entrepreneurship on
growth. After noting Schumpeter’s ambiguity with respect to the welfare impact of “creative
destruction”, he reminds that innovation is associated both to positive and negative externalities.
Innovation activities present positive knowledge spillovers due to his non-rivalness
characteristics - and this leads to the market failure of less than optimal innovation effort by the
market formalised by Arrow (1962). On the other hand innovation generates negative
externalities because it turns obsolete previous technologies and is detrimental to incumbent
firms. Baumol joins the majority that consider that both types of external effects cancel each
other with zero or positive external net effect, and a full direct effect on innovation that enhances
productivity or/and consumer surplus. Nevertheless it should not automatically be ruled out that
in particular times and industries, or if the turbulence surpasses a certain threshold, there may
be welfare losses or at least reduced welfare gains with respect to their potential level in case of
less “destruction”.

Entrepreneurship, self-employment and unemployment

Given that new small firms and the rate of firm turnover are considered basic, observable
indicators for industrial dynamics, the attention of a good part of the profession has been turned
to the analysis of new firms. The scenario of the entrepreneurial economy implies that new firms
are the driving force of innovation and the creation of skilled jobs. There are some empirical
studies that would confirm this theory, for instance, the report Enterprises in Europe (2001)
produced by the European Commission confirms that in the period 1987-1997 the European
regions that experienced the highest growth rates were also those with the highest proportion of
small firms. The exception are those regions with a high proportion of small firms but that have
a specialization in manufacturing industries; regions in this situation present low growth rates.
Since traditional manufacturing is not a high growth sector, this might explain the unfavourable
performance of those regions that are specialized in this group of activities.
Since in most countries the majority of new small firms enter into the category of self-
employment (individuals that establish, and run their own business), and if entrepreneurship is
visualized as an individual psychological feature, it has been quite natural to employ the rate of
self-employment as a proxy measure of the rate of entrepreneurship. At the same time it has
been often recalled that the big group of the self-employed embrace several types of business
and professional activities that do not match up the concept of innovative entrepreneur. There is
ambiguity between concept and measures.
On the other hand the birth of very small firms has since long been negatively related in many
models to the opportunities of finding a paid dependent employment, and to the unwanted
“push” of rising unemployment (Bogenhold, 2000). It is generally accepted that an important
share of the self-employed, are not driven by the motive of market innovation, and should not be
considered entrepreneurs in its Schumpeterian innovative sense. Most new firms start their

8
activity with one or two employees or no employees at all, they enter into the categories of self-
employment and there are no simple methods to discriminate between entrepreneurs and
conventional business.
According to the Eclectic Theory of entrepreneurship (Audretsch, Thurik, Verheul, and
Wennekers, 2002) the level of entrepreneurship can be explained making a distinction between
the supply side of labor market (push forces) and the demand side (pull forces). The level of
entrepreneurship in one given time and economy is determined by a combination of factors
belonging to the micro (individual), meso (industry and market) and macroeconomic space.
There is wide consensus in the distinction between the entrepreneur as introducer of
innovations and other agents running a business. It can be expressed as the difference
between an entrepreneur and a “shopkeeper” (Audretsh, Carree and Thurik, 2001). Or as the
distance between the group of “income substitutors” and “entrepreneurial business” in the
terminology of David Birch. Baumol (1968), distinguishes between entrepreneur and manager,
like Penrose (1959) Other researchers including Bogenhold (2000), Dhalquist and Davidsson
(2000) have analysed from different approaches the motives that lead some people to start a
business. Reynolds at al. (2001) have chosen to refer to “opportunity entrepreneurship” and
“necessity entrepreneurship”. And the case is that if not all new firms, not all self-employed
enter into the category of entrepreneurs, an interesting question, from the point of view of the
industrial dynamics analysis is to find ways of sorting out the types of agents that take the
decision to create a firm and the importance of their respective contribution to economic growth.

