Manuscript Entrepreneurship, Middle Class Consolidation and Social Mobility in Latin America. Scope and Limits. Andres Solimano* May 3, 2012 *Comments by Eduardo Lora, Francesca Castellani, Jose Anchorena, Nestor Gendelman, Lucas Ronconi and Roberto Velez to previous version of chapters of this manuscript are appreciated. 1 Outline. Chapter 1. Introduction. pp.3 Chapter 2. What do we (reasonably) know on Entrepreneurship, the Middle Class and Social Mobility? An Overview of Literature. pp. 6 Chapter 3. Empirical Evidence for Latin America: Main Findings of Six Country Studies. pp. 46 Chapter 4. Public Policy Implications for Fostering Entrepreneurship in Heterogeneous Societies and Issues of Future Research. pp. 80 2 Chapter 1. Introduction Entrepreneurship is a critical process in a dynamic capitalist economy. It is a source of creation of new productive capacities, innovation, new goods and processes, fostering employment creation, growth and development. At the same time, distorted patterns of entrepreneurship can lead to over-building of capital and corrective cycles. Entrepreneurship is an important and fascinating topic. It cuts across several disciplines: psychology, the theory of production, labor economics, talent economics, risk-bearing theory, public policy and related fields. The prototype view of the entrepreneur depicts him or her as an ambitious, competitive, creative, independent-minded individual with the courage to undertake new endeavors in uncertain contexts: the ideal of competitive capitalism. Business schools literature, in turn, focuses on complex practical themes such as the objectives of the entrepreneurs, his skills, and the core strengths of the firm, the drawing of a business and strategic plan, the discovery of opportunities, market niches and financing possibilities and so on. From a public policy perspective we would like entrepreneurs coming not only from rich elites but also from the middle class and low- income groups as a way to broaden opportunities for realizing the hidden productive potential of individuals at all levels in society. However, entrepreneurial traits -- such as a propensity to envision opportunities, mobilize resources, take risks and innovate -are not widely distributed among the population. In fact, entrepreneurship is a small proportion of the economically active population although the impact of successful entrepreneurship can be large indeed. Public policies in Latin America and elsewhere that wants to promote entrepreneurship must engage the middle class and the bottom parts of the income 3 distribution. The promotion of entrepreneurship is envisaged as a way to foster upward socially mobility and boost economic dynamism, personal autonomy, and productive transformation. Historically, the middle class was a main source of entrepreneurship in the development of capitalism in England and other countries when landed aristocracies in decline gave room to a nascent segment of entrepreneurial middle class drawn from urban areas. In contemporary times, major breakthroughs in technological innovations with a commercial orientation (the development of software and of emblematic products such as goggle, facebook and others) were conducted by young, educated individuals operating independently in small scale firms. The extent this largely spontaneous process can be replicated in different places and contexts remains as an open question. At the same time, these success stories coexist with a reality of widespread ―necessity entrepreneurs‖ in Latin America and the developing world. Necessity entrepreneurs often operate in the informal sector and their ventures have low technological levels and earn a rate of return equivalent to relatively modest salary jobs but facing more risks than employees in the formal sector. The distance between the bold, innovative and daunting Schumpeterian entrepreneur and the numerous modest entrepreneur of the developing world is striking. Therefore entrepreneurship is a very heterogeneous segment of the population making it a potentially elusive target of public policy. Still these policies would like to exploit synergies between educational capabilities, family background in households with an entrepreneurial tradition and the quest for independence and a drive to undertake productive projects. The objective to promote an enlarging middle class viewed as a source of entrepreneurial capacities and upward social mobility, political moderation and social mobility also permeates the desires of many policy-makers around the world. 4 This book looks at the potential but also the limits of policies to promote entrepreneurship as a main vehicle for social mobility across broad social segments in society, looking also at other forms of social mobility such as pursuing careers as employees and self-employment and the constraints to entrepreneurship in credit markets, education and other supportive factors. Of course, these obstacles can be removed by appropriate public policies. This volume assesses relevant literature on entrepreneurship and connects it with new developments in middle class and social mobility analysis. The book is organized around four chapters included this Introduction. Chapter two undertakes a review of the economic literature on entrepreneurship and relates it with the economic and sociological literature on middle class and social mobility. It dissects some main theories, and evaluates its relevance and validity for promoting growth, development and social in the developing countries of the early 21 st century. The underlying focus is the Latin American and Caribbean region, although some of the issues can be of more general validity for both advanced economies and developing countries. Chapter 3 presents the methodologies and the main findings and public policy potential implications of a set of six country empirical studies comprising Argentina, Bolivia, Colombia, Ecuador, Mexico and Uruguay and regional papers on entrepreneurship, middle class and mobility commissioned by the Research Department of the Inter-American Development Bank. Chapter 4 explores public policy implications of the previous analysis and the results of the empirical studies and closes with highlighting areas for further research. 5 Chapter 2. What do we (reasonably) know on Entrepreneurship, the Middle Class and Social Mobility? An Overview of Literature. 1. Introduction The literature on entrepreneurship, the middle class and social mobility often run in quite separate directions. Entrepreneurship is seen as dynamic process of business creation and destruction and is therefore naturally linked with the process of economic growth. However, entrepreneurship was not always given a central role in economic analysis dominated by theories of the production process that gave the main role to the mechanical accumulation of capital and labor growth with little role for the process of organizing production, envisioning opportunities, mobilize factors of productions and link them with credit and product markets all in a context of uncertainty and risk. The literature on the middle class has been often the realm of sociological approaches more concerned with issues of social identity and class differentiation in which links with entrepreneurship and economic growth was largely neglected. Social mobility is also a critical and dynamic process for promoting equality of opportunity; reduce inequality and intergenerational progress in the economic ladder. An integration of those strands of thought is required not only for analytical purposes but also from a public policy perspective. New avenues of thought to identify novel economic and social mechanisms to spur economic dynamism and social equity are required. Economists are rediscovering some alleged virtues of 6 the middle class as a source of entrepreneurship, values, consumer power and socio-political stability. These propositions, of course, need proper empirical verification using a variety of methods such as econometric testing, historical evidence and country and micro case studies. We need to know more about the nature and characteristics of entrepreneurs and the determinants of the choice of becoming an entrepreneur. We also need to know the extent to which entrepreneurship advances social mobility. In addition, we are interested in understanding better the influences of family background, education and values, risk-taking and occupational choice, in shaping entrepreneurship. This chapter reviews main issues and accompanying literature on the subject of middle class, entrepreneurship and mobility keeping in mind its relevance for public policy in the Latin American region. 2. Entrepreneurship The word entrepreneur comes from the French, it intends to mean ―undertake‖ and was first used by Richard Cotillon in the 18th century. Cotillon was an early writer on the functions of the entrepreneur as an agent that deals with risk in business and production. John Stuart Mill and Jean Baptiste Say, in the 19th century, influenced by Cotillon, elaborated on the role of the entrepreneur as an organizer of new business, bearing risk and exerting control of the production process. Marx developed a theory of the ―capitalist‖ (in some sense the equivalent of the entrepreneur) in the 19th century stressing its role as a new class that revolutionizes the modes of production and social relations along the way. This author highlighted the function of the capitalist factory system in combining technology and the use 7 of wage-labor for attaining profits to be reinvested again in the search for more profits. Let us look briefly how different schools of thought and main thinkers viewed the entrepreneur and his main features in the economic process. Neoclassical Theory of Production: Is there a role for the entrepreneur? The theory of the entrepreneur is a complex subject in economic theory. In neoclassical economics, production and growth follows from a production function, whose origin is rarely discussed, that offers managers, entrepreneurs and administrators a blueprint of economically efficient combinations of factors of production such as labor, capital and technology to produce goods and services. The production function, however, is ultimately a ―black box‖. In