Business start-ups, closures and economic churn: A review of the literature

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Introduction. What is it? Dynamic process by which firms enter and exit a market. How do we measure it? Some background and definitionsWhat do we know? Empirical research and data issuesWhat does it mean to us? Entrepreneurship, small business, start ups and closures in the UK Why is it impo

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Business start-ups, closures and economic churn: A review of the literature

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1. Business start-ups, closures and economic churn: A review of the literature Brigid O’Leary, Ana Rincon, Kate Robinson And Mary O’Mahony and Geoff Mason

2. Introduction What is it? Dynamic process by which firms enter and exit a market. How do we measure it? Some background and definitions What do we know? Empirical research and data issues What does it mean to us? Entrepreneurship, small business, start ups and closures in the UK Why is it important - And is there an optimal rate? The macro perspective and role for policy What do we want to know? Ideas for further research, evidence gaps and empirical analysis. Hello and thank you for coming to our workshop. Today, Kate and I are presenting an overview of the literature review on economic churn for the small business service. This is work by Ana Rincon with advice and contributions from Mary O’Mahony and Geoff Mason. I am going to give a brief overview of the aspects of churn we have considered and then kate will elaborate on some of the key issues. So to start with, I will just touch on how we have thought about economic churn and why we are interested in it. Economic churn is a dynamic and ongoing process of firms entering and exiting a market. It is the reallocation of resources to more efficient uses through competitive and innovative behaviour, improved productivity, innovative behaviour and ultimately economic growth. However, it is not a seamless process, as the term ‘churn’ implies and comes with some upheaval – the costs of reallocating resources, the disruption to supply chains and the impact on the labour market through unemployment means that there is a tradeoff between the benefits of churn and the social and economic costs. So first I will go through some definitional issues and outline different ways in which churn can be measured. Then I will give you a brief overview of existing empirical research on the subject and outline current obstacles in this area. Kate will develop on these issues and consider the UK experience and the role of churn in the aggregate economy. This includes our key question for the day – is there an optimal rate of churn? And is there a role for policy intervention? Finally, we’d like to outline our ideas for future research and invite suggestions, comments and questions from the audience. Hello and thank you for coming to our workshop. Today, Kate and I are presenting an overview of the literature review on economic churn for the small business service. This is work by Ana Rincon with advice and contributions from Mary O’Mahony and Geoff Mason. I am going to give a brief overview of the aspects of churn we have considered and then kate will elaborate on some of the key issues. So to start with, I will just touch on how we have thought about economic churn and why we are interested in it. Economic churn is a dynamic and ongoing process of firms entering and exiting a market. It is the reallocation of resources to more efficient uses through competitive and innovative behaviour, improved productivity, innovative behaviour and ultimately economic growth. However, it is not a seamless process, as the term ‘churn’ implies and comes with some upheaval – the costs of reallocating resources, the disruption to supply chains and the impact on the labour market through unemployment means that there is a tradeoff between the benefits of churn and the social and economic costs. So first I will go through some definitional issues and outline different ways in which churn can be measured. Then I will give you a brief overview of existing empirical research on the subject and outline current obstacles in this area. Kate will develop on these issues and consider the UK experience and the role of churn in the aggregate economy. This includes our key question for the day – is there an optimal rate of churn? And is there a role for policy intervention? Finally, we’d like to outline our ideas for future research and invite suggestions, comments and questions from the audience.

