Entrepreneurship, Economic Growth and Microfinance.

Chantelle Blachut and Ichiro Uehara.(9/12/2010)

Outline. Introduction Link Between Entrepreneurship and Growth Empirical Evidence Policy Implication Microfinance & Entrepreneurship

(connections and basic literature ideas) India & Microfinance

(current problems) Concluding Remarks

Linking Entrepreneurship and Economic Growth

• Some economists say input factors are...– Technology (A)– Capital (K)

• Human and physical

– Labor (L)– AND Entrepreneurship (E)– Y = A * K^α * L^β * E^1-α+β

Paper

• Linking Entrepreneurship and Economic Growth by Wennekers and Thurik (1999)

Entrepreneurship and Economic Growth

Dictionary Definition of Entrepreneur

• Someone who stars a company, arranges business deals, and takes risks in order to make a profit– By LONGMAN Advanced American Dictionary

Definition of Entrepreneurship

• Entrepreneurship is the manifest ability and willingness of individuals, on their own, in teams, within and outside existing organizations, to:– Perceive and create new economic opportunities (new

products, new production methods, new organizational schemes and new product-market combinations )

– Introduce their ideas in the market, in the face of uncertainty and other obstacles, by making decisions on location, form and the use of resources and institutions

Roles of Entrepreneur1. Person who assumes the risk associated with uncertainty2. Supplier of financial capital3. Innovator4. Decision-maker5. Industrial leader6. Manager or superintendent7. Organizer and coordinator of economic resources8. Owner of an enterprise9. Employer of factors of production10. Contractor11. Arbitrageur (Trader)12. Allocator of resources among alternative uses13. Person who realizes a start-up of a new bussiness

Hébert and Link (1989), Van Dijk qnd Thurik (1995), Van Praag (1996)

Types of Entrepreneurs

• Entrepreneurial v.s. Managerial• Self-Employed v.s. Employee

Types of Entrepreneurs

• Real Entrepreneurs– Schumpeterian Entrepreneurs: own and direct

independent firms that are innovative and creatively destroy existing market structure; mostly small firms

– Intrapreneurs: embodiment of leadership in entrepreneurial ventures in large firms; e.g. Employee of R&D Department in a firm

• Managerial business owners: e.g. franchisees

Dynamics of Entrepreneurship

Entrepreneurship in Neo-Classical Model

• Entrepreneurship does not fit in Neo-Classical models1. Perfect competition; thus no profit2. General equilibrium models do not take into

account the dynamics of innovative entrepreneurship

Neo-Classical v.s. Endogenous Models

Couclusion: Linking Entrepreneurship and Economic Growth

• Three main field of research1. Measuring entrepreneurship

• Development of typologies of entrepreneurship at micro level

• Operationalization of a multidimensional concept of entrepreneurship at higher levels of aggregation (industries and nation)

2. Determinants of entrepreneurship• In what condition?

3. Impact of entrepreneurship on economic development

Couclusion: Linking Entrepreneurship and Economic Growth

Empirical Evidences

• The Effect of Entrepreneurial Activity on National Economic Growth by Stel, Carree and Thurik (2005)

• Used Global Entrepreneurship Monitor (GEM) data 2002 and Growth Competitive Index (GCI) 2001

• ΔGDPt=α+βTEAt-1+γlog(GDP/capitat-1)+δGCIt-1+ζΔGDPt-1+ε

Empirical Evidences

• Result… Total Entrepreneurial Activity (TEA) is not significant.

Empirical Evidence

• Interpretation: in developing countries, there are not enough large companies and entrepreneurs have lower human capital levels

• Potential Problem: – Selection Bias

• One African Country• Most of them are developed counties

– Endogeneity

Empirical Evidence

• Update Stel’s work– GEM 2006 and GNI 2007

• Add Human capital variable– Average Education expenditure between 1993 and

2007

• ΔGDP08=α+βTEA06+γlog(GNIC07)+δGCI07+ζΔGDP93-07+ηEDU93-07+ε

Empirical Evidence

• TEA is marginally significant 10.2%

_cons 12.65003 7.491151 1.69 0.100 -2.557814 27.85788educati~9307 -3.48e-13 5.96e-12 -0.06 0.954 -1.24e-11 1.18e-11laggrow~9307 .2278272 .258716 0.88 0.385 -.2973942 .7530486 gci07 -.4984891 1.146853 -0.43 0.666 -2.826724 1.829746 loggnic07 -2.358485 2.060794 -1.14 0.260 -6.54212 1.82515 tea06 .1263491 .0753352 1.68 0.102 -.0265895 .2792878 growth08 Coef. Std. Err. t P>|t| [95% Conf. Interval]