fact, the question of who leads monitors and carry-out the process of organizing production, hiring labor and combining it with capital according to a blueprint of technologies is absent or hidden. The role of the entrepreneur as an organizer and coordinator of the production process and a linkage with goods and credit markets is nowhere in the production function framework (e.g. a variable E, say for entrepreneur, is not a factor of production). The preferences, skills, attitudes and capabilities of such organizer of production, the entrepreneur, is absent of the picture. The Entrepreneur according to Joseph Schumpeter and Frank Knight. The main theoretician of the entrepreneur in the 20th century was Joseph Schumpeter. Frank Knight also offered important insight on the subject that we shall review below. Schumpeter developed a theory of the entrepreneurs based on a mix of direct observation, psychological theory and economic analysis. Typically the entrepreneur has a talent for combining 8 capital, labor and for entertaining a vision of opportunities and the prospects for profits (see Schumpeter 1934 [1989]). The critical role of the entrepreneur in Schumpeter is making innovations such as introducing a new good, a new line of production; open a market in a process of ―creative destruction‖ in which new technologies and ways of doing business replace the old ones. Schumpeter emphasized the peculiarities of the entrepreneur that make him different from the manager, the pure inventor and the owner of capital. The capacity to undertake new decisions in the unchartered waters of new activities conducted under conditions of uncertainty and risk. A ―developing‖ economy in Schumpeter terms is one that jumps from one circular flow to another driven by innovations. An economy may be growing but is not developing if it stays in the same (stationary) circular flow under the same technology and organization (remember that Schumpeter´s classic 1911 book (English edition, 1934) was called A Theory of Economic Development). Frank Knight, in turn, influenced both by the Austrian school of economics of Menger, Von Mises, Bohm- Bawerk and Hayek and the neoclassical theory, linked entrepreneurship and profits with risk and uncertainty. He stressed the role of the entrepreneur and the manager to organize production when the productivity of workers is unknown and other contingencies relevant in production cannot be ascribed precise probabilities chiefly because the presence of ―uncertainty‖. For Frank Knight profit was the remuneration of risk taking, a different category than the return on the capital invested in the firm. Some interpretations of Knight also emphasize that the entrepreneur needs residual property right (as owners) to exercise its function of ―specializing in judgment, common sense and intuition as 9 vehicles to carry productive decisions in a world of uncertainty‖ (Langlois and Cosgel, 1993). Kenyes ´s volatile Investors. The British economist John Maynard Keynes was interested in the psychology of the ―investor‖ –both in financial assets and in physical production -- as well as the context under which he undertakes his investment decisions. In contrast to Joseph Schumpeter, Keynes did not share the almost romantic view of Schumpeter of the entrepreneur as the ―hero of capitalism‖ that against all odds carries forward his vision of innovation and productive creativity. Keynes shares with Knight1 (and Schumpeter) the awareness on the complications introduced by effects of intrinsic uncertainty for rational economic calculation. However, he depicted the investor-capitalist of the real world more as a ―casino player‖, a bit of a gambler, rather than a hard-work puritan prone to delayed gratification (sacrifice of consumption) in favor of capital accumulation. Keynes coined the expression of ―animal spirits‖ to denote human behavior driven by something more than enlightened values and a rational calculation of pecuniary costs and benefits. The original passage by Keynes in the General Theory (1936) reads: Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of 1 See F. Knight classic book, Risk, Uncertainty and Profit. 10 which will be drawn out over many days to come, can only be taken as the result of animal spirits - a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Thus, if animal spirits are dimmed and spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die. (pp. 161-162, The General Theory.) This quote conveys some important features that we ascribe to entrepreneurs such an urge to action rather than inaction, the role of optimism and so on. Keynes stressed also the point that investors are affected by herd behavior, interdependent expectations and changes of mood and perceptions that lead to waves of optimism, euphoria, and manias, followed by periods of pessimism and depression generating sharp business and financial cycles. The Choice to be an Entrepreneur. There is consensus that the psychology of the entrepreneur is different of the employee. The wage- earner is supposed to be more risk averse than the entrepreneur and has a lower quest for independence than the entrepreneur and the self-employed. In terms of long run economic success it is not clear that the entrepreneur is a superior choice. A well educated, apt employee that can make a career in a corporation (and/or move to others) can reach senior positions as a manager that can be well remunerated and rewarding from a professional viewpoint. In contrast, entrepreneurship is risky and not all succeed. In addition, pursuing an entrepreneurial career may have an irreversibility component that prevent reinsertion in employee positions as eventually (entrepreneurial paths) erode in people certain 11 capacities such as developing reporting capacities and tolerance and patience for collective decision-making required for holding successful employee positions.2 As we shall see below empirical evidence tells that for many individuals the choice of entrepreneurship comes after being an employee for a while, although the reverse seems to be less frequently.3 Choice theoretic models derive rules of occupational choice depending on risk preference and other parameters including wage/profit ratios. Some authors have tried to make endogenous the formation of preferences such as the propensity to save the preference for leisure and work, the tolerance and even love of risk-taking. The mechanism for preference formation is through the efforts of the parents to instill their own values to their children (see Doepke and Zillibotti, 2008 and references on cultural transmission of values provided thereof). In fact, as we shall see below, the probability of becoming an entrepreneur is higher in families in which parents are (or have been) entrepreneurs than in households without an entrepreneurial background. The relationship between endowments of human capital and entrepreneurship is also an interesting subject and not always obvious. Entrepreneurs are not necessarily people with a high stock of formal education (holding PhD‘s or Masters) such as the scientist, the expert or the intellectual who we usually identify with ‗human capital‘. Empirical studies confirm this assertion (see below). In this line, Lazear (2002) has put forward the ―balanced skills hypothesis‖ of the entrepreneur and tested it empirically. The basic notion is that entrepreneurs are people with various 2 I thank Jorge Rosenblut for making this point to me. 3 Of course some individuals start as entrepreneur’s right at the beginning of their economically active life. 12 skills (for management, people interaction, a capacity to deal with financial and technical problems) compared to employees and professionals –―the specialists‖. Using longitudinal data of top universities in the United States comprising study and employment stories of the same individuals over time, Lazear found that those who in graduate school chose a greater variety of subjects and also have a more varied occupational experience have a higher propensity to become entrepreneurs than individuals that chose more specialized educational strategies and employment experiences. Entrepreneurship and Family Background The previous discussion underlines the role of family background, risk attitudes, education levels and preferences for understanding the formation and development of entrepreneurship. Dynastic models tend to see persistence across generations of father and sons (and daughters) regarding patience, time preference, demand for leisure and attitude towards work. According to these models entrepreneurial propensities of the parents tend to be inherited, to some degree, to the children that also seek to be entrepreneurs.4 An additional hypothesis is that the children of managers of big corporations are less likely to become entrepreneurs than the children of small firm owners (see Glaser, Rosenthal and Strange, 2009). This is an interesting twist that underscores the importance of small scale firms in promoting entrepreneurship. An empirical study that sheds some light on these issues is Wadhwa, et.al. 2009. The report, based on a sample of 549 survey of company founders respondents covering mainly the technology sector in the United 4 It becomes an empirical task to determine the degree of persistence in entrepreneurship through different cohorts and generations. 