3. Economic churn Theoretical models Aggregate economy, Industry characteristics and Firm decisions Definitions of entry and exit: Diversifying firms, changes in ownership, business start-ups Takeover, Bankruptcy, Change of industry Measurement issues Entry rate/ turnover rate entry penetration rate volatility measures I will briefly outline the theory which underlies economic churn. Models of endogenous growth show that economic growth and technological progress at an aggregate level are determined by competition among entrepreneures that generate innovation. Successful firms capture monopoly rents while unsuccessful firms exit the market. Theory also suggests that some industry characteristics will impact on churn both through entry behaviour (where high sunk costs to an industry deter entry) and that market size and concentration in an industry can direclty effect turnover rates. Finally, there is a role for firm entry decisions and survival probabilities in models which caputre firms characteristics and learning processes. In these models, successful firms grow but unproductivie/uncompetitive orinefficient firms will eixt., but young firms are less familiar with their attributes and capabilities so are more likely to exit while learning about their cost structure. So what do these measures really capture? It would be misleading to assume all entrants are new startups and all exiting firms go bankrupt. When we say ‘entrant’, we include firms diversifying into a new industry, firms which change ownership, through mergers, acquisitions or takeovers, and, of course, to the traditional new entrant of a business start up. We can refer to domestic and international sources of competition. it is pertinent to our empirical analysis of churn to recognise a wider definition of entry and the differing effects on economic churn. Similarly, the term exit may include firms who go bankrupt, are taken over by other firms or where firms change industry and exit one market to enter another. Empirical research shows that impact on the churn process will be different depending on the category an entering or exiting firm. While Kate will go into more detail on this, it is important now to recognise that while measurements of churn may include all or only some of these categories, understanding the underlying causes and effects of entry and exit on an industry or the aggregate economy relies on recognising the different characteristics of these groups. The industry level and the time frame of analysis are also important – the short term effects of churn may be misleading if they capture the upheaval without the improvements.I will briefly outline the theory which underlies economic churn. Models of endogenous growth show that economic growth and technological progress at an aggregate level are determined by competition among entrepreneures that generate innovation. Successful firms capture monopoly rents while unsuccessful firms exit the market. Theory also suggests that some industry characteristics will impact on churn both through entry behaviour (where high sunk costs to an industry deter entry) and that market size and concentration in an industry can direclty effect turnover rates. Finally, there is a role for firm entry decisions and survival probabilities in models which caputre firms characteristics and learning processes. In these models, successful firms grow but unproductivie/uncompetitive orinefficient firms will eixt., but young firms are less familiar with their attributes and capabilities so are more likely to exit while learning about their cost structure. So what do these measures really capture? It would be misleading to assume all entrants are new startups and all exiting firms go bankrupt. When we say ‘entrant’, we include firms diversifying into a new industry, firms which change ownership, through mergers, acquisitions or takeovers, and, of course, to the traditional new entrant of a business start up. We can refer to domestic and international sources of competition. it is pertinent to our empirical analysis of churn to recognise a wider definition of entry and the differing effects on economic churn. Similarly, the term exit may include firms who go bankrupt, are taken over by other firms or where firms change industry and exit one market to enter another. Empirical research shows that impact on the churn process will be different depending on the category an entering or exiting firm. While Kate will go into more detail on this, it is important now to recognise that while measurements of churn may include all or only some of these categories, understanding the underlying causes and effects of entry and exit on an industry or the aggregate economy relies on recognising the different characteristics of these groups. The industry level and the time frame of analysis are also important – the short term effects of churn may be misleading if they capture the upheaval without the improvements.

4. Empirical evidence on churn Productivity impact Micro panel datasets (Bartelsman and Doms 2000) Decomposition analysis (reallocation among incumbents and via entry and exit). Ongoing process of restructuring by incumbents is essential The net entry process also important (Bartelsman et al, Baily et al 1992, Olley and Pakes, Liu 1992, Griliches and Regev 1995, Aw, Chen and Roberts 1997) Cross country evidence: Important to help identify role of policy and institutions BUT data problems (Bartelsman et al 2005) More UK research needed It is with the improved availability of micro panel datasets that these conceptual ideas of economic churn and their relationship to productivity can be better measured. Understanding firm heterogeneity is important for understanding why some firms fail while others succeed, Long run micro panel data sets provide large, statistically representative samples so that production units can be tracked over time and provides the foundations for analysing the relationship between firm activity and production choices, the dynamic industry market and aggregate economic growth through linking micro and macro data sets. Empirical analysis which captures the effect of churn decomposes movement in the market into reallocation amongst incumbents, an entry and an exit effect. Reallocation can take the form of changes within firms, between firms or cross firms. This captures the effect of high productivity firms producing a higher share of output for the industry but the time frame of analysis is of importance – long run studies are more likely to find a stronger role for net entry. Of particular interest to our work on economic churn are 2 US studies of service industries where net entry dominates in explaining productivity growth, while in the UK, Disney Haskel and Headen 2003 on manufacturing studies show that entry and exit is responsible for half of ALP and TFP growth. The extension of such analysis to cross country studies is a new area. It is an important consideration in understanding cross-country differences in productivity and may offer insight into the role of policy and instutions. However, it is confounded by numerous data problems so existing research is rare and results are best viewed as preliminary. One problem is that micro panel data sets may be of unreliable quality to start with but developing equivalent datasets for cross-country comparisons is even more demanding, where definitional issues, deflation etc are present.. It is with the improved availability of micro panel datasets that these conceptual ideas of economic churn and their relationship to productivity can be better measured. Understanding firm heterogeneity is important for understanding why some firms fail while others succeed, Long run micro panel data sets provide large, statistically representative samples so that production units can be tracked over time and provides the foundations for analysing the relationship between firm activity and production choices, the dynamic industry market and aggregate economic growth through linking micro and macro data sets. Empirical analysis which captures the effect of churn decomposes movement in the market into reallocation amongst incumbents, an entry and an exit effect. Reallocation can take the form of changes within firms, between firms or cross firms. This captures the effect of high productivity firms producing a higher share of output for the industry but the time frame of analysis is of importance – long run studies are more likely to find a stronger role for net entry. Of particular interest to our work on economic churn are 2 US studies of service industries where net entry dominates in explaining productivity growth, while in the UK, Disney Haskel and Headen 2003 on manufacturing studies show that entry and exit is responsible for half of ALP and TFP growth. The extension of such analysis to cross country studies is a new area. It is an important consideration in understanding cross-country differences in productivity and may offer insight into the role of policy and instutions. However, it is confounded by numerous data problems so existing research is rare and results are best viewed as preliminary. One problem is that micro panel data sets may be of unreliable quality to start with but developing equivalent datasets for cross-country comparisons is even more demanding, where definitional issues, deflation etc are present..