Policy issues

The problem of finding ways to distinguish between the different types of new firms is not an
irrelevant aspect. If the contribution to growth and welfare depends upon the predominant
nature of each particular firm – innovative, imitative, basic survival, meet local demand for
standard goods and services, etc. – this means that the degree of potential market failures
depend also on the type of firms, and this has direct implications for policy analysis and design.
Another related but very interesting aspect about the behaviour, incentives and reaction to
policy arrangements of entrepreneurs has been pointed to by William Baumol (1990) when he
distinguishes between productive, unproductive and destructive entrepreneurship. Baumol
hypothesis is that the productive contribution of the entrepreneurial activities varies substantially
between societies, not so much because of differences in the total supply of entrepreneurs
across countries, but because the variation in the allocation of entrepreneurial effort between
productive activities such as innovation and unproductive activities such as rent seeking or, in
certain societies, organised crime. From this perspective Baumol considers that in order to
reallocate productively the entrepreneurship effort, effective policies should look at the rules that
determine relative rewards.
Rent seeking behaviour has been long considered one of the undesirable and unintended
consequences of government non-discriminatory policies that subsidise new firm start-ups. The
empirical work in this field is still scarce and full of difficulties. Rent seeking itself is not a directly
observable variable and most works try to ascertain how the availability of state subsidies
impacts on the rates of entry and the post-entry performance of firms. Some research results
point to the fact that entry subsidies do not improve aggregate efficiency (Aranguren et al. 1991,
Peña, 2001; Santarelli and Vivarelli, 2002).
Audretsch et al. (2002) highlight the importance of the institutional arrangements for the
development of entrepreneurship activities. According to their analysis the European Union,
with its lasting unemployment difficulties, risks to incur in a penalty in terms of growth rate if
industrial restructuring continues to be impeded by institutional and regulatory barriers. So,
policy should shift from regulating and prohibiting to enabling individual initiatives. The authors
argue that policy should follow the lines of deregulation, privatization and labor market flexibility.
Literally quoted: “The central role of government policy in the entrepreneurial economy is
enabling in nature. The focus is to foster the production and commercialization of knowledge.
Rather than focus on limiting the freedom of firms to contract through antitrust, regulation and
public ownership, government policy in the entrepreneurial economy targets education,

9
increasing the skills and human capital of workers, and facilitating the mobility of workers and
their ability to start new firms” (Audretsch and Thurik, 2001).
In a recent piece of research Davidsson and Herekson (2002) obtain results compatible with the
thesis of Audretsch and Thurik. Both authors find that Swedish institutional arrangements give
too little weight to economic renewal, particularly in the policy fields of the regulations on labor,
firm taxation and venture capital.

Empirical Analysis

In this part of the paper we use a data base from Spain to compare the pattern of new business
creation between firms with 0 employees with those with positive employment, which we refer to
as small businesses. This comparison enables us to test the hypothesis that the behavior of
self-employed firms is different from small business (defined as firms having employees).
Entrants with 0 employees form the vast majority of the self-employed. We argue that entrants
with 0 employees react to incentives that are different from those affecting entrants with
employees, and that the proportion of entrepreneurs is apparently much lower among self-
employed with 0 employees than among the rest of firms. Our first hypothesis is that the
commitment to pay employees can be interpreted as a signal that the new firms have higher
expectations of growing and lasting that when a firm starts with no employees. And, a second
hypothesis is that, although the composition of solo-employment is very heterogeneous, for a
substantial part it is associated to more weakness in terms of capital and human resources.
These reflect businesses founded out of desperation, where the founder is unable find an
acceptable paid, dependent, job.
In the European Union business without employees account for more than 50 per cent of the
stock of active firms, they represent 10 per cent of employment and almost 4 per cent of
turnover. The share of this business is even higher in Spain, where they account for around 56
per cent of firms, 19 per cent of employment and 8 per cent of turnover. (Table 2)

Table 2: Enterprises in the EU and in Spain— Breakdown of enterprises, employment and turnover
by employment size class — 1996 (%)
Employment Enterprises Employment Turnover
size classes
EU Spain (*) EU Spain (*) EU Spain (*)
0 50,4 56,3 10,0 18,7 3,8 8,3
1-9 42,7 38,5 24,4 28,6 14,1 19,7
10-49 5,9 4,5 18,8 20 16,8 17,4
50-249 0,8 0,6 13,1 12,5 19,5 16,6
250+ 0,2 0,1 33,8 20,2 45,8 38
Total SMEs 99,8 99,9 66,3 79,8 54,2 62

Enterprises in Europe. Sixth report.