13 States (computer and electronics, defense, health care and services sector) found that a majority of founders of new companies (71 percent) were of middle class background (according to Dennis Gilbert (2008) six class definition) with a very small percentage (less than 1 percent) coming from extremely wealthy or extremely poor backgrounds. In addition, the study found that the average age for starting a business is 40. Most company founders had considerably high levels of education (over 95 percent had a Bachelors degree and 47 percent had more advanced degrees). Their academic performance located them among the top 30 percent in high school and college (with better academic performance in the former). In turn, company founders (entrepreneurs) generally did not initiate a start-up right after graduating from college. They generally had previous work experience as employees (around six years), suggesting that the choice between being an employee or become an entrepreneur may be sequential in time. Finally, slightly more than half of them were the first to initiate a business in their families and the motivation to become an entrepreneur reflects a combination of aspirations of building wealth, the lure of commercializing an idea, being their own bosses and, when relevant, continue a family tradition of entrepreneurship. International mobility of entrepreneurs. From an international perspective, entrepreneurs can transfer their innovative and wealth-creating capacities from one country to another. Historically, the immigration of people with entrepreneurial capacities and a favorable attitude towards risk-taking contributed to business creation, resource mobilization, colonization, and innovation, – all factors that supported economic growth in countries of destination. In the Atlantic economy of the 19th century and early 20th centuries, successful 14 entrepreneurs (and bankers) – such as Mellon, Vanderbilt, Carnegie, and Rockefeller, and, more prominently, the famous banking dynasty of the Rothschild, with operations in London, Zurich, Paris, and other financial centers – were foreign-born or first descendants of immigrants. In the south, Argentina was the main recipient of migrants with entrepreneurial skills in the late 19th century and early decades of the 20th century. This country relied both on net immigration (entrepreneurs and working class), primarily from Spain and Italy, and on capital, from England and Germany, for its economic development, using both to mobilize its vast natural resources. In turn, the Chinese Diaspora has been an important source for the supply of entrepreneurs in South and East Asia, as have Palestine and Syria for the supply of entrepreneurs in South America. More recently, in the late 20th and early 21st centuries, entrepreneurial emigrants from India, Taiwan, Israel and China have provided an important human resource to support the creation of high-technology industries both in hardware and in software in Silicon Valley in the United States and connect them with technological industries in their home countries. These foreign-born entrepreneurs, who many times came to study in the United States and Europe before turning into entrepreneurs acting in both the receiving and home countries have played a critical role in transferring entrepreneurial talent, market connections and new products and technologies among distant economies. Their location and mobility have helped also to develop technological industries in developing nations traditionally importers of high-tech goods (See Saxenian, 2006 and Solimano 2008). Heterogeneity, firm-size, credit constrains and entrepreneurship. 15 Entrepreneurs in Latin America and other developing regions often operate under highly differentiated productive structures. This heterogeneity is reflected in significant differences between micro, small and medium size companies (SME) and large firms in terms of capital intensity, employment generation, technology development, credit access and export orientation. The SME are often viewed as important sources of employment creation but not necessarily of technological development. This view can be challenged by the experience of the United States in which the Small Business Administration reports that small firms innovate more than large firms and have a higher percentage of patents per employee than big companies; in turn, younger firms are more likely to have more patents per employee than older firms (Wadhwa et.al, 2009). Entrepreneurs are highly heterogeneous. The entrepreneurial profile of Bill Gates or Michael Bloomberg is certainly different from that of a owner of a hot dog vender in the US or a small shop owner in a developing country. Large scale entrepreneurs with capacities to mobilize capital and technology can have a different impact on economic activity than small entrepreneurs. Urban economist Edward Glaeser5 makes the simple but important point that the number of firms in an industry or city is an important consideration for assessing levels of entrepreneurship (and employment growth capacity too). In fact, for a given level of employment if it is distributed among a larger number of firms then the number of firm leaders or entrepreneurs per worker must be higher. This suggests that countries with relatively larger SME sectors must have a higher degree of entrepreneurship. 5 Glaeser, 2007. 16 An interesting empirical result in Glaeser (2007)´s reported regressions is the negative relationship between the average size of firms and employment growth. In turn, this result is statistically significant for a sample of 533 firms in the US. In general, we think of an inverse relation between firm size and employment in levels but here the relation is also in terms of employment growth. So entrepreneurship and employment growth seem to go hand in hand. An important difference between large and small size companies is the nature of the restrictions they face. The financial markets generally operate with asymmetric information between credit suppliers and applicants on the loan on their repayment capacity and economic viability of companies. This point was raised years ago in a seminal paper by Stiglitz and Weiss (1981) that proved that increasing credit costs (raising interest rates) could be an inefficient mechanism to sort-out between good and bad debtors. It is often the case that information asymmetries affect more serious in small size companies that have their balances and financial information less developed and systematized than in larger companies. Another factor that inhibits making loans to smaller sized companies, encouraging banks to concentrate on a portfolio of larger companies, is the size of the credit operations. If banks want to serve small and medium sized companies, they must reduce the size of their credits, which leads to dividing the fixed costs of collecting information and client analysis amongst smaller operations. This makes it less profitable for the bank from a private point of view – to give credit to smaller companies. The result is often chronic lack of access to working capital and investment funding for SME a hurdle that small entrepreneurs have to face and that certainly tends to discourage this activity. The segment of micro, small and medium size firms often face 17 various handicaps to grow besides limited access to financing. They face disadvantages in market access, delays in paying practices from providers of inputs and buyers of final products, backward technological platforms, more time spend in dealing with the bureaucracy of the state for permits and licenses; in turn, their managerial capacities are often more limited than in large companies. 3. The Social Origins of the Entrepreneur and the Middle Class. Business historians and economic historians have highlighted the middle class origins of the entrepreneur in the historical context of 19th century capitalism in England. The emerging middle class or ―bourgeoisie‖ was seen as different from the landed aristocracy that lived out of the rent on land holdings. The new entrepreneurial class was interested in making profits in industrial production organized around the capitalist factory using wage-laborers rather than the pre-industrial revolution craftsman. Therefore the social origin of the entrepreneur in nascent capitalism was more middle class than aristocratic or coming from landed elite. That tradition of tracing the social class origin of the entrepreneur was largely lost in economic analysis.6 Nonetheless, there seems to be a renewed interest in reappraising the social background of entrepreneurs using broader definitions of the 6 The two more influential figures in the analysis of social classes were Karl Marx (1818-1883) and Max Weber (1864-1920). However, there were also important contributions by Wilfred Pareto (1848-1923), Gaetano Mosca (1858-1941) and Thorsten Veblen (1857-1929) to social analysis, elites and classes. The “Italian school” (Wilfredo Pareto and Caetano Mosca as main exponents) held a merit–oriented view of elites, its dynamics and interactions with other social classes although were not very specific in linking elites with entrepreneurial activity. Veblen, in turn, focused on the characterization of the business elite and the importance of symbolic (conspicuous) consumption and a culture of leisure to signal prosperity and abundance in the gilded age in America. 18 middle class and more popular classes in the context of developing countries and emerging economies, including of course the Latin American region. In the Latin American context, the wide-spread presence of ―entrepreneurship by necessity‖, say people who cannot find jobs as employees and workers in the formal sector of the economy and that choose to engage in independent ―entrepreneurial‖ activities as a strategy of economic survival rather than as rational choice among alternative occupations. These people often come from the lower segments of the middle class and the lot of the poor and often operate in a context of informality. We shall return to this issue below and in the next chapter. In terms of social class origin entrepreneurs may come from the economic elites, from the middle class and from the poor. This underscores their heterogeneity in terms of scale of operations, family background, education levels, wealth, values and attitudes. A critical question is the extent to which class background affects the decision --or the necessity-- of becoming an entrepreneur. In turn, defining a social class is not an easy matter. Marx, for example, defined social classes in terms of the relation of people to the ―modes of production‖ a concept that entailed social relations, technology and patterns of ownership of the means of production (feudalism, capitalism, socialism are all economic systems and modes of production).7 7 Social classes also develop views of the world or ideologies in function of their place in society and the economic process. Marx, who wrote in the middle of 19th century at the peak of the industrial revolution, stressed two classes: the bourgeoisie (capitalists) who own the means of production and control wealth, shape institutions and political power and proletarians that own their labor power and are disenfranchised. The dynamics of social change and transformation of society was coming from class conflict and was viewed as an engine of long run change. According to Marx, capitalism would lead to increasing polarization and social differentiation. He dismissed the idea of a “permanent middle class” and portrayed the “petit bourgeoisie” – our equivalent of the middle class – essentially as a class averse to social change due to their interest in protecting their asset and social position in society, in spite that they are not in the higher echelons of social hierarchy. 