5. Rates of churn Bartelsman et al have gone to considerable lengths to produce a harmonised data set for decomposing economic churn. From a UK perspective, the preliminary results are interesting. UK performs more in line with industrial countries and above the average rate of churn in manufacturing sectors but is not represented in total economy or service sector analysisBartelsman et al have gone to considerable lengths to produce a harmonised data set for decomposing economic churn. From a UK perspective, the preliminary results are interesting. UK performs more in line with industrial countries and above the average rate of churn in manufacturing sectors but is not represented in total economy or service sector analysis

6. a) Entry via diversification Firms diversify because they may be able to exploit existing resources and knowledge and have better: Information about opportunities for profitable entry Access to productive resources Ability to respond to changes in demand Most entering firms are new, but diversifying entrants are larger, and can have a quicker impact on the market (Dunne et al 1988, Mata et al 1995). Are able to enter markets at a smaller scale than new start-ups, since resources can be transferred (Hariharan and Brush 1999) Entry through diversification more likely to survive, since it has cost advantages. So we have seen some of the empirical evidence that shows the prevalence of churn, but we need to take a step back and consider its components a bit more thoroughly before moving on to evaluate the importance of its impact on productivity. We see in the literature that different modes of entry and exit are likely to be the result of different motivations, and also likely to have different long and short run impacts. Following the work of Dunne and mueller, amongst others, we focus on three modes of entry – the first of which, is entry through diversification. Existing firms may choose to enter other industries in order to better exploit there assets (including knowledge). They have certain advantages over brand new entrants in that they are likely to have better knowledge of the market and information on profits (particularly if the diversification is up or downstream from their existing line of business). Their investment is already in place, and so they are able to respond relatively more quickly to changes in demand. Empirical studies that have specifically considered diversifying firms have found that although they make up a relatively smaller proportion of all entrants, compared to new entrants, they are generally larger on entry and therefore are able to have a quicker impact on the market. Other empirical evidence suggests that diversifying firms are in a position to enter industries at a smaller scale than that viable to new start ups, and in this way are effectively able to test the water before investing heavily in a line of business. Evidence on survival rates points to greater probability of survival because of cost advantages…..So we have seen some of the empirical evidence that shows the prevalence of churn, but we need to take a step back and consider its components a bit more thoroughly before moving on to evaluate the importance of its impact on productivity. We see in the literature that different modes of entry and exit are likely to be the result of different motivations, and also likely to have different long and short run impacts. Following the work of Dunne and mueller, amongst others, we focus on three modes of entry – the first of which, is entry through diversification. Existing firms may choose to enter other industries in order to better exploit there assets (including knowledge). They have certain advantages over brand new entrants in that they are likely to have better knowledge of the market and information on profits (particularly if the diversification is up or downstream from their existing line of business). Their investment is already in place, and so they are able to respond relatively more quickly to changes in demand. Empirical studies that have specifically considered diversifying firms have found that although they make up a relatively smaller proportion of all entrants, compared to new entrants, they are generally larger on entry and therefore are able to have a quicker impact on the market. Other empirical evidence suggests that diversifying firms are in a position to enter industries at a smaller scale than that viable to new start ups, and in this way are effectively able to test the water before investing heavily in a line of business. Evidence on survival rates points to greater probability of survival because of cost advantages…..