(*) 1997.

The share of 0 employee enterprises is even higher, in terms of enterprises, employment and
turnover, in all service sectors than in manufacturing and energy. (Table 3)

10
 Table 3: Enterprises in the EU and in Spain— Percentage of enterprises with no employees as a
proportion of total sectoral firms, employment and turnover — 1996 (%)
Employment size Enterprises Employment Turnover
classes
EU Spain (*) EU Spain (*) EU Spain (*)
Industry and energy 34,2 34,3 2,4 4 1,4 1,6
Construction 54,8 46,9 16,1 18,3 7,7 7,1
Trade and HoReCa** 46,5 55,3 13 25,3 5 7,8
Transport and 59,8 70,7 9,1 30 4,4 13,6
communication
Financial 56,3 65,2 4,2 11 0,9 4,7
Intermediation
Other business 56,4 69,2 12,6 20,3 8,4 20,6
activities
Other services 56,6 60,1 15,3 23 12,7 22,3
All aggregates 50,4 56,3 10 18,7 3,8 8,3

Enterprises in Europe. Sixth report.

(*): year 1997
(**) Short for Hotels, Restaurants and Catering

This high proportion means that all analyses involving industrial demography, or using the
standard measures of entrepreneurship that include 0 employee businesses are highly
influenced by the characteristics of this large group, at least if the unit of analysis is the number
of firms. This bias would be less important if the analysis was in terms of number of workers or
turnover
It is possible to compare the behavior of 0 employee enterprises with firms consisting of 1 and 2
employees and 3 or more employees in Spain between 1994-2000. The data base used is the
DIRCE or “Directorio Central de Empresas”, obtained from Spanish “Instituto Nacional de
Estadística”. This is a relatively new longitudinal data base starting in 1994. The only variable
this data base contains is the number of employees, and the individual information is not
publicly available. It is only possible to obtain data for nine size classes, including the 0
employee class. For the purpose of this work we have opted for the graphic analysis which
allows a better and more direct assessment in this case.

Firm demography by size

Figures 1 and 2 compare the entry and exit behavior of self-employed firms to small businesses
over the period 1994-2000. The patterns suggest that their share in entries and exits is higher
than in active firms, so their rate of turbulence is higher than the rest of enterprises. All of these
different measures reflecting different aspects of entrepreneurship suggest that demographic
dynamism is higher in enterprises with 0 employees than in the rest. These units not only have
higher gross entry and exit rates, but also higher net entry rates, so their impact in measures of
market structure might not be not so weak.

11
Figure 1

Demographic rates 1994-2000. Breakdown by size class

1
0,11 0,10
0,9 0,19

0,8 0,20 0,23

0,7 0,25

0,6

0,5

0,4
0,69 0,68
0,3 0,56

0,2

0,1

0
Entries Stock Exits

0 empl 1-2 empl 3+ empl

Although the demographic dynamism of 0 employment enterprises is higher than the rest
(Figure 2), their life expectancy is lower than in enterprises with employees. As we observe in
Figure 3, less than half of 0 employee enterprises created in 1994 survived in 2000 (43 per
cent), while this percentage increases to 48 per cent for enterprises created with 1 or 2
employees and to 55 per cent for firms with three or more workers. Alternatively, if we consider
the size distribution of the surviving firms in year 2000 it appears that a good number of those
that were born with 0 employees have jumped to the class of firms with employees. In terms of
the size in 2000, survivors with 0 employees represent only 33 per cent of the entrants in the 0
employee class, but survivors with 1-2 employees and with 3 or more employees represent 72
per cent and 92 per cent of the entrants in classes 1-2 and 3 or more respectively.