19 Max Weber writing in early 20th century shared Marx´s notion that social classes were important and largely determined by their role in production and the ownership of productive assets. However, Weber created a more complex concept of social class in which prestige, status, occupation and mobility played an important role. For Weber social class were the main determinant of the ―life chances‖ say the capacity of people to enjoy a good, secure, prestigious and enjoyable life style or, in contrast a life of hardship, insecurity and anonymity. Modern analysis of stratification and social class (see Gilbert, 2008) is eclectic and use insights of Marx, Weber and other authors. Stratification and class analysis tend to use a multi-variable approach in which income, occupation, education level, status and prestige, values, thinking and lifestyle are used to define social classes. The Middle Class: The Economist Perspective Economist had for a long time forgotten and even dismissed class analysis. However, in the last decade we have witnessed a resurgence of interest in the subject and a new vitality in middle class analysis. MIT economist Lester Thurow, in the mid 1970s, did somewhat pioneering work on the middle class in the context of the United States economy. At that time the US economy was hit by the combination of higher inflation and supply shocks (stagflation) that squeezed the possibilities of a rising middle class used to steady prosperity in the three decades since the end of World War II. Thurow stressed the importance for capitalism and democracy of having a strong middle class and cautioned that the raise of lower pay jobs in the United States as indication of economic polarization and eventual shrinking 20 middle class with adverse consequences for social cohesion. These trends were reinforced in subsequent decades by increased inequality, stagnant median wages and middle class indebtedness. The author used an income metric and defined middle class as those between 75 and 125 percent of median income. In the early 2000s, Thurow´s arguments were taken up in the context of international development, by Birdsall, Graham and Pattinato (2000) and Easterly (2001). Later in the decade Solimano (2009) using a sample of 130 countries looks at cross-country correlations between the relative size of the middle class and variables such as income per capita, inequality (Gini coefficient), the size of the state, the share of small and medium size enterprises and an index of democracy.8 The literature on the middle class written by economists has grown rapidly and several of these studies are reviewed in this chapter. Easterly (2001) based on panel regressions argues for a ―middle class consensus‖ showing that a higher share of income for the middle class (and lower ethnic polarization) are empirically associated with higher income, higher growth, more education and other favorable development outcomes. In fact, Easterly (2000) says that countries with a middle-class consensus are indeed ―fortunate societies‖ because they have [H]igher levels of human and infrastructure capital accumulation (p. 24) . . . . [Such countries also] . . . have a higher level of income and growth . . . And because they have more human capital and infrastructure accumulation, they have better national economic policies, more democracy, less political instability, more ―modern‖ sector structure, and more urbanization. (p. 29) 8 The study finds a non-linear relation between income per capita and size of the middle class and inequality and an strong inverse relation between inequality and the size of the middle class. The rest of the variables show a milder relation with the middle class according to the existing data. 21 A caveat here is the need not to jump from correlation to causality. While it is a well established empirical fact that advanced economies with higher per capita incomes and good levels of social cohesion have also a large middle classes it does not necessarily follows that the middle class causes these positive outcomes (see Solimano, 2009). Entrepreneurial and other Roles of the Middle Class in the Development Process The new interest on the middle class is closely linked to the contribution the middle class can make to the development process, public policy and the stability of democracy. In this perspective we can identify at least three roles and the first of them highlights the entrepreneurial capacities of the middle class: (i) The middle class as a source of various types of entrepreneurs (Supply Side). As already mentioned the identification of the middle class as a source of entrepreneurial activities has an historical root. Before the industrial revolution in England the dominant landed aristocracy was considered as a low saving, low investment, segment of the population that preferred more leisure than hard work, risk taking and entrepreneurship (see summary of these views in Doepke and Zilibotti, 2007). A somewhat similar theme, in the American context of the late 19th century, was developed by Thorsten Veblen in his Theory of the Leisure Class. Veblen stressed the propensity of economic elites for conspicuous consumption and leisure rather than an orientation towards hard work and 22 savings.9 In that sense the leisure class was not an entrepreneurial class. Max Weber noted the influence of an emerging capitalist class influenced by a Protestant ethic more oriented to savings (a lower time preference), hard work and a willingness to take risks. This new entrepreneurial middle class, in this view, tolerated delayed gratification in order to save and accumulate capital, earn profits and ascend in the social hierarchy. This new set of values –the ―spirit of capitalism‖ factor-- would be embedded in the patterns of behavior of this new bourgeoisie. In modern times with developed capital markets and availability of credit, in principle, entrepreneurs may not need to be strong savers to finance with their own resources their productive ventures. However, the presumed efficiency of modern capital markets to offer credit to all that need it has to be qualified. Small and medium size entrepreneurs often face much tighter credit constraints than large firms and well connected large scale entrepreneurs. The rise of venture capital industry has somewhat filled this gap for start-ups a niche that commercial banks are reluctant to enter.10 The identification of middle class with (idealized?) entrepreneurial values of thriftiness, hard work and delayed gratification has to be qualified11 as the ―middle class‖ is a heterogeneous segment of the population that includes individuals with different values within the same class. For example, the middle class contains several occupation categories 9 The work orientation of the economic elites probably changed again in the last decades of the 20 th century with market liberalization and the lowering of income and corporate taxation in the 1980s and cut in taxes on capital gains and inheritance taxes that led to apparently led to an increase in working hours (and salaries and bonuses) earned by CEO´s of big corporations and banks. 10 See the Latin American Venture Capital Association (LAVC) for scores on availability of capital in Latin America. 11 The implicit theory is that different social classes have distinct values and cultural traits (the class-value specificity hypothesis). 23 in it such as entrepreneurs, self-employed and employees, which are agents with different attitudes and preferences towards risk.12 In addition, within the middle class entrepreneurial segment it coexist entrepreneurs of opportunity with ―entrepreneurs by necessity‖, (owners of small shops and firms that earn a modest rate of return that provide an income for living). An empirical study for 13 low to middle income countries, Banerjee and Duflo (2008), provides evidence of the pervasiveness of the entrepreneur by necessity in the developing world. The typical middle class entrepreneur in their sample has one employee (in some cases a maximum of three employees), their stores or ―firms‖ have minimal productive assets like machine and equipment and the activities engaged display very low levels of technological intensity. A comment to the findings of this study is that the sample is dominated by low income countries with large informal sectors; in turn, the low range definition of middle class individuals (those earning between U$ 2 to U$10 per day) is highly likely to include people in poverty and therefore capturing mostly entrepreneurs by necessity. (ii) The middle class as a source of consumer power (Demand Side). The argument here is that a strong middle class with growing purchasing power can be a source of steady increases in aggregate demand good for companies that seek to sale and also to avoid recessionary trends and keep the economy at the vicinity of full capacity.13 The marginal propensity to consume of the middle class may be higher than the propensity of the rich 12 Middle class individuals that are employees tend to prefer a steady more stable flow of income (salary) rather than face potentially more profitable but also more risky income/profit profiles associated with entrepreneurial activities. This is typically the middle class that work in the public sector in different levels of hierarchy from clerical work, medium level staff and even executives of ministries and public agencies. A similar logic could be extended to middle class individuals that are employees of firms and corporations in the private sector. 13 Solimano and Gutierrez (2009). 