7. b) Changes in ownership Takeovers, mergers and acquisitions are form of reallocation of resources. 3 major explanations (Berkovitch & Narayanan 1993) Synergy: Economic gains from merging resources Agency: Pursuit of management goals Hubris: firms incorrectly identify gains for synergy Empirical evidence on productivity impact US evidence - Ravenscraft and Scherer (1987): No productivity gain after acquisition; Berkovitch & Narayanan (1993): Positive gains in ¾ of takeovers UK – Harris and Robinson (2002): Productivity gains from FDI changes in ownership (US), but not quite so clear from domestic changes. Explanations for ambiguity of findings -Adjustment costs -Objectives other than improving efficiency - gain access to a market (FDI); to acquire specific attributes such technology. A second mode of entry that we have identified is through changes in ownership. Of course, changes in ownership also constitute a mode of exit also. This form of reallocation has been identified as being explained in three basic ways; firstly synergy, where the purchasing firm has identified economic gains from merging resources, being able to streamline production processes…etc. The agency explanation offers a non profit orientated reason behind mergers and takeovers, for example, the pursuit of growth maximisation to enhance management status, etc. Finally, Berkovitch and Narayanan identify a hubris explanation for changes in ownership, where firms have simply made mistakes in identifying synergies. This may be the result of unrealistic expectations of the costs involved as much as incorrectly identifying the gains…. Empirical evidence on the impact of changes in ownership is largely concentrated in the US and has traditionally found productivity gains relatively elusive. Evidence for the UK by Richard Harris and I looked at 4 digit manufacturing industries over the 1980s and 1990s and found that there was some evidence of productivity gains in the case of foreign acquisition, but it was much less strong from domestic changes. The ambiguous findings have been attributed to short run adjustment costs in assimilating new assets, implementing new production systems, etc.. In most cases, the ‘long run’ has not been observed – data constraints, particularly as we don’t really know how long these teething problems will take to run their course. It is also worth mentioning that in the case of FDI, and to a lesser extent this may be valid for domestic firms too, but other objectives than improving efficieny may dominate – in particular, there is the technology sourcing arguments put forward by driffield. A second mode of entry that we have identified is through changes in ownership. Of course, changes in ownership also constitute a mode of exit also. This form of reallocation has been identified as being explained in three basic ways; firstly synergy, where the purchasing firm has identified economic gains from merging resources, being able to streamline production processes…etc. The agency explanation offers a non profit orientated reason behind mergers and takeovers, for example, the pursuit of growth maximisation to enhance management status, etc. Finally, Berkovitch and Narayanan identify a hubris explanation for changes in ownership, where firms have simply made mistakes in identifying synergies. This may be the result of unrealistic expectations of the costs involved as much as incorrectly identifying the gains…. Empirical evidence on the impact of changes in ownership is largely concentrated in the US and has traditionally found productivity gains relatively elusive. Evidence for the UK by Richard Harris and I looked at 4 digit manufacturing industries over the 1980s and 1990s and found that there was some evidence of productivity gains in the case of foreign acquisition, but it was much less strong from domestic changes. The ambiguous findings have been attributed to short run adjustment costs in assimilating new assets, implementing new production systems, etc.. In most cases, the ‘long run’ has not been observed – data constraints, particularly as we don’t really know how long these teething problems will take to run their course. It is also worth mentioning that in the case of FDI, and to a lesser extent this may be valid for domestic firms too, but other objectives than improving efficieny may dominate – in particular, there is the technology sourcing arguments put forward by driffield.

8. c) Business start-ups (and closures): Explore motivation behind business start-ups and closures, with emphasis in the UK case. Significant component of churn in the longer run Additional effect Innovative component Focus of policy measures Determinants of start-ups and closures Emphasis on small firms UK industrial policy Its recent focus and choices The final, and the most easily identifiable sources of churn to focus on are the business start ups and closures. And this brings us to another of the questions the SBS asked us to go on to consider. Need to bear in mind that this is a significant component of churn, particularly in the long run, and is certainly the focus of policy. Business start ups are thought to be additional, in the sense that they haven’t directly displaced existing effort, they are noted to be the driving force for innovation, a point to which we return later. For these reasons, we focus in more detail than the other sources of churn on the determinants . So in the next few slides I will consider the determinants of start ups and closures, emphasising small firms, and then we will go on to consider some of the recent policy directions in the UK.The final, and the most easily identifiable sources of churn to focus on are the business start ups and closures. And this brings us to another of the questions the SBS asked us to go on to consider. Need to bear in mind that this is a significant component of churn, particularly in the long run, and is certainly the focus of policy. Business start ups are thought to be additional, in the sense that they haven’t directly displaced existing effort, they are noted to be the driving force for innovation, a point to which we return later. For these reasons, we focus in more detail than the other sources of churn on the determinants . So in the next few slides I will consider the determinants of start ups and closures, emphasising small firms, and then we will go on to consider some of the recent policy directions in the UK.

