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Self-Employment, Micro-Enterprise and Local Development

Mr.Alistair Nolan

Routes through Which New Firms Can Impact on Local Economies

The creation of employment, for owner-managers and employees, and the consequent increases in tax revenue and incomes, with subsequent income multiplier effects for the surrounding community. Research suggests that small and micro firms are more likely to employ local staff (Ella Joseph 2000).

Employment effects over time as workforce skills rise with periods in self-employment.

The improved local provision of services, such as retail facilities. Aside from the enhanced availability of such services - the scarcity of which characterises many distressed communities - increased local services supply can help retain incomes in the locality.

The effect on motivation. Anecdotal accounts attest to the positive influence on expectations that local company creation can have. The creation of productive enterprise and positive role models will be a welcome development in many distressed areas.

Entrepreneurial skills in the non-profit sector can help meet explicit social goals.

Fast-growing regions usually have high rates of enterprise start-up (various studies).

In the UK, work by Bank of England, based on inferences from VAT registration data, indicate that the more deprived an area the lower the level of entrepreneurial activity. However, the correlation is broad.

And a not insignificant number of localities have both high levels of deprivation and high levels of enterprise start-up.

Little research on the local impacts of entrepreneurship.

Selected barriers to enterprise in disadvantaged localities

• Small, possibly remote, local markets.

• Low values of housing and/or potential entrepreneurs live in rented accommodation. This can constrain enterprise creation given that housing is an important source of collateral for many start-ups.

• Low incomes and limited savings constraining start-up. Typically, most enterprise start-up finance comes from own-resources, family or friends.

• Often limited social and business networks in distressed communities. Entrepreneurs who maintain and develop contacts with other entrepreneurs tend to outperform those who don’t.

• Sectoral clustering. An excess of firms in easy-entry markets requiring limited capital and/or skills.

• High crime rates.

Also Path dependency.

Areas with few entrepreneurs are likely to experience low rates of future entrepreneurship, other things unchanged, because of the imitative nature of entrepreneurship.

Before moving to the policy recommendations it is important to note the heterogeneity of the self-employed. In many countries, both the least and the most educated persons have the highest probabilities of being self-employed. This heterogeneity reflects diverse motives for entering self-employment. Consequently, a fall or rise in national or local levels of self-employment is neither good nor bad per se. Key issues are the ease of entry, access to services and the overall quality of micro-enterprise.

Some of the recommendations do little more than map the limits of policy, which is necessary nevertheless.

Others are more prescriptive as regards specifics of programme design and operation.

Policy Recommendations on Self-Employment, Micro-Enterprise and Local Development

Strategy
National and local levels of government

• Make explicit the strategic goals of enterprise support.

In many countries a plethora of enterprise support programmes has grown up. Clarifying the strategic goals of these programmes will facilitate assessment of effectiveness and inform decisions on how support should be targeted (e.g. if regeneration is the goal then universality of provision is not important).

To illustrate the issues around strategy choices: overall employment generation objectives are probably best met by targeting those most likely to succeed in business. But such a strategy would also entail greatest dead weight. Addressing social equity via enterprise promotion may involve lower dead weight but higher displacement and more limited employment creation. Strategy choices are finally shaped by the scale of resources relative to the size and nature of employment and area-development problems. In practice, different goals are often pursued simultaneously, with little strategic specification.

• Do not view the promotion of self-employment and micro-enterprise as a solution to social exclusion.

Those most likely to benefit from self-employment programmes include the more motivated, persons possessing work experience and accumulated human and financial assets, those with an employed spouse, etc.

Entrepreneurs who employ others also tend to be from among the better qualified.

Furthermore, expected returns in the wage labour market fall in line with the length of unemployment, the long-term unemployed have greater incentives to enter self-employment. However, their ability to operate a successful business venture may also decline if skills have eroded (some research has found a threshold effect at 12 months of unemployment). Furthermore, self-employment can have undesirable features. These include low and volatile earnings, long working hours, and limited social security.

A range of other actions - such as in housing, health and policing - is also required to address social exclusion.