24 (albeit lower than the poor). The argument also highlights also that the middle class can be an important source of expansion of consumer market in education, health services, housing, durable goods, entertainment and other goods and services. 14 The notion of the middle class as an economically robust and solid social segment has to be qualified, however. Middle class people and families many times rely on debt to finance the acquisition of housing, purchases of durables, university education and so on; therefore middle class expenditure is vulnerable to real and financial shocks that may force to cut consumption in the wake of adverse shocks. Typically middle class families depend on jobs as their main source of income. A recession or a financial crisis is bound to affect them significantly. (iii) The middle class as a stabilizing segment in society (Political economy argument). The recent interest on the middle class comes also from political economy considerations. The argument is that a moderate political center would come along with a large and consolidated middle class and this would reinforce economic and political stability. In contrast, unequal societies that are economically polarized with strong elites, a weak and frustrated middle class and a disenfranchised poor may be attracted by authoritarianism and populism, which are inimical trends for a stable democracy. The evidence shows that high inequality tends to be correlated with social conflict, authoritarian cycles, populism and recurrent economic crises in Latin America (see Smith, 2005 and Solimano, 2006). As mentioned before, Easterly (2001) has shown for a large sample of developing countries, that a higher share of income going to the middle class 14 Banerjee and Duflo, 2008) find that as the share devoted to food falls as income increases and middle class people spends more on entertainment, education and health care and domestic in infrastructure. 25 (along with lower ethnic polarization) is empirically associated with higher income, higher growth, more education and other favorable development outcomes. Econometric evidence may not be enough, however, to settle the issue. In fact, the historical record of the behavior of the middle classes during episodes of crises of democracy in Latin America and Europe in the first half of the 20th century suggests a more nuanced story of the relation between middle class and democracy. Authoritarian experiences in Latin American such as the military coups of the 1960s, 1970s and 1980s do not render convincing support for the hypothesis that the middle class is always and everywhere a staunch guardian of democracy. In fact, the authoritarian regimes that governed Brazil, Argentina, Chile, and Uruguay at different times in those decades had different degrees of support from the middle classes, apparently pleased that military rule was ―restoring order‖ in societies affected by mass movements pushing for redistribution of economic and political power away from the elites. Further back in history the regimes of Mussolini in Italy and Hitler in Germany in the 1920s and 1930s were popular among wide circles of the Italian and German middle classes frightened by the economic insecurity, unemployment, crises and the rise of left-wing political movements that affected the Weimer republic and Italy after the Great War. 15 Alternative Definitions of the Middle Class In discussions of what constitutes a middle class in any one country, whether in advanced capitalist economies or in the developing world, 15 See Hobsbawm (2002) and R Frieden (2006) for good historical accounts of those periods in Europe. 26 researchers have used a range of definitions and measurements. The literature concurs that defining and measuring a ―middle class‖ is a task subject to caveats and ambiguities. Economists tend to prefer an incomebased (or consumption-based) definition of the middle class. In turn, sociologists use also definitions of occupations, of asset ownership, values, of attitudes toward risk, of aspirations toward upward social mobility, or of its conformity to a certain status- quo. Income and Consumption based Definitions. Relative definitions of the middle class work with shares of income distributions. Easterly (2001) defines the middle class as those households in the second, third and fourth quintiles (20th to 80th deciles).Solimano (2009) adopts a definition of the middle class encompassing the 3rd to the 9th deciles with a distinction made between a lower middle class (3rd to 6th deciles) and an upper middle class (7th to 9th deciles).16 There are absolute definitions of the middle class that include a range of income between 2 to 10 dollars per day ( Banerjee and Duflo, 2008), a range of U$ 2 -13 per day in PPP (Ravallion, 2009). In turn, Kharas and Gertz (2010) use expenditure in the range of U$ 10 –100 per day. A mixed definition is used by Birdsall (2010) for income between U$ 10 a day up to the 90th percentile. Beyond actual income or expenditure there are subjective definitions of the middle class. In the subjective definition people is asked for their perceived position in a wealth scale (ranging from 1 to 10) and then respondents are classified into three subjective social classes: poor, middle class and rich, using the 16 This distinction could be useful for the dynamics of the middle class: the lower middle class is a segment vulnerable to fall in poverty in the event of adverse shocks while the upper middle class may move up to the segment of the rich under certain favorable economic conditions. A relative definition of middle class is the level of income from the 75 to 125 percent of median income (Birdsall et.al. 2000), 27 relative sizes of the objective classes as a reference (Lora and Fajardo, 2011). Empirical estimates of the middle class in Latin America (16 countries) using objective and subjective definitions and the 2007 World Gallup Survey produce a variety of values. 17 Occupation and source of income based definitions. One body of literature exemplified by Dennis Gilbert—a sociologist widely regarded as the expert on class structure in the United States — associate classes with job positions (occupations) in the economic system and their sources of income (capitalist property, job earnings and government transfers). In the American Class Structure, Gilbert (2008) provides a definition of middle class as the ―majority‖ class. His six social classes taxonomy is the following: (i) A capitalist class, in which people obtain their income from profits and the return on productive and financial assets, (ii) An upper middle class of college-trained professionals and managers, (iii) A middle class whose members have significant skills and perform varied tasks of work, under loose supervision, (lower managers, semi-professional, non-retail sales workers, craftsmen), (iv) A working class are less skilled workers than the middle class and work at routinized and supervised manual and clerical jobs, (v) a poor-working class of people employed at low skill jobs often at marginal firms (laborers, service workers and low-paid operatives) and (vi) An underclass of unemployed and part time workers depending on government transfers. Gilbert then aggregates these six classes into a three class scheme of: (a) A privileged class 17 Using absolute definitions yield between 58 percent and 66 percent of the population as middle class. When relative definitions are used, around 60 percent of the population is middle class. Estimates based on percent of the median income deliver a middle class of 42 percent. With mixed measures the size of the middle class is down to 22 percent. It is apparent that the size of the middle class is very sensitive to the empirical definition used. 28 (composed by capitalists and upper middle), (b) A majority class (composed by middle and working class) and (c) A lower class (formed by the working poor and the underclass).18 The three class classification of Gilbert of privileged, majority and lower class is not very different from the rich, middle class and poor classification often used in income and consumption based definitions of social classes. Gilbert‘s majority class comprises 60 percent of the population. Gilbert´s approach puts more emphasis on the qualitative characteristics of jobs and sources of income rather than total incomes. The Values of the Middle Class and the Values of the Entrepreneur A social class is not just a statistical abstraction concocted by economists or sociologists. In the real world its members hold certain values, attitudes and aspirations and play a political and economic role in society. The popular notion of ―middle class values‖ point to a social segment that attaches great importance to stability, having solid jobs, holding moderate political views and a capacity to progress economically, educate their children and own a house. In turn, the values of the entrepreneur are subject to dispute: a capacity for delayed gratification, thriftiness and hard work was stressed by Max Weber connected to the protestant ethic. Schumpeter, in turn, emphasized the resilience of the entrepreneur and his innovative capacities. Keynes viewed the investor (entrepreneur) dealing, chiefly, with the intricacies of uncertainty and having features of a ―gambler‖. Business schools nowadays stress various features such as 18 Typical annual household income levels for the United States as calculated by Gilbert (2008) give a range between U$ 150,000 and U$ 2,000.000 for the privileged class; U$ 40,000 to U$ 70,000 for the majority class and U$ 15,000 to U$ 25,000 for the lower class. 