9. Factors determining start-ups Profitability in an industry. This may be the result of the stage of the product life cycle. Concentration. Traditionally the more concentrated an industry the less likely firms are to enter. Geroski and Murfin (1985) point out that entry through niches may be appropriate in concentrated industries. Barriers to entry: Product differentiation, scale economies and access to inputs, especially finance. Co-operation between organisations. Firms in early stages of development benefit from location within formal/informal network: R&D, labour recruitment, and facilities (Keeble et al 1998) Factors determining startups. I think these are not particularly contentious points, profitable industries will attract entry; this may in part be a feature of the product life cycle, young industries will naturally attract a great number of entrants. Declining industries in the more mature stages of life less so. Industry concentration is thought to have a significant bearing on the entry decision. More concentrated industries are likely to be harder to enter. More concentrated industries are also likely to be more mature…concentration does not prevent entry, however, since firms may be able to enter into niches. Related to concentration are barriers to entry (and consequently exit also ) such as branding, scale economies, access to inputs, particularly finance, all of which negatively impact on entry and exit. These factors are likely to be highly colinear with concentration especially. Finally, another factor that is thought to have a significant impact on whether firms enter an industry is the nature of cooperation between organisations. firms in the early stages of development benefit from spillovers from a regional environment conducive to early stage firms - these factors offer further indication of why start up rates vary so significantly across regions. Factors determining startups. I think these are not particularly contentious points, profitable industries will attract entry; this may in part be a feature of the product life cycle, young industries will naturally attract a great number of entrants. Declining industries in the more mature stages of life less so. Industry concentration is thought to have a significant bearing on the entry decision. More concentrated industries are likely to be harder to enter. More concentrated industries are also likely to be more mature…concentration does not prevent entry, however, since firms may be able to enter into niches. Related to concentration are barriers to entry (and consequently exit also ) such as branding, scale economies, access to inputs, particularly finance, all of which negatively impact on entry and exit. These factors are likely to be highly colinear with concentration especially. Finally, another factor that is thought to have a significant impact on whether firms enter an industry is the nature of cooperation between organisations. firms in the early stages of development benefit from spillovers from a regional environment conducive to early stage firms - these factors offer further indication of why start up rates vary so significantly across regions.

10. The case for entrepreneurship Storey (1994) Location endowments (population density, clusters, local planning regulations, transport & communications, infrastructure, industry policy) Individual endowments (wealth, qualifications, experience). Qualitative research by Cosh (2006) reveals motivations for business start-ups (CBR Survey): Desire to run ones own business: 70% Unemployment: 21% Desire to implement new idea: 27% If we turn to the small business literature, the book by Storey has been incredibly influential in considering the start up and closure determinants in small businesses (in the UK). He too emphasises the importance of location endowments and regional networks and infrastructures. In addition to geographic factors, the nature of the individual is also crucial. Individual endowments, wealth, qualifications, family background, experience are also cited in the literature as being key determinants of an individuals desire to move into self employment. Very recent qualitative research by the CBR at Cambridge has revealed motivations behind starting up ones own business – they found that the desire to run ones business is the key motivating factor, and was given as a reason in 70 per cent of all responses – note that more than one answer was possible….the desire to implement a new idea ie innovation accounted for just less than a third, while at the time the survey was carried out, just over a fifth of respondents started their own business as a choice between that and unemployment – obviously this reason given is most likely to be affected by business cycle effects. If we turn to the small business literature, the book by Storey has been incredibly influential in considering the start up and closure determinants in small businesses (in the UK). He too emphasises the importance of location endowments and regional networks and infrastructures. In addition to geographic factors, the nature of the individual is also crucial. Individual endowments, wealth, qualifications, family background, experience are also cited in the literature as being key determinants of an individuals desire to move into self employment. Very recent qualitative research by the CBR at Cambridge has revealed motivations behind starting up ones own business – they found that the desire to run ones business is the key motivating factor, and was given as a reason in 70 per cent of all responses – note that more than one answer was possible….the desire to implement a new idea ie innovation accounted for just less than a third, while at the time the survey was carried out, just over a fifth of respondents started their own business as a choice between that and unemployment – obviously this reason given is most likely to be affected by business cycle effects.