Figure 2

Rates of gross entry and exit, net entry and

turbulence

14%
2%
3 or more 6%
8%

21%
0%
1 or 2 10%
11%

32%
3%
0 14%
17%

26%
2%
All 12%
14%

Gross entry Gross exit Net entry Turbulence

12
 Figure 3

Rate of surviving firms according to size class. Firms

born in 1994 alive in 2000.

0,43
0 empl
0,33

0,48
1-2 empl
0,72

0,55
3+ empl
0,92

Initial size Final size

Entrepreneur or Selfemployed

The following figures give a quite transparent picture of the inverse relationships between firms
with and without workers. Figure (4) shows that net entry rates correlate positively between
firms with only 1 or two workers and firms with 3 or more, but that net entry rate of business with
0 employees presents an inverse correlation with all other groups. It is interesting to observe
that the difference is not between very small firms and the rest, the difference can be observed
even between firms with 0 employees and firms with only one or two employees. A first
interpretation of this fact is that both types of firms respond to different incentives and that a
significant part of the 0 employee businesses enter into and exit from self-employment
depending on the situation of the job market dominated by firms that hire workers.

Figure 4

Net entry rates

0,08

0,06

0,04

0,02

0,00

-0,02

-0,04

-0,06

1994 1995 1996 1997 1998 1999 2000

0 empl 1 or 2 3+

It can be clearly observed that, again, the evolution of the numbers of start-ups and exiting firms
differs between the two groups of firms – the self-employed and small business -- and present
an inverse relationship (Figures 5 and 6). One important qualification is that in the period 1994-
2000 the business cycle was in an expansion phase, with a continuous reduction in
unemployment rates and high annual GDP growth rates. (Figures 7 and 8). Thus, it is not
possible to examine the impact of the entire business cycle on the relative behavior of self-
employed and small businesses.

13
Figure 5

Evolution number new firms

150
140
130
120
110
100
90
80
70
60
1994 1995 1996 1997 1998 1999 2000

0 empl 1 or 2 3+

Figure 6

Evolution number exiting firms

120

110

100

90

80

70

60

50

40
1994 1995 1996 1997 1998 1999 2000

0 empl 1 or 2 3+

Figure 7

Rate of growth of GNP. Spain

5,00

4,00

3,00

2,00

1,00

0,00

-1,00

-2,00
1992 1.993 1994 1995 1996 1997 1998 1999 2000 2001

14
Figure 8

Rate of unemployment . Spain

30,00

25,00

20,00

15,00

10,00

5,00

0,00
1992 1.993 1994 1995 1996 1997 1998 1999 2000 2001

Figures 9 and 10 confirm that the self-employed firms behave in a manner that is different and
inverse to the behavior of small businesses. When exit rates of small business increase, there is
a concomitant decrease in the number of self-employed firms. Similarly, when the number of
new firms with employees tends to rise, the number of self-employed firms diminishes. And then
Figure 11 confirms the inverse behavior between the evolution of number of new firms with
employees and the numbers of new solo-employed.

Figure 9

Movements positively correlated. Entrants with 0 employees and exit of

firms with 1-2 or 3 or more employees

110

100

90

80

70

60

50

40
1994 1995 1996 1997 1998 1999 2000

Ent 0 Exits 1 or 2 Exits 3+

15
Figure 10

Movements positively correlated. Entries of firms with 1-2 or more than 3

workers, and exits of firms with 0 employees

160

140

120

100

80

60

40
1994 1995 1996 1997 1998 1999 2000

Ent 1 or 2 Ent 3+ Exit 0

Figure 11

Movements negatively correlated. Entries of firms with 1-2 or more than 3

workers, and entries od firms with 0 employees

160

140

120

100

80

60

40
1994 1995 1996 1997 1998 1999 2000

Ent 1- 2 Ent 3+ Ent 0

Legal form

In this analysis solo-self-employment is treated as a homogeneous population. But of course it

is not homogeneous and the picture we obtain is heavily dependent of the characteristics of the
dominant groups inside this, in reality, heterogeneous population. If we look at the legal form
adopted by the firms we can already begin to sort out different types of business inside the huge
group of the solo-selfemployed.
Only 12 per cent of the solo-selfemployment are constituted as business with limited liability.
More than 82 per cent are simply individuals registered as selfemployed. The figures for firms
with 1 to 5 employees present a much higher proportion (42 per cent) of business under limited
liability, and lower proportion of individuals (48 per cent). A possible untested hypothesis is that
those self-employed that adopt a limited liability legal form are more likely to be entrepreneurs
than other legal entities.