29 resilience, innovative capacity, and vision and so on. Implicitly, they their draw their views of the entrepreneur from some thinker on the subject besides actual practice-based knowledge. In turn, empirical evidence reviewed in the next chapter provides new clues on the subject. Various theories have been formulated on the origin of values and culture and their causal relations with the economic system. Neoclassical economics considers values, tastes and culture as exogenous variables that are generally constant or, at best, change very slowly over time. Max Weber (1905 [2001]) highlighted the importance of religion, especially the protestant ethic that rewards savings, work and the accumulation of wealth in facilitating the spread of capitalism. Capitalism needed a value structure functional to capital accumulation, technological change and accelerated social mobility. These values are different from those prevailing in the feudal order based on the divine origin of authority and tradition. In Max Weber the implicit causality goes from values (affected by religious preferences) to the economic system. However, this is not the only line of causation or mutual interaction between values and culture and the material base of society. Karl Marx (1848[1979]) in his effort to contest Hegelian idealistic philosophy prevailing in the early to mid 19th century stressed the role of the economic structure, modes of production and the concomitants supportive social relations in shaping ideas, beliefs, values and ideology in society19. 19 For a philosophically-oriented treatment of the issue see Wolff (2003). An economist perspective is provided in Foley (2006). 30 Thus, Marx postulated a different line of causality (albeit his analysis did not mention this term) than Max Weber.20 In turn, the Italian theorist and political activist Antonio Gramsci, developed the concept of ―cultural hegemony‖21. This concept refers to the prevalence and acceptance in the population of the beliefs, values and ideas of the dominant social classes. Once these values and perceptions are shared by the population at large (various social classes), they become ―common sense‖ for society. In turn, this common sense helps to maintain the legitimacy of the economic and social system. In this perspective, ideas and culture could be even more important than traditional forms of political power based on coercion, for the maintenance and cementing of social orders. A variant of this thesis was developed by MIT Professor and father of modern linguistic Noam Chomsky who coined the concept of the ―manufacturing of consent‖ as the action of the media and education to legitimize certain values (chiefly among them the profit-motive) in a capitalist society. An important question in the literature on culture, values and social structures is the extent to which they are class-dependent. If values are ―class-dependent‖ we may expect that the values of the middle class do not necessarily coincide with the values of the rich or the values of the poor. 22 20 Marx highlighted, in his study of capitalism the ―commoditization‖ of human work under conditions of wage labor and the creation of a market for labor power in which the typical worker has little or no control whatsoever of the production process – different to the craft of the skilled artisan worker under previous, pre-capitalist, economic formations. Karl Marx also emphasized the alienation of work in the factory system (see Hobsbawm, 2011). 21 22 See Forgacs (1988). Note that the concept of “rich” varied over time (from landed aristocracy to new bourgeoisie to leisure class). 31 An additional question is to what extent the values of the middle class overlap with the values of the entrepreneur. Of course we need to know first what the values of these two segments are. Weber´s cultural story of the ―spirit of capitalism‖ is, certainly, class-dependent: the old elite (landed aristocracy and the ―old rich‖) had different values from the new middle class regarding delayed gratification, leisure, work-ethic and thriftorientation. Another possibility, in line with cultural hegemony theories, is that the values of the ―dominant social class‖ (the concept includes of course the ruling elites which is a different concept to the entrepreneurial class) become shared values by the rest of society through the construction of a common sense shared by wide segments of society. Interestingly, the concept of ―cultural homogeneity‖ (a la Gramsci), would be equivalent to the hypothesis of lack of middle class (or poor) particuralism in values advanced more recently in the literature. Empirical Verification Recently there have been attempts to use large international panel data sets to assess the values of the middle class and test their degree of particularism (or the lack of it).23 These studies use, respectively, the World Values Survey (around 80 countries and several years) and Ecosocial a value-survey applied to seven Latin American countries. The results obtained in these studies are based on (subjective) survey-responses and people are classified in different social strata or classes according to various criteria such as (subjective) self-perception and (objective) income and expenditure measures. These studies look at the type of values held by 23 These empirical studies include Amoranto, Chun and Deolikan (2010) of the Asian Development Bank and LopezCalva, Rigolini and Torche (2011) at the World Bank. 32 middle class individuals and the degree to which these values are shared (or not by) the rich and the poor. If the values of the middle class differ from the values of the rich and poor then we talk of ―middle class particularism‖. The World Value Survey identifies ―values‖ that are correlated with variables such as economic growth and accountability and include questions about market competition, gender equality, upward mobility, trust in others and trust in institutions, social tolerance, nationalism, political activism and technology adaptation. The Asian Development Bank study ( Amoranto et.al. 2010) shows significant regional variations in values. In addition, respondents from OECD countries are found to be more liberal in some values than developing countries. In addition, this study shows that the middle class has a higher degree of political activism than the rich or the poor. In turn, the World Bank study (Lopez-Calva et. al. 2011) finds no support for the hypothesis of ―middle class particularism‖ (no statistically systematic differences is detected in values between the middle class and the upper and lower classes). Apparently, middle class values seem to be dictated by moderation and lie between those of the poor and the rich. Lopez-Calva et. al. (2011) also finds evidence of large cross-country and regional differences in responses about values in line with the findings of Amoranto et.al (2010). This may reflect underlying cultural attitudes that may have a strong country, historical and religion bias. The paper also shows that income is a reasonable good predictor of social and political orientation. This new empirical work on class and values could be considered as an advance in a complex and difficult topic. However, the results obtained are better taken as tentative and suggestive. What is considered as ―values‖ in these studies could reflect also ―opinions‖ of individuals. These opinions on 33 different topics tend to have more short term variation than values that are more ―structural‖ and slow changing in time. In addition, we should not rule- out the presence of mutual causation between social class and values. Growth, Inequality and the Middle Class. Recent economic literature has highlighted the positive effects of economic growth on the formation of an ample middle class. The rise of a new middle class in China, India and Latin America and even sub-Saharan Africa, regions that have experienced respectable growth in recent years (or decades), is shown as evidence of the positive effect of growth on the middle class as growth leads people to pull-out of poverty. These findings, however, should not lead us to think that economic growth is nearly all what we need for having a strong and well consolidated middle class. The level of inequality also matters. In an empirical cross-section study for 130 countries, Solimano (2009) shows a strong negative association between the (income) Gini coefficient and the relative size of the middle class. The effect of economic growth on expanding the size of the middle class could be, at least partly, offset by the inequality factor. The rise of inequality in China and India thus conspires against a stable middle class. A statistically growing middle class –measured by income or expenditure-does not imply, per se, that the middle class has significant influence on the process of policy-making in society or that is financially sound to deal with a variety of contingences such as health , financial and employment shocks and natural disasters.24 24 Lopez-Calva and Ortiz-Suarze , (2011). 34 A broader concept is that of empowerment. This concept refers to the capacity of individuals to exercise their economic, social and political rights, have voice and vote in the democratic process and exert a reasonable degree of influence in the public policy process. A growing middle class in its role of source of consumer power is not necessarily equivalent to a middle class composed by individuals that assert their citizenship and hold authorities accountable. The effects of Vulnerability on the Middle Class. An Economic Security Index (ESI) has been prepared at Yale University (supported by the Rockefeller Foundation) that offers a framework for identifying and measuring potential sources of vulnerability and fragility of the middle class (and other social classes).25 The Index focuses on three dimensions: (i) the labor market (loss of employment and fall in wages), (ii) financial markets (over-indebtedness and the tightening of credit) and (iii) health shocks such as catastrophic illnesses, injuries, disabilities and death. The Index seeks to pick-up the impact on individuals and households of a variety of events such as recessions, unemployment, credit tightening, high debt and low financial protection to face adverse health contingencies. Economic insecurity affects all social classes but its impact on the poor and the middle class is higher since these two large segments are less protected to face adverse shocks. The ESI shows that in the last quarter of century the degree of overall economic insecurity (across all social classes) in the United States increased. Moreover, the Great Recession of 2008-09 25 www.economicsecurityindex.org. 35 has further exacerbated it. 26 As discussed before, ―the squeeze on the middle class‖ was a trend already ongoing in the 1980s, 1990s and 2000s. Moreover, the fall in private household savings since the 1990s and the rise of household debt levels are serious warning of financial vulnerability of the middle class. In the Latin American context, a recent empirical analysis of vulnerability of the middle class is Lopez-Calva and Ortiz-Juarez (2011). The paper focuses on Chile, Mexico and Peru and identifies a relative threshold of 60 percent of the income distribution and proposes a definition of U$ 10-50 at 2005 PPP for defining middle class. This is certainly a more reasonable threshold for defining the middle class than other studies that offer definitions not very suitable for studying the behavior of this segment in upper-middle income countries (low thresholds tend to include as middle class many households living in poverty). The study makes also the relevant point that not all people that are above the poverty line are middle class. Those in the vicinity of the poverty line are very vulnerable to fall in poverty and should not be considered as middle class according to this study. The authors document an increase in the absolute number of households in the middle class in the period 1992-2000 in Chile, Mexico and Peru and show a reduced probability of falling into poverty in the late 2000s compared to the late 19 4. Social Mobility Social mobility is important as an indication of the efficiency of the economic system to reward individuals that work hard and succeed in their 26 According to ESI calculations, one in five Americans has experienced a decline of over 25 percent of household income between 2008 and 2010 without having the financial resources to cope with this decline. 