11. Competition and innovation 2 theories a) Competition may discourage innovation and inhibits productivity growth by reducing expected rents from innovation (Aghion and Howitt 1992) b) Competition encourage innovation in since incumbents are forced to innovate to compete with entrants (Nickell 1996, Blundell, Griffith and Van Reenen 1999). Possible explanation of both theories: Competition and innovation u inverted relationship (Aghion et al 2005 : a) dominates for low levels of competition and b) at higher levels. Entry has positive effects on incumbent innovation incentives but only in industries initially close to technological frontier (Aghion et al 2006) and in advanced countries, rather than in less developed countries that rely on imitation and adaptation of technologies ( Acemoglu, Aghion and Zilibotti 2003) The fundamental rationale for the encouragement of start ups is the competitive contribution they make to the market and the role they play in bringing new innovations to the market and so a natural point for consideration is the role that they play in competition and innovation. But the relationship between competition is an interesting one. There are two competing theories – firstly, there is the argument that competition discourages innovation, since it drives firms to be relatively short term in their priorities, and reduces expected rents from innovation. The second vein of literature sees the competitive pressure as being encouraging of innovation since incumbents are forced to directly compete with incoming, innovative entrants. Recent work by Aghion et al has identified that both theories hold in the case where competition and innovation have an inverted u relationship, thus allowing innovation to be high at very low and very high levels of competition.The fundamental rationale for the encouragement of start ups is the competitive contribution they make to the market and the role they play in bringing new innovations to the market and so a natural point for consideration is the role that they play in competition and innovation. But the relationship between competition is an interesting one. There are two competing theories – firstly, there is the argument that competition discourages innovation, since it drives firms to be relatively short term in their priorities, and reduces expected rents from innovation. The second vein of literature sees the competitive pressure as being encouraging of innovation since incumbents are forced to directly compete with incoming, innovative entrants. Recent work by Aghion et al has identified that both theories hold in the case where competition and innovation have an inverted u relationship, thus allowing innovation to be high at very low and very high levels of competition.

12. Innovation and small firms Which firm size is most conducive to innovation? General empirical support of a u shaped relationship between firm size and innovation output (Hoffman et alia 1998) Large firms have a relative innovative advantage under some circumstances and small firms have relative innovative advantage under other circumstances (Acs and Audretsch 1987) Large firms: In industries capital-intensive, concentrated, highly unionised, and with differentiated goods. Small firms: In industries in early stages of the life-cycle, innovative, with high skilled labour. Characteristics of SME innovators Located in niche markets, product innovators, external linkages. Important role by means of imitation and diffusion (Cosh et al 2006) Innovative capabilities in UK SME determined by (Romin and Albaladejo 2000) : Internal factors: owner technical education, technical skills of workforce, R&D, training. External factors: Public R&D support, interaction with R&D and training institutions, Interaction with suppliers, customers and similar firms not found important. Looking specifically at innovation in relation to small firms, we see that the literature points to a u shaped relationship between size and innovation, with both large and small firms having a disproportionate share of innovative success. These are dependent on the market conditions – large firms thrive innovatively in concentrated, unionised, capital intensive environments, whereas small firms manage to contribute significantly to industries in the early stages of the life cycle, with highly skilled labour. IF we turn to consider the attributes of small firm innovators, we see that they are located in niche markets, and are generally product innovators with external linkages. The recent Cambridge survey again highlighted the importance of the role of SMEs in the imitation and diffusion of technology. The innovative capabilities of SMES are said to be determined by internal and external factors, analogous to the location and individual factors we noted earlier as determinants of start ups. Internal factors include education and skills of the workforce, external factors relate to the environment in which the firm operates. Note that customers and similar firms were not found to be important in determining innovative SMEs. Looking specifically at innovation in relation to small firms, we see that the literature points to a u shaped relationship between size and innovation, with both large and small firms having a disproportionate share of innovative success. These are dependent on the market conditions – large firms thrive innovatively in concentrated, unionised, capital intensive environments, whereas small firms manage to contribute significantly to industries in the early stages of the life cycle, with highly skilled labour. IF we turn to consider the attributes of small firm innovators, we see that they are located in niche markets, and are generally product innovators with external linkages. The recent Cambridge survey again highlighted the importance of the role of SMEs in the imitation and diffusion of technology. The innovative capabilities of SMES are said to be determined by internal and external factors, analogous to the location and individual factors we noted earlier as determinants of start ups. Internal factors include education and skills of the workforce, external factors relate to the environment in which the firm operates. Note that customers and similar firms were not found to be important in determining innovative SMEs.