Total 382.363572 40 9.5590893 Root MSE = 2.5795 Adj R-squared = 0.3039 Residual 232.877431 35 6.65364089 R-squared = 0.3910 Model 149.486141 5 29.8972282 Prob > F = 0.0029 F( 5, 35) = 4.49 Source SS df MS Number of obs = 41

Empirical Evidences

• Entrepreneurship, Innovation and Economic Growth by Wong, Ho, and Autio (2005)– Used GEM data

– Total Entrepreneurship Activity (New Firm Creation) was not significant… Innovation was…

Empirical Evidences

• How is Entrepreneurship Good for Economic Growth? By Acs (2007)– Necessity Entrepreneurship: became an

entrepreneur because no other choice (undeveloped economy)

– Opportunity Entrepreneurship: an active choice to start a new enterprise because of unexploited or underexploited business opportunity

Empirical Evidences

• How is Entrepreneurship Good for Economic Growth? By Acs (2007)

Policy Implication

• How is Entrepreneurship Good for Economic Growth? By Acs (2007)

• For developing countries…– Improve national economic condition and

entrepreneurial environment• Underdeveloped countries…

– Focus on bringing in FDI– Moving people from agriculture and self-employment

(necessity-entrepreneurship) – Elementary and secondary education

Policy Implication

• How is Entrepreneurship Good for Economic Growth? By Acs (2007)

• Less developed countries…– Strengthen small and middle sized businesses– Financial assistance, management assistance,

training and reducing regulatory burdens– Reduce number of self-employed

Policy Implication

• How is Entrepreneurship Good for Economic Growth? By Acs (2007)

• For developed countries…– Strengthen entrepreneurial condition

• Make early stage funding available• Strengthen technology transfer• Support entrepreneurial activity

– Focus on high value added, high technology, innovation and technology commercialization

– Higher education

“Entrepreneurship and Microfinance: A Review and

Research Agenda”

(Phillip H Phan)

Paper. Examines 54 papers (1998 - 2008) whose research

questions are related to microfinance and entrepreneurship.

Aim: Highlight the most common questions / methodological approaches and key findings.

This would take forever for us to talk about so I want to focus on the point that I feel is most important:

The papers discussion on the general economic theory behind microfinance. (mental model)

. After this we will then discuss the example of what is right now occurring in the Indian state of Andrah Pradesh. (reality)

Theory (mental model). A communities productivity is correlated with

accumulated Human Capital and also Capital Stock. In subsistence economies the capital component of

production functions is small.CPF is given by available HK. For the community to rise

above the CPF it must accumulate capital at a faster rate than consumption.

When the energy expended by community to engage in consumption (eg. searching for water) does not yield a production surplus (that can allow for deferred consumption) this is called an “energy deficit”.

Deferred consumption is critical for consumption smoothing (During a drought we can’t eat all of our stored grain - we need to save seeds to plant for next season).

=> poverty trap. Constantly reliant on external resources.

Key Arguments (mental model). One way to break the poverty cycle is to encourage petty

entrepreneurship amongst poor (fosters production surpluses).Done by increasing the capital component of the

entrepreneurial production function (as SR productivity of HK cannot be significantly improved).

=> elimination of the energy deficit => capital accumulation => breaking free of poverty trap.

MICROCREDIT (more capital) = main input to kick start entrepreneurial production process. (Which is then meant to kick-start everything else).

Basic mechanics.Loans generally from “a few” to $200. Creation of local committee to oversee the loans

(generally “elders”).Loan committee offers loans to Solidarity Groups (4-5

ppl, known to each other, some MFIs disallow family).Whether or not a loan is re-payed affects the entire

group (if yes all granted access to future credit, if no not).Weekly meetings (discuss business, plans, problems,

family, anything that may impact timing of payment - often believed to have spillover effects (HK and SK) ).