36 productive or intellectual endeavors. Also mobility is relevant for income distribution and for social integration. Milton Friedman who was a strong believer in the capacity of competitive capitalism to properly reward ingenuity and effort in his famous book Capitalism and Freedom distinguished between temporary, short run differences in incomes and long run differences in income status (see op.cit. pp. 170-71). He compared a ―dynamic society‖ in which every year individuals and families move up (and down) in the income ladder with a ―status societies‖ with great rigidities and lower mobility. In this case the dynamic society with high social mobility would be less socially unequal in a longer term sense. Freeenterprise capitalism would be such dynamic society according to Friedman. An important component of capitalism is entrepreneurship. Successful entrepreneurship can foster upward social mobility. This upward mobility takes place when the entrepreneur succeeds and makes good and sustained profits. Conversely, this mobility can be in the downward direction if the entrepreneur fails and descends into debt or go downright bankrupt. However, it is important to note that entrepreneurship is only one mechanism for social mobility. In general, an individual face at least four such mechanisms for social mobility: (a) Entrepreneurship (b) Working as employee © Education (d) Independent activities and self-employment. The choice between these different vehicles of mobility depends on several considerations some of them discussed in this and next chapter. It is 37 important to note that these choices are not necessarily substitute one from another: they may well sequential as mentioned before. Education is often a pre-requisite for broader occupational choices including entrepreneurship. In turn, the empirical evidence suggests that people chooses first to be an employee and after acquiring enough experience and knowledge decide to turn into an entrepreneur or an independent self-employed. However, this is not always the case. Super-stars entrepreneurs such as Bill Gates from Microsoft, Sergei Brin and Larry Page from Google or Mark Zuckerman from Facebook all decided at some pointy to cut-short their education, suspended or abandoned their studies and turn into entrepreneurial endeavors with great success. Of course, there are many drop-outs from college that do not succeed. Many studies of entrepreneurship and its merits suffer from some degree of selection bias as they do not often include the stories of failure. Additionally, analysis of social mobility make a distinction between: (a) Short term mobility and (b) Long run mobility An additional, related, distinction is between: © Intra-generational and (d) Inter-generational mobility. Intergenerational mobility refers to the correlation in economic and financial outcomes between parents and children.27 It is an important measure of the degree of equality of opportunity (or the lack of it). A society with a high 27 In the sociological tradition, the degree of social mobility in a society is linked to its productive and occupation structure as well as the education background and social connections of the individual and more generally to background of social class. 38 degree of intergenerational mobility is one in which the correlation between the economic fortunes of parents and children is low. Conversely, intergenerational mobility is low when that correlation is high. It is important to note that this correlation refer to economic and financial considerations. Inherited genetic attributes, the transmission of values and family socialization are all important factors in society and families play a critical role in this. Variables identified to measure intergenerational mobility are the level of occupation, income or wealth of the son compared to the occupation, income and wealth of the father.28 In general transition matrices (of income, occupation or education) tend to show that father´s occupation (income and wealth) levels are a good predictor of son´s occupation (income and wealth) but this prediction often has a range of variation. In fact, there can be upward mobility (sons doing better than fathers), downward mobility (sons doing worse than fathers) or no mobility. A mobile society is one in which there tends to be a tendency towards upward mobility over time. Empirically this is not simple to measure unless we have longitudinal data in which the same individuals and cohorts can be followed over time in terms of various measures of economic performance. 29 Some studies have found a greater 28 Torche (2009) provides a very useful overview of empirical studies of intergenerational studies for Latin America and other developing countries. 29 Empirical studies have developed a variety of indices of social mobility based on rank ordering, timeindependence, positional movement, share movement, non-directional and directional income movement (see Fields, 2010). Most of these measures tend to study social mobility using current (single-year) income as measure comparing an initial and final year. As Fields (2010) shows the equalization of long term income is a very different concept of the equalization of single –year income and develops a class of axiomatic statistical measures for studying equalization (or the lack of it) of long term income compared to a base year. When these measures are applied to the United States, the author finds a tendency to equalization of long term income for men in the 1980s but not in the 1980s and 1990s. In contrast that tendency is observed in France since the 1960s, see Fields (2010). 39 influence of parental economic conditions on children´s outcomes in the United States and the United Kingdom (two countries with relatively higher income Ginis in the industrialized countries) compared to the more egalitarian Sweden (see Torch 2009). The degree of intergenerational mobility in the Latin American countries varies from country to country. For Chile the evidence shows increased intergenerational mobility in the middle and lower classes but closed patterns of mobility in the top decile (Torche, 2009). This is consistent with a high concentration of income and wealth at the top but a more even distribution of income for the bottom 90 percentile (Solimano, 2012). Studies for Brazil find an important role played by family background in explaining overall earnings inequality (Bourguignon, Ferreira and Menendez, 2007). In Mexico a changing occupational structure has led to greater opportunities for social mobility in the last four decades or so but family background continues to play an important role in the economic possibilities of their children. In general the evidence for Latin America, drawn mainly from cross-section surveys including retrospective information about social origins and economic characteristics of parents, point in the direction of strong mechanisms of reproduction of inequality of wealth and status across generation but not necessarily of reproduction of poverty.30 The transition from an agrarian to an industrial society reduced the relative importance of low-wage jobs in agriculture and increased the share of higher-paid jobs in the industrial sector. This led to social mobility from rural to urban areas, leading to improved productivity and higher earnings A similar interest of studying mobility in connection with long run income distribution is shared by inequality experts such as Atkinson, Bourguignon and Shorrocks. 30 See Torche (2009). 40 but this mobility also entailed some costs and dislocations (stress, lower time devoted to family-life and hardship associated with urban life in crowded cities). Social mobility is not always equivalent to welfare improvement. In turn, the transition from an industrial society to a post-industrial society -- the post-industrial society is also called the ―knowledge economy‖, the ―service economy‖ or simply the ―new economy‖. This transition entailed also profound changes in the occupation structure (decline in the share of manufacturing jobs and increase in the share of service and tertiary occupations).31 This transformation also affected the nature of the middle class, the patterns of entrepreneurship (of opportunity and necessity) and created new dynamics of upward and downward social mobility. The financial sector, technological entrepreneurs and big corporations are identified as the big winners of the new economy. A new middle class is created around these sectors as technological entrepreneurs come from the middle class and a plethora of managers, professionals, financial and technological experts linked to the newly dynamic industries have developed. The knowledge economy puts a premium to individuals with high education levels, special skills and marketable knowledge. Still, many jobs in the new economy are far from the glamorous high prestige jobs of well paid lawyers, financial experts, engineers, technical experts and so coached around the knowledge economy. In contrast, many new jobs locate in the 31 In the United States the transition from an agrarian to an industrial society took place between circa 1870 (end of the civil war) and the 1930s. The transition to a post-industrial society started in the 1970s. In turn, the 1990s and 2000s were considered high points of the knowledge-economy, new economy or finance-dominated economy. see Dilberg, 2008, chapter 3. 