313 38458 viewpoint NUMBER NOTE 2006 Entrepreneurship Leora Klapper NOVEMBER Leora Klapper How Much Does the Business Environment Matter? (lklapper@worldbank.org) is a senior financial Entrepreneurship is important for the continued dynamism of modern PRESIDENCY economist in the World economies and for job creation. Policymakers need to know how new Bank's Development VICE Research Group, Finance firms get started and what financial and institutional factors and Private Sector promote entrepreneurial activity. A new cross-country, time-series Development Team. data set shows a strong correlation between entrepreneurship and the quality of the legal and regulatory environment, ease of access to DEVELOPMENT finance, and prevalence of informality. This finding tells policymakers what they can do to promote entrepreneurship. SECTOR Efforts to measure entrepreneurship at the This working definition helped in developing a PRIVATE global level have focused mostly on the industrial methodology applicable in all countries and in world or on specific regions. To address this gap, making the data comparable across diverse AND a new World Bank Group study collected annual legal and economic systems. data on the total number of firms in each of 95 countries and on the number of new firms in 63 Business density and new entry FINANCIAL countries (box 1).1 These data, by establishing an The first step in the analysis is to calculate busi- international comparison of entrepreneurship, ness density, defined as the number of regis- can help answer these questions: tered firms as a percentage of the active Is entrepreneurship an indicator of eco- population (those ages 15­64), and the entry nomic development? rate, defined as new firms (those that were reg- GROUP What is the relationship between entrepre- istered in the current year) as a percentage of neurship and economic growth? total registered firms. The entry rate is the key BANK Can the business environment foster entre- indicator of entrepreneurship. All data in this preneurship? If yes, which of its dimensions analysis are for year-end 2003. are important? On average, the analysis finds about 50 The study defines entrepreneurship as the businesses for every 1,000 active individuals. WORLD effort an individual or group of individuals Business density ranges from less than 1 percent makes to initiate an economic activity under a in many low-income African countries to 23 per- THE legal form of business within the formal sector. cent in Australia. Entry rates range from less E N T R E P R E N E U R S H I P H O W M U C H D O E S T H E B U S I N E S S E N V I R O N M E N T M A T T E R ? countries of the Middle East, Africa, and Asia. Box What the study and the data set cover Industrial countries also had the highest entry 1 rates in 2003, averaging more than 10 percent. The entrepreneurship study is limited to enterprises registered in the formal sector. To preserve consis- Interestingly, mean entry rates are consistently tency, it used as its primary data source business registries in the countries surveyed. Alternative about 7­8 percent across developing countries. sources such as tax authorities, finance ministries, and national statistical offices also occasionally pro- Business density varies widely across country vided information. The data were collected for as many years as available between 1990 and 2003. income groups, ranging from less than 1 per- Despite the large number of countries participating in the survey, some issues preclude a complete analysis of entrepreneurial development. For example, some countries were excluded from the survey cent on average in low-income countries to even though they collect data on enterprise creation--simply because they lack the tools or resources almost 10 percent in high-income countries (fig- to process the data or because the data are archived in decentralized facilities or paper format. ure 2). Entry rates show less variation by income In addition, not all registered firms are economically active, requiring the study to cope with a level. Still, greater entrepreneurship appears to systematic measurement error in the data set. Low-income countries tend to have the least accurate be associated with higher income levels. data on closed firms and as a result may overreport total firms (including more registered but inac- tive firms) relative to higher-income countries. And many high-income countries might overreport total Importance of the business environment registrations (including shell and other inactive companies established for tax purposes). Several results highlight the importance of the The study also collected information on the disclosure requirements for registered firms. About 65 business environment for the growth and devel- percent of countries require corporations to submit annual financial statements. Almost 90 percent opment of businesses. Barriers to starting a busi- require all firms to report closures, though enforcement of this requirement is reportedly weak. A few ness are significantly and negatively correlated countries, such as Denmark, maintain active registries that annually confirm that registered firms are with business density and the entry rate. For still operating. This type of mechanism improves the integrity of the data and their usefulness for creditors and business partners. example, the fewer the procedures required to start a business, the greater the number of reg- istered firms--and the higher the entry rate (fig- ures 3 and 4). than 5 percent in India and Pakistan to almost There is also a significant relationship 20 percent in Germany, New Zealand, and the between the cost of starting a business (as a per- United Kingdom. centage of gross national income, or GNI) and At a regional level, the highest business density business density and the entry rate (not shown).2 is found in industrial countries and the transition For example, for every 10 percentage point economies of Europe and Central Asia (figure 1). decrease in entry costs, density and the entry rate The lowest is in the low- and middle-income increase by about 1 percentage point.3 Business density and entry rate by Figure Business density and entry rate by region, 2003 Figure country income group, 2003 1 2 Percent Business density Entry rate Percent Business density Entry rate 12 12 23 23 10 24 10 24 63 13 10 8 18 8 10 17 5 21 7 21 6 6 91 