13. The UK experience Churn Evidence from Bartelsman et al (2005) suggests that churn in UK manufacturing is almost 24 per cent greater than the cross country average they find (19 per cent) Half of entry and exit employment due to entry/exit from new establishment by existing enterprises. (Disney, Haskel and Heden 2003) Single plant closures are 50% less likely – exit is a last resort, but closure of young US-acquired plants 165% more likely (Harris and Hassaszadeh, 2002) Harris and Robinson (2001) looked at entry and exit in relation to firms in receipt of government assistance and found that assisted plants were less likely to exit. Entry and exit and productivity In the UK, contribution of entry and exit to labour productivity and TFP growth is 50% for 1980-1992 (Disney, Haskel and Heden 2003). Okay, so to recapitulate, we have considered the various modes of entry and to a lesser extent exit, and have looked at the literature that relates to the determinants of start ups specifically. In the review we also consider to some extent the role of exits in the process, but we have limited time here. So now we look at the UK experience in relation to churn, entry and exit, and start to consider their impact on productivity, and hence their impact on the wider economy. The most recent Evidence for churn in the UK was mentioned by brigid. Bratelsman et al suggest rates of churn 1.24 times the cross country average of 19 per cent. I believe Jonathan may have been involved with this study, and so look forward to discussing this finding with him. Other UK evidence of churn has been carried out by Haskell on ARD data and has found that half of entry and exit in employment terms is due to new establishments by existing enterprises, harking back to our discussion of the mode of entry. Richard and Parastoo is one of the few uk studies to consider exit using micro data and finds that single plant closures are 50 per cent less likely to exit than plants that belong to multiplant organisations. They also consider the inter-relationship between ownership characteristics, age and survival and find that … In a separate study Richard and I looked at entry and exit in relation to firms receiving governement assistance and find that there is some indication that plants with lower levels of productivity were slow to exit as a result of government assistance. When we look at the productivity impact, again work by haskel et al offers considerable insight into the contribution entry and exit make to labour productivity… Perhaps more here Okay, so to recapitulate, we have considered the various modes of entry and to a lesser extent exit, and have looked at the literature that relates to the determinants of start ups specifically. In the review we also consider to some extent the role of exits in the process, but we have limited time here. So now we look at the UK experience in relation to churn, entry and exit, and start to consider their impact on productivity, and hence their impact on the wider economy. The most recent Evidence for churn in the UK was mentioned by brigid. Bratelsman et al suggest rates of churn 1.24 times the cross country average of 19 per cent. I believe Jonathan may have been involved with this study, and so look forward to discussing this finding with him. Other UK evidence of churn has been carried out by Haskell on ARD data and has found that half of entry and exit in employment terms is due to new establishments by existing enterprises, harking back to our discussion of the mode of entry. Richard and Parastoo is one of the few uk studies to consider exit using micro data and finds that single plant closures are 50 per cent less likely to exit than plants that belong to multiplant organisations. They also consider the inter-relationship between ownership characteristics, age and survival and find that … In a separate study Richard and I looked at entry and exit in relation to firms receiving governement assistance and find that there is some indication that plants with lower levels of productivity were slow to exit as a result of government assistance. When we look at the productivity impact, again work by haskel et al offers considerable insight into the contribution entry and exit make to labour productivity… Perhaps more here