16
Conclusions
Recent studies have sought to link entrepreneurship to economic performance. This has
generated a set of results shrouded in ambiguities. This paper has sought to identify at least
one reason for the ambiguous findings in the entrepreneurship literature – the heterogeneity
inherent in the most prevalent measures of entrepreneurial activity. Studies linking
entrepreneurship to economic performance typically include firms across a fairly wide spectrum
in a single measure. Using data from Spain, the results of this paper indicate that the behavior
of the self-employed is distinctly different, and in some cases orthogonal to the behavior of
small businesses, which have at least some employees. This suggests that entrepreneurship is
very much a heterogeneous phenomenon. It may be that the only way to unravel the links
beteween entrepreurship and economic performance is by undertaking analyses at a
considerably less aggregrated level. This of course, will make cross-national comparisons even
more difficult. But the challenge for future research is to find meaningful units of analysis in the
quest for identifying the economic contributions of entrepreneurship.

17
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20
APPENDIX

Survival rate in 2000 by initial size (born 1994)

54,41
All aggregates 47,50
43,15
54,55
Other services 50,76
45,67
58,44
Other business activities 50,60
45,81
48,97
Financial intermadiation 45,75
42,24
58,15
T ransport and communication 53,94
55,15
53,95
T rade and HoReCa 44,34
38,50
53,66
Construction 51,44
47,61

53,98
Industry and energy 47,45
42,23

0,00 10,00 20,00 30,00 40,00 50,00 60,00 70,00

0 empl 1 or 2 empl 3+ empl

Enterprises in the EU Breakdown by employment size class 1996

100% 0,2
0,8
5,9
90%
33,8
80%
45,8
42,7
70%

60% 13,1

50%
18,8 19,5
40%

30%
50,4 16,8
24,4
20%

10% 14,1
10,0
3,8
0%
Enterprises Total employment Turnover

Class 0 1-9 10-49 50-249 250+

21
 Enterprises in Spain. Breakdown by employment
size class. 1997

100% 0,1
0,6
4,5

20,2

80% 38
38,5
12,5

60%
20
16,6

40%
17,4
28,6
56,3

20% 19,7

18,7
8,3
0%
Enterprises Total employment Turnover

Class 0 1-9 10-49 50 - 249 250+

Enterprises with no employees as a proportion of

total number of units.
Industry Construction Trade Transport and Financial Other Other All
and and business services aggregates
communication Intermediation
energy HoReCa activities
Belgium 50.8 66.7 70.7 59.8 50.5 83.5 80.0 71.0
Denmark 42.6 41.7 48.3 52.5 30 62.8 61.6 49.9
Germany 20.4 18.4 39.7 30.8 54.6 39.6 36.8 34.9
Greece 37.2 63.6 52.1 59 59.3 56.7 57.2 53.7
Spain 34.3 46.9 55.3 70.7 65.2 69.2 60.1 56.3
France 29.3 41 44.2 58.1 61.8 51.9 67.7 50.6
Ireland 28.3 46.3 32.2 72.2 14.2 23.2 44.4 36.6
Italy 34.1 45.6 53.4 61.3 58.4 59.3 64.6 52.5
Luxemburg 23.8 20.1 38.4 36.8 32.1 54.1 55.6 40.9
Netherlands 31.6 41.3 37 36 24 62.2 41 41
Austria 16.7 15.5 30.8 32.9 40 37.4 46.2 31.9
Portugal 4.6 1.6 2.1 2.9 37.7 4.8 5.6 3.2
Finland 46.1 51.4 50.9 54.3 59.8 50.7 68.4 54
Sweden 39.3 50.8 34.6 23.6 51.6 36.4 56.7 41.3
United 55.5 82.9 42.4 76.3 65.1 61.4 63.8 63.1
Kingdom
Norway 10.3 11.3 16.5
EUR-11 29.4 37.4 46.4 55 56.5 54.6 53.7 46.5
EUR-15 34.2 54.8 46.5 59.8 56.3 56.4 56.6 50.4
th
Source: Enterprises in Europe 6 Report