• Recognise that the success of programmes in affecting area development depends greatly on initial conditions, as well as factors outside of local control.

In some localities - such as those that are isolated, have low-incomes and high probabilities of significant displacement effects - a preferred strategy may be to concentrate on assisting existing firms. The local success rate of programmes will also be a function of whether the starting point is one of long-term unemployment or of short-term employment change.

• Address the research gap.

Little empirical work exists on the impact of self-employment and entrepreneurship on local economies. Much more research exists on regional and macro-economic dimensions of entrepreneurship. Longitudinal studies are needed in specific localities examining, inter alia, displacement effects, incremental employment effects over the short and long-term, who are the beneficiaries of employment generated, local money flows, start-up rates, closures (corrected for the fact that survival rates in areas of high-unemployment will generally be lower than elsewhere), and productivity and growth in new firms.

• Promote public awareness of entrepreneurship using a variety of media.

Scottish Enterprise Business Birth Rate Strategy..

Graduate Entrepreneur.

Also important for changing attitudes in public services.

• Ensure that micro-enterprises are given proper attention in the system of enterprise support.

Micro-enterprises sometimes fall below the notice of statistical agencies, and can be effectively omitted from some support measures. Data on VAT registrations often exclude many smaller companies. Databases of Chambers of Commerce and Enterprise Agencies may be unrepresentative or incomplete.

• Identify and redress benefit traps that can discourage enterprise

In some jurisdictions, persons contemplating starting a venture may find themselves worse off initially if benefits are terminated prior to receiving income from the firm.

Generally, if benefits arrangements are slow in responding to the changed circumstances of potential recipients, this might discourage individuals from moving into more productive activities, especially into activities where earnings might be low, uncertain and variable.

• Invest in education and training as a means of enhancing enterprise quality and survival.

Many firms fail for reasons unrelated to the underlying viability of the business, but instead for reasons such as the inability to manage cash flow.

Training may help reduce unnecessary business failure.

Research also suggests that many micro business owners do not enlarge their firms on account of the problems associated with employee management and recruitment. In part this reflects insufficient time to train new recruits, but it can also be a symptom of the cost and difficulty of identifying suitable external training.

Other research shows that, after controlling for the effects of human capital, wealth is not correlated with business longevity. Human capital is decisive. Training allowances for the unemployed.

(Benefits from increased enterprise survival times include: greater savings in unemployment benefits; more time for the development of work-related skills; increased tax revenues and a larger local economic multiplier.)

Local level

• In general, expect limited aggregate employment creation from self-employment promotion, especially over the short-term.

Research shows that promotion of self-employment start-up has a relatively small impact on employment growth, reflecting low survival rates, displacement, dead weight, and low growth. Only a small fraction of the unemployed will benefit directly from these programmes. One indicative estimate, including displacement and dead-weight effects, shows 42 new jobs per 100 businesses created. Some evaluative work has found that the self-employed most likely to create jobs for others would have entered self-employment in the absence of assistance. However, reductions in the duration of unemployment for those already unemployed can be an important outcome.

As a general rule, the promotion of entrepreneurship is unlikely to yield major benefits in the short-run. Therefore, entrepreneurship strategies should be developmental constants, rather than responses to short-term employment crises.

• Seek to ensure the availability of adequate business premises offering affordable and flexible rates (see the policy recommendations in Good Practice in Business Incubation).

The lack of premises is an often-cited reason why micro-enterprises migrate.

Finance

National Level

• Consider introducing regional flexibility in the terms of national loan guarantee schemes, reflecting regional differences in the real value of housing stock.

Persons with equally viable projects may face differential constraints on start-up owing to house price fluctuations outside their control. Due to minimum loan-size requirements, the relevance of loan guarantee schemes to micro-enterprise should be examined. Guarantee schemes might also be opened to micro-credit intermediaries and community finance institutions.

An advantage of guarantee schemes is low dead weight amongst borrowers, as because of their higher cost, there would be no incentive to access the scheme until other sources of finance are exhausted.