4 4 26 17 2 22 2 7 19 0 0 Low Lower middle Upper middle High Middle East Asia Europe and Latin America and Industrial All income income income income and Africa Central Asia the Caribbean countries countries Note: The numbers above the bars are the countries in each income group for which Note: The numbers above the bars are the countries in each region for which data are shown. data are shown. Source: World Bank Group Entrepreneurship Database. Source: World Bank Group Entrepreneurship Database. Density and number of procedures to Entry rate and number of procedures to Figure start a business, 2003 Figure start a business, 2003 3 4 Business density (percent) Entry rate (percent) 20 20 16 16 12 12 8 8 3 4 4 0 0 0 2 4 6 8 10 12 14 16 18 0 2 4 6 8 10 12 14 16 18 Number of procedures to start a business Number of procedures to start a business Note: Coefficient = 0.006, p-value = 0.000, R = 0.21, N = 88. Note: Coefficient = 0.338, p-value = 0.009, R = 0.08, N = 62. Source: World Bank Group Entrepreneurship Database; World Bank Group 2005. Source: World Bank Group Entrepreneurship Database; World Bank Group 2005. Figure Entry rate and logged GDP per capita, 2003 Figure Entry rate and private credit, 2003 5 6 Entry rate (percent) Entry rate (percent) 20 20 16 16 12 12 8 8 4 4 0 0 4 5 6 7 8 9 10 11 12 0 50 100 150 200 Log of GDP per capita Private credit (percentage of GDP) Note: Coefficient = 0.007, p-value = 0.014, R = 0.101, N = 63. Note: Coefficient = 0.026, p-value = 0.006, R = 0.117, N = 62. Source: World Bank Group Entrepreneurship Database; World Bank, World Development Source: World Bank Group Entrepreneurship Database; World Bank, World Development Indicators database. Indicators database. A boost from economic and financial growth larger informal sector in countries with higher The data also show a positive and significant entry barriers. The data also show a significant relationship between economic and financial relationship between the entry rate and the development and entrepreneurship. The log of informal sector (figure 8). GDP per capita and domestic credit to the pri- Together, these results suggest that an vate sector (as a percentage of GDP) are both increase in total and new registered firms might positively and significantly correlated with the indicate a decrease in the size of the informal sec- entry rate (figures 5 and 6) and business density tor. Indeed, the data show that a 30 percentage (not shown). This suggests that greater business point increase in business density and a 10 per- opportunities and better access to finance are centage point increase in the entry rate are com- related to a more robust private sector. mensurate with a 10 percentage point decline in the informal sector (as a share of GDP). Relationship with the informal sector Total firm registrations are significantly higher Conclusion in countries with a smaller informal sector (fig- The new data set shows that the business envi- ure 7). This suggests a substitution effect and a ronment matters for rates of entrepreneurship. E N T R E P R E N E U R S H I P H O W M U C H D O E S T H E B U S I N E S S E N V I R O N M E N T M A T T E R ? Business density and the informal sector, Figure 2003 Figure Entry rate and the informal sector, 2003 7 8 Business density (percent) Entry rate (percent) 20 20 16 16 viewpoint 12 12 8 8 is an open forum to encourage dissemination of 4 4 public policy innovations for 0 0 private sector­led and 0 20 40 60 80 0 20 40 60 80 market-based solutions for Informal economy (percentage of GDP) Informal economy (percentage of GDP) development. The views Note: Coefficient = 0.1515, p-value = 0.000, R = 0.19, N = 80. Note: Coefficient = 0.052, p-value = 0.102, R = 0.04, N = 54. published are those of the Source: World Bank Group Entrepreneurship Database; World Bank Group 2006. Source: World Bank Group Entrepreneurship Database; World Bank Group 2006. authors and should not be attributed to the World Bank or any other affiliated If governments reduce barriers to starting a for- References organizations. Nor do any of mal business and ease access to credit (such as Djankov, Simeon, Raphael La Porta, Florencio López- the conclusions represent through better collateral laws, contract enforce- de-Silanes, and Andrei Shleifer. 2002. "The Regulation of official policy of the World ment, and credit information sharing systems), Entry." Quarterly Journal of Economics 117 (1): 1­38. Bank or of its Executive rates of entrepreneurship might grow, all else Klapper, Leora, and Juan Manuel Quesada. 2006. Directors or the countries equal. The data set and indicators of entrepre- "Entrepreneurship and Economic Development." Develop- they represent. neurship also provide tools for monitoring and ment Research Group Working Paper. World Bank, evaluating such policy reform efforts, helping to Washington, D.C. To order additional copies maximize impact and communicate with stake- Klapper, Leora, Luc Laeven, and Raghuram Rajan. contact Suzanne Smith, holders in reform. They make it possible, for Forthcoming. "Barriers to Entrepreneurship." Journal of managing editor, example, to measure how reforms in the busi- Room F 4K-206, Financial Economics. ness environment affect the growth of the for- The World Bank, World Bank Group. 2005. Doing Business in 2005: 1818 H Street, NW, mal sector and how political, macroeconomic, Removing Obstacles to Growth. Washington, D.C. http:// Washington, DC 20433. and other shocks affect the entry and exit of pri- www.doingbusiness.org. vate firms. ------. 2006. Doing Business 2007: How to Reform. Telephone: Washington, D.C. 001 202 458 7281 Fax: 001 202 522 3480 Notes Email: 1. The World Bank Group Entrepreneurship ssmith7@worldbank.org Database is available on the Web at http://www.ifc.org/ ifcext/sme.nsf/Content/Resources. The data were col- Produced by Grammarians, lected and the first annual database published through the Inc. collaboration of the World Bank's Development Eco- nomics Research Group and the International Finance Printed on recycled paper Corporation's Small and Medium Enterprise Department. 2. Data on the cost of starting a business are from World Bank Group (2005). 3. Countries with entry costs greater than 40 percent of GNI per capita are excluded. T h i s N o t e i s a v a i l a b l e o n l i n e : h t t p : / / r r u . w o r l d b a n k . o r g / P u b l i c P o l i c y J o u r n a l