41 services sector such as retail trade, food services, cleaning and so on with relatively modest remunerations. There seems to be a tendency towards internal differentiation in the middle class: successful entrepreneurs of opportunity, professionals, experts and managers have tended to move up in the income, occupation and wealth ladders. For them social mobility works and they become the upper strata of the middle class (or the lower strata of the rich class). In turn, medium level managers, office workers, clerical people and salesperson are also members of the middle class but their economic fortunes are not the same of the previous group. A relevant question is to what extent choosing being an entrepreneur improves the chances for upward social mobility compared with choosing being an employee. The distribution of pay-offs of an entrepreneur may have a larger mean but also greater variance. In turn, the mean income (salary) of the employee may be lower but its variance is also smaller than the mean income of the entrepreneur. In the case of the ―entrepreneur by necessity‖ it was shown that the mean income is very similar to the salary of a worker of comparable educational background and skills but the variability of incomes tends to be higher as well. The answer to what is a better strategy to improve the life- chances of social mobility is very complex and will depend on the preferences for risk of the individual and the different careers paths he or she face besides good luck and other random factors. If an individual enters a big corporations,(but not necessarily a SME) stays there for a sufficient time and performs well, his or her chances of upward mobility within the firm may be higher than if he/she chooses a more volatile occupation path involving entrepreneurial activities. 42 Concluding Remarks This review of issues and literature highlights the importance but also the complexity of the subject at hand. Entrepreneurship is an intricate topic, heterogeneity is serious and competing theories about the nature and motivations of the entrepreneur are not easy to reconcile among themselves. The historical record, casual evidence and empirical research indicate that the middle class is a source of entrepreneurship (of various kinds) in nascent capitalism in the 18th and 19th centuries and in the last wave of technological entrepreneurship of the late 20th century and early 21st century. The nature of entrepreneurship has varied through history and space and its determinants involve a complex interaction of family background, quest for independence, education, desire to accumulate wealth, the needs of economic survival, ingenuity and risk- taking capacities. Heterogeneity is evident when we compare entrepreneurship in low productivity areas in the service sector of developing countries, largely dominated by entrepreneurs of necessity with technological entrepreneurs of middle class background in advanced economies. In Latin America entrepreneurs of opportunity can play also a valuable role for promoting growth and create employment. Still the pervasiveness of the entrepreneurship by necessity in the developing world suggests its practical importance as a mechanism of economic survival for lower middle class households and the poor to cope with informality, scarce jobs at middle and lower-end occupations and public sector regulations and taxation. The international mobility of entrepreneurs is an emerging subject, albeit comparatively little studied so far. It has the potential to increase the 43 presence of developing countries in the technological sector and as a vehicle of transferring contacts, market information, skills and knowledge. Middle class analysis is per se a complex subject. At an analytical level the concept and definition of middle class is still not a settled issue and an understanding the relation between middle class and entrepreneurship requires further research. The middle class is certainly a source of consumer power in a growing economy but its apparent reliance on debt to finance durable consumption, pay education fees and acquire housing makes it potential vulnerable to financial shocks, recessions, unemployment and health contingencies. The potential contribution of the middle class to the stability of democracy is a theme in the literature on the middle class. Claims of a pro-democracy middle class seems to be broadly supported by recent value surveys; however, contemporary and historical experiences of Latin America in the 1970s and 1980s and Europe in the 1920s and 1930s show that the middle classes were not unsupportive of authoritarian regimes when democracy collapsed in these nations. Upward social mobility is a desired feature in any dynamic society and is viewed as an antidote for entrenched inequality of social origin and institutional rigidities for economic progress. However, the mechanisms for middle class mobility can be wide open. In principle, this mobility can be achieved through various vehicles such engaging in entrepreneurial activities or choosing the route of an employee (the ―intrapreneurial‖ option) and being a self- employed person. The public policy implications of the literature reviewed is an important next topic and is considered in chapter 4. The topic raise a range of issues starting with the potential, but also the limits, to promote entrepreneurship as a large scale policy, the perennial but ever present theme of how to ease 44 obstacles and restrictions to the latent entrepreneurial potential of individuals facing constraints in the access to credit, education, technology and markets, the ability of policies in promoting small and medium scale entrepreneurship that create new jobs, enhance social mobility and income generation when facing the power and influence of big corporations, conglomerates and economic elites that pressure governments to limit competition and make it difficult the entry of new actors to the market. 45 CHAPTER 3. Empirical Evidence for Latin America: Main Findings of Six Country Studies. 1. Introduction. In the previous chapter we analyzed the main issues and different approaches to entrepreneurship, middle class analysis and social mobility. This chapter summarizes the main findings of the six country studies and regional papers on entrepreneurship, middle class and mobility commissioned by the Research Department of the Inter-American Development Bank. These studies are oriented to provide quantitative and qualitative information useful for an informed comparative analysis of entrepreneurship in Latin America, its scope (and limits) for promoting social mobility and the cementing of a new middle class. The six country studies comprise Argentina, Bolivia, Colombia, Ecuador, Mexico and Uruguay. The country studies use various sources of information including national census data, household surveys, firm-level surveys and special questionnaires for entrepreneurs. When considering values of the entrepreneur and the middle class several of the country studies use the World Value Survey. The chapter is organized in nine sections, including this brief Introduction. Section 2 reviews several empirical measures of entrepreneurship used in the literature and provide the definitions chosen in the country studies; section 3 analyses the links between macro cycles (booms and recessions) and entrepreneurship; section 4 examines main socio-demographic and firm level features of entrepreneurial activity. The choice between entrepreneurship and employee already discussed briefly in the preceding chapter is considered in section 5 and the links between 46 social mobility, entrepreneurship and class origin are taken up in section 6. Section 7 deals with the issue of values of the entrepreneur and section 8 highlights internal and external obstacles for entrepreneurship detected in some of the empirical studies. The chapter closes with a summary of the main findings of the country studies in section 9. 2. Defining and Measuring Entrepreneurship To assess the magnitude of entrepreneurial activity we need some empirical measures of it. We can distinguish at least three main approaches to define entrepreneurship. (a) Self-employment with hired workers. The most natural measure of entrepreneurship is self-employment measuring the share of people that lead their own firm. The statistics of the economically active population typically distinguishes between owners and managers, employees, and self-employed. The country studies of the IDB project define entrepreneur as a self-employed who owns or manages a firm of at least two people.32 An entrepreneur has to hire other people as (paid) employees or workers for productive purposes as part of his resource mobilization function. The self-employment measure still is a crude measure of entrepreneurship as it can include both large scale entrepreneurs as well as a small shop owner. In addition, it says nothing, per-se, if the entrepreneur is successful or not. For that purpose including information of firm size and the income bracket of the entrepreneur can add important insight to the self-employed measure of entrepreneurship. Most of the country studies provide this information. 32 The self-employed person working alone, or as an independent professional, is not an entrepreneur. 47 (b) Business Creation. This second measure focuses on new business creation. The World Bank Global Group Entrepreneurship Survey (WBGES), in particular, focuses on new business creation in the formal sector. It measures the number of newly registered firms in a given year over the total number