• Consider the creation of incentives for bank support to micro-credit initiatives (for instance through tax credits, public awards for lending in disadvantaged localities, etc.).

Such schemes exist in a number of countries.

Theoretical and empirical debate on market failure in lending to SMEs is inconclusive - with evidence both for and against - but lending gaps at smaller scales are commonly reported.

Collateral issue: for the smaller loans collateral not taken by banks, as the costs of assessing its worth and collecting it in the case of default are too high relative to the size of the loan. Instead, personal credit history is relied on. Where this is the case, and where there are persons who combine potentially viable projects with poor credit histories, then public intervention can be valuable.

The point has also been made that if micro-finance can facilitate the creation of more highly capitalised ventures then it may help reduce displacement.

• Ensure effective enforcement of anti-discrimination laws in bank lending.

There is econometric and anecdotal evidence of discrimination in credit markets against some ethnic minorities and women. Entrepreneurship amongst the former is often geographically concentrated, not infrequently in areas with poor business environments. Bank lending in under-invested communities might be monitored (as with the Bank of England), and consideration given to statutory bank disclosure of lending activities (as in the United States).

• The broad issue of a lack of banking facilities in deprived localities also needs to be addressed, as this will affect enterprise creation.

For the potential entrepreneur, lack of previous contact with the banking sector - not having held a savings account for instance - will make access to credit more difficult.

1/10 households in the UK do not have a bank account.

Assessment of creditworthiness: exhortation: a history of regular mortgage repayment was taken as evidence of low default risk, but a history of regular rental payment was not. Paying off a loan was an indicator of creditworthiness, but regular payment into savings was not.

Local level

• Work with local banks to facilitate access to finance for entrepreneurs.

Banks can be encouraged to refer failed loan applicants to advisory schemes. Training schemes can also help improve the quality of loan applications and ease anxieties among some over the approachability of banks. Banks can act as partners in organisations providing microfinance, for example by lending staff as advisors and mentors.

Joint bank/business start-up organisation loan funds have features which recommend them: each organisation provides a service in which they specialise, and there can be a clear delineation of the costs for each agency. Banks can reduce risk and costs, while the start-up agency may more easily access funding for viable projects. Furthermore, banks already have loan funds, whereas building one from scratch can be “difficult and slow”. (Tax incentives to contribute to funds: guarantees on funds.)

Micro-finance schemes generally require public support. It is also unlikely that schemes will grow in more prosperous areas without public assistance - which is important if equality of opportunity for the unemployed is a consideration.

Programme Design

National and local levels of government

• To help avoid programme duplication and competition, consider incorporating new purposes into existing institutions, rather than creating new organisations.
  

• Ensure flexibility in self-employment support programmes. For example, modalities for paying monetary assistance could vary according to the financial circumstances of the recipient.

Unemployed executive with half a career of accumulated savings

An unemployed young person who has perhaps never worked

There is some evidence of greater survival rates when assistance delivered as a lump-sum.

• Systematically evaluate programmes and policies and ensure that evaluation findings inform policy.

In some countries evaluation has produced improved programme cost-effectiveness.

However, in general there is too little evaluation of entrepreneurship programmes.

In this context, worth recalling that entrepreneurship is not an end in itself. It is a means to raising incomes, independence and well being. Programmes should be judged against these broader goals, not simply in terms of numbers entering self-employment. In fact, most persons exiting self-employment do so to take up waged employment, often on better conditions. Because of dead-weight costs, enterprise survival rates alone cannot be used as a measure of programme success. Standardised evaluation approaches - using comparator groups - should be employed, and data collection for evaluative purposes should be built into programme design.

A few words:

- Evaluations confined to single programmes, rather than the complex of programmes typical in many distressed areas.

Consider how the choice of performance measures can shape programme implementation/effectiveness.

Funders, intermediaries and providers: funding dependent on achieving certain performance measures (management control of subcontract relationships, accountability and evaluation).

Continued funding depends on meeting performance targets. The process is often formal and perfunctory. Much of this data not used to shape strategy, much information collection felt to be unnecessary.