22
Enterprises with no employees as a proportion of
total sectoral employment. 1996
Industry Construction Trade Transport and Financial Other Other All
and and business services aggregates
communication Intermediation
energy HoReCa activities
Belgium 4,2 22,6 25,8 6,1 1,6 22,4 26,1 17,8
Denmark 1,7 5,7 6,8 5,5 0,6 9,4 12 5,1
Germany 0,8 2,9 6,6 2,3 3,5 4,5 6,8 4
Greece 4,1 20,8 35,1 28,9 6,4 25,6
Spain 4 18,3 25,3 30 11 20,3 23 18,7
France 2,4 12,8 12,70 5,3 3,7 8,7 32,8 11,10
Ireland 4,1 4,6 0,3 3,2 3,6
Italy 3,4 13,2 20,7 8,6 5,4 26,5 26,4 13,2
Luxemburg 0,6 1,3 9,5 2,4 1,1 8,6 17,8 5,6
Netherlands .. .. 9,4 3,4 1,3 10,3 .. 5,5
Austria 0,7 1,2 5,2 1,7 1,4 6,2 13,7 3,6
Portugal 0,5 0,4 0,8 0,4 2 1,2 2,2 0,7
Finland 1,6 8,6 6,4 6,5 0,9 8,3 16,1 5,5
Sweden 1,8 7,6 6,5 2,1 1,7 .. .. 5
United 4,9 41,8 6,4 12,3 4,8 16,3 15,1 11,6
Kingdom
Norway 0 0 0
EUR-11 2,1 9,9 14,1 8,2 4,5 11,6 15,4 9,3
EUR-15 2,4 16,1 13 9,1 4,2 12,6 15,3 10
Source: Enterprises in Europe, 6yh Report.

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 Turnover of enterprises with no employees as a proportion of total
turnover
Industry Construction Trade Transport and Financial Other Other All
and and business services aggregates
communication Intermediation
energy HoReCa activities
Belgium 8,4 19,8 14,1 8,0 10,8 18,0 24,7 12,4
Denmark 4,5 9,6 6,9 7,6 0,5 12,5 15,7 6,4
Germany 0,2 0,8 2 0,9 0,3 2,5 5 1,3
Greece 6,1
Spain 1,6 7,1 7,8 13,6 4,7 20,6 22,3 8,3
France 1,60 7,00 5,10 3,50 5,20 8,60 21,80 5,30
Ireland 0,3 4,6 5,4 4,4 0 3,6 1,8 1,2
Italy 1,9 11,3 8,2 5,1 8,5 14,3 25,1 6,5
Luxemburg 2,3 2,4 9,3 10,3 0,3 16,8 11,5 3,7
Netherlands 0,5 1,3 6,1 2 : : 3 3,5
Austria 0,2 1,5 4,1 1,2 0,1 5,8 9,9 2,5
Portugal 0,5 0,4 0,5 0,3 5,2 4,2 8,6 1,3
Finland 1,3 7,7 4,9 5,6 0 9,3 11 3,3
Sweden .. .. .. 2,4 2,1 7,7 11,9 3,6
United 1,2 18 2,9 4,3 0,2 8 7,1 2,1
Kingdom
Norway 0,4 0,9 1,7
EUR-11 1,4 5,2 5,3 4,5 2,5 8,3 14,1 4,4
EUR-15 1,4 7,7 5 4,4 0,9 8,4 12,7 3,8

th
Source: Enterprises in Europe 6 Report

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