14. Is there an optimal rate of churn? Churning also turbulent process for firms and employees: Business closures are disruptive to supply chains and networks and labour market. Trade-off between ‘bad socioeconomic consequences’ and ‘good competitive’ effect (Boltho 1996). Caballero and Hammour (1998) consider welfare effects Unemployment Net productivity effect is a relationship between level of creation and level of destruction Passive destruction: Exogenous reasons for failure Privately efficient destruction: Schumpeterian Privately inefficient destruction: Due to financial constraints. Van Stel (2005) considers the optimal rate of churn using a volatility measure Finds no evidence of an optimal rate Given the findings of producitivity studies in the UK and elsewhere, we turn now to consider whether there is such a rate of optimal churn. Some attempts have been made in the literature to identify the amount of churn over and above that which expands the industry that does not result in an improvement in the allocation of resources. This recognises that churn is a turbulent process for all concerned and has social costs associated with it. Thus there is a trade off between bad socioeconomic consequences and the good competitive effect of churn. One of the key papers that looks to evaluate the welfare effects of churn is Caballero and Hamour. This identifies the costs in terms of the short term unemployment as a result of the exit… Van Stel also looks at testing this empirically and finds no evidence of an optimal rate of churn. Given the findings of producitivity studies in the UK and elsewhere, we turn now to consider whether there is such a rate of optimal churn. Some attempts have been made in the literature to identify the amount of churn over and above that which expands the industry that does not result in an improvement in the allocation of resources. This recognises that churn is a turbulent process for all concerned and has social costs associated with it. Thus there is a trade off between bad socioeconomic consequences and the good competitive effect of churn. One of the key papers that looks to evaluate the welfare effects of churn is Caballero and Hamour. This identifies the costs in terms of the short term unemployment as a result of the exit… Van Stel also looks at testing this empirically and finds no evidence of an optimal rate of churn.

15. UK industrial policy to foster start-ups Government’s action plan for small businesses (DTI): “to make UK the best place in the world to start and grow a business” 7 POLICY AREAS: 1. Knowledge and enterprise culture 2. Dynamic start-up 3. Improving management capabilities 4. Financial constraints 5. Addressing social inequalities 6. Providing better access to services 7. Reducing impact of regulation. Subsidies: Interfere with churn process if indiscriminate But targeted financial support can be very important useful for small businesses, especially for innovative ideas. Policy should ensure market environment is conducive to business, not distortionary ( e.g. tax or regulations should not act as barrier of entry) Okay, so given the evidence on the determinants of start ups, the role they play in churn, in innovation and in competition, we now turn to consider current uk policy. The current mission statement, I’m sure most of you know better than me is to make the UK the best place in the world to start and grow a usiness, and in order to achieve this there are 7 policy areas…. Policy has a choice of operating at the firm level or the environment level – clearly the firm level has the greatest potential to make a difference, however identifying the winners is not easy…… Okay, so given the evidence on the determinants of start ups, the role they play in churn, in innovation and in competition, we now turn to consider current uk policy. The current mission statement, I’m sure most of you know better than me is to make the UK the best place in the world to start and grow a usiness, and in order to achieve this there are 7 policy areas…. Policy has a choice of operating at the firm level or the environment level – clearly the firm level has the greatest potential to make a difference, however identifying the winners is not easy……

16. The business environment: Determinants for success In a recent paper, Atherton has suggested a sort of SWOT analysis of businesses as a means of evaluating whether or not they are likely to survive and whether they are ‘good bets’ for financial support. And I think there is some mileage in this. I think it adapts the firm specific attributes into identifiable goals…In a recent paper, Atherton has suggested a sort of SWOT analysis of businesses as a means of evaluating whether or not they are likely to survive and whether they are ‘good bets’ for financial support. And I think there is some mileage in this. I think it adapts the firm specific attributes into identifiable goals…

17. Proposal for future analysis in UK So far focus on manufacturing sector. Increase availability of services microdata at ONS. Consider more aggregate data in combination with micro data to identify effects on growth, employment. E.g. construct measures of churn by industry using microdata Include these measures as explanatory variables in industry production function/employment equations Can use datasets in Bartelsman et al. international study combined with country and industry panel data for EUKLEMS Finally, we consider the gaps in the existing literature. Much of the existing work has focussed on the manufacturing literature , hopefully our next presentation from Jonathan goes some way to starting to address this when he considers the retail sector, but clearly there is a long way to go. Secondly we have identified a need to consider the impact of churn at a more aggregate level, and as such are looking for ways to combine churn data with industry level data on productivity. One of the key findings from the first part of the literature review is the importance of definition and as such, harmonised measures of not only churn but of output variables such as value added, etc. Finally, we consider the gaps in the existing literature. Much of the existing work has focussed on the manufacturing literature , hopefully our next presentation from Jonathan goes some way to starting to address this when he considers the retail sector, but clearly there is a long way to go. Secondly we have identified a need to consider the impact of churn at a more aggregate level, and as such are looking for ways to combine churn data with industry level data on productivity. One of the key findings from the first part of the literature review is the importance of definition and as such, harmonised measures of not only churn but of output variables such as value added, etc.

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