Program officers offer financial advice + act as counsellors.

Other Important Points. Concept of (Social) Collateral.

Seen to be important factor accounting for higher repayment rates than traditional institutions.

Theory of MF gained recognition following the publicity won by the Grameen Bank.Seen as a panacea / Silver Bullet.Before: social policy could not reconcile high IRs.Higher IRs due to greater costs (more smaller loans).

Changing understandings of MFIs:Efficient aid distributors (helping to alleviate poverty).Sustainable business (less loan forgiveness / higher

IRs). Sustinable MFI has greater reach into poor areas.

So theory is great and all but what about something happening in real life?

We actually want to hear YOUR opinions on this so jump in at

anytime.

BEFORE we look at what’s currently going on in AP lets consider

something …

However to do this I need your help.

I need you to do the following:…shout out as quickly and loudly as possible the colour that is on the screen…

Mostly, the intuitive, or mental models that we use

to understand the world match reality…

(*sometimes they don’t).

So what’s happening in India?

“A replay of the American subprime debacle.”– D. Roodman (CGD)

Many layers but here’s the basic idea… End of 2004 - 1 million micro-loans. Present - 27 million micro-loans (1/3 in AP).

“Bubble” (IRps 225b). Not uncommon to have 3 - 4 loans. Reports of suicides accumulating from 2010.

At present only anecdotal evidence (although cited in October 14 Ordinace).

Anecdotal Evidence.“My wife who committed suicide, had taken 8 loans and had to pay back 2 loans on Monday, 1 Tuesday, 1 Wednesday, 1 Thursday, 1 Friday, 1 Saturday (every fortnight one), and 1 once a month. There was no respite during the week and on Saturday, she felt happy that Sunday was the next day but that was short lived as we had to make payments from Monday again and the whole cycle continued. When one has to pay loan repayments on 6 days a week and people will not leave without collecting payments, it is downright harassment.”

AP MFI Ordinance 2010. “An ordinance to protect the women Self Help Groups …

…who are being exploited by private MFIs through usurious interest rates and coercive means of recovery resulting in their impoverishment & in some cases leading to suicides…”

Repayments now monthly instead of weekly and must be paid at Panchayat Offices.

All micro creditors must register and provide a list of borrowers to the district in which they operate.

”All loans in respect of which an MFI has realised from the borrower…an amount equal to twice the amount of the principal shall stand discharged…”

However… Inherent purpose of ordinance is to protect

women in SHGs (State Led Program) not to specifically those indebted to micro creditors. AP has 1m SHGs (each 10-12 members) & approx. $1bl

from World Bank. Women were reneging on SHG loans before micro. Seems micro credit became a threat to the government

program (key agents in writing the ordinace were those running government program).

Regional offices are now being told to encourage citizens not to repay micro creditors. Apparently more powerful than the formal decree.

Something else… According to (formally) calculations by David Roodman

(CGD) - interests rates for one MFI (Grameen) in Bangladesh (not India) were initially believed to be around 24%.

However, he then discovered that borrowers are allowed to “top-up” (or borrow back again) their loans after having re-paid at least half. This increases the average loan amount without altering the rate.

By his calculations this means that the true interest rate would be closer to 17 - 20% (not accounting for inflation)Compares to credit card rate for US consumer. India: Most at about 30% (many larger MFIs cap 24%).Break even 20% - 38%.

Some Questions.So… we are left with the questions of whether this is

simply a political campaign or whether Indians simply got caught up in the fast growth of credit access? (some combination?)

Can you have too much of a good thing?

Help, kill or don’t change microfinance in India?

Are MFIs really to blame for expectations so high they are impossible to fulfil in such a short period?

Concluding Remarks.

More research is needed to examine the exact nature of the relationship between poverty, microfinance and entrepreneurship.

References. Phan, PH (2009-11) ‘Entrepreneurship and Microfinance: A

Review and Research Agenda’, Working Paper, Carey Business School JHU.

Worth a look… ‘David Roodman’s Microfinance Open Book Blog’. http://blogs.cgdev.org/open_book/

October 14 Ordinace, Andrah Pradesh, India. http://indiamicrofinance.com/wp-content/uploads/2010/10/Andhra-MFI-Ordinance.pdf