A control device (advisors should not become monitoring agents). Monitoring needs to be conducted in partnership. And to ensure that service providers themselves find the data useful.

The indicators of performance need to be chosen with care:

If schemes are assessed against the number of persons entering them, then this may provide an incentive to assist projects irrespective of their risk. Assessing schemes against start-up numbers may shift support away from services likely to enhance survival rates. Also likely to lead to high dead weight costs.

Survival rates and numbers of jobs created are often measured over the short-term. This can lead to an emphasis on achieving short-term effects - with assistance directed at those easiest to work with.

Output-related funding requires payment in arrears. This can direct support towards provision that requires least up-front funding.

Measures should combine start-up data with survival data. Weightings towards measures showing low displacement for regeneration projects (certain industries, size of capital invested, income from the business, etc). To avoid cherry-picking, a weighting towards barriers to enterprise (persons with poor credit record, towards people whose loan applications turned down by a bank, people without a bank account, etc.).

Smaller providers may be unable to plan across years, and therefore make capital investment, such as in training. Need for longer-term rolling contracts.

- Improved collation at national level of performance data across programmes, at least for government-funded programmes.

- Greater consistency of performance measures would be helpful. It could easily be within the government’s power to stimulate such a shift. Standardising evaluative data requirements can reduce administrative burden, especially for service providers that receive funds from more than one source.

Local level

• Design self-employment support programmes such that budgets and capacities can be expanded in a pre-emptive manner, as economic downturns raise demand for programme services.

• Comprehensive programme outreach is costly and unnecessary, so ensure a single visible point of referral to professional advisors.

The availability of on-call advice and mentoring is ideal. Entrepreneurs often also prefer advice given by other entrepreneurs. Where possible, ensure that business advisors possess a detailed knowledge of the local community. Institutional visibility is important given the often-confusing plethora of support-giving organisations.

Evidence from statistical analysis of the efficacy of business advisory services, growth most closely associated with private sources of advice….lawyers, customers, friends in business.

Some evidence that public advisory services seem to have little effect on growth, but do help rescue ailing firms.

Limited overall evidence.

• Invest in pre-start advisory services.

The effect of pre-start advice is to identify unviable business plans, to caution prospective entrepreneurs (the self-employed are “super-optimists”) and to improve the viability of nascent firms (a well-prepared business plan for instance will facilitate access to finance).

Self-employment is sometimes entered into from force of circumstance, rather than choice. Such enterprises have low rates of survival. Public services can help redirect persons who wish to establish a business for the wrong reasons, recalling that the consequences of business failure for individuals and their families can be severe.

Evidence suggests that charging the unemployed for business planning assistance greatly decreases take-up.

• Ensure a strong marketing component in assistance programmes

The problem of displacement is likely to be greatest among the types of firms typically present in poor localities - those in mature-low-growth, easy entry markets with low profit margins.

So to help avoid displacement, assist firms in trading outside the area. Most start-ups serve local markets, reaching wider markets as the business matures. There is sectoral variation, however, with services more closely linked to local customers. There is evidence that firms serving wider markets have greater longevity.

In Germany, in order to address the displacement problem, some support has been restricted to businesses likely to create a given minimum level of income (on the assumption that they will enter less contested markets), although this may raise dead weight and lower access for poorer income groups. Some schemes restrict support to ventures with “relatively high capital requirements.” Other approaches exclude business categories such as hairdressers and retail or seek to work with firms in non-saturated markets.

• Encourage team-starts.

Firms established by groups of entrepreneurs have greater longevity, other things the same.

• Examine where the public sector can play a catalytic role in establishing private-sector-led networks.

Through the use of network brokers various forms of small-firm collaboration can be facilitated. Networks of particular relevance to self-employment and micro-enterprises include mutual credit guarantee associations, peer-group lending/borrowing programmes, schemes to link micro-entrepreneurs with larger corporations, and joint marketing initiatives. Networks can also help entrepreneurs counter isolation, racism, and sexism.

Mutual credit guarantee schemes / Italy.

The results indicate that the self-employed that graduated from a peer group process earn more than those receiving individual loans.