Latin America has the world’s highest rate of business creation but one of the slowest rates of business growth

May 9, 2014

Editor's note: Pablo Sanguinetti is director of socioeconomics research at CAF-development bank of Latin America and professor of economics at Universidad Torcuato Di Tella in Buenos Aires.

By Pablo Sanguinetti

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 per cent in 2011, to 2.9 per cent in 2012, to 2.7 per cent in 2013 and with commentators dismissing the growth momentum of the preceding decade as a commodity-driven fluke, the region seems indeed to be on a path to oblivion.

So the time is ripe for a fresh debate about growth and growth drivers in the region. In the 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, according to 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, companies of 26 years of age or older employ 12 times more workers than at birth, in Latin America they employ only 7 times more workers than at birth.

As a result, Latin America has too many small businesses, sometimes, even one-person businesses. While 68 per cent of companies in the US employ up to 10 people, this is the case for 91 per cent of companies in Latin America. And while only 15 per cent of the workforce in the US works in companies with up to 10 employees, this is the case for almost half of the workforce in Latin America. Obviously, too many people are working in companies that are too small.

This diminutive average company size is bad news: small companies are, on average, less productive. In particular, people working in companies with more than 5 employees make almost 25 per cent more on average than people working in smaller ones.

So, why are Latin American businesses not growing? It is not for lack of entrepreneurial talent. According to our 2012 survey –which gathered information about the 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 the 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 entrepreneurs themselves. A lot of them, precisely those not employing other people, have as many or fewer entrepreneurial traits as people with salaried jobs, with the exception of risk tolerance.

These entrepreneurs – in reality just self-employed – are colossally over-represented in the Latin American labour market. They account for 28 per cent of the workforce across the continent, compared with only 6.1 per cent in the U.S. The larger their share of the national 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, 7 per cent of the self-employed of the region had been unemployed in the previous year, compared with only 2 per cent in the U.S.

Unfortunately, few of these entrepreneurs are likely ever to take off. On average, only 6 per cent of the many self-employed in the region become employers after a year, while 10 per cent of the few self-employed in the U.S. do. And 6 per cent of them go back to joblessness after a year, compared with only 3 per cent in the U.S.

Does this mean we should just forget about entrepreneurship support initiatives? Not quite. While 75 per cent 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 per cent of these micro-entrepreneurs have 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 per cent of the remainder resemble informal employees, with significant employability challenges.

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

Entrepreneurship policy as such, programs 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.

Credit: Beyondbricks, http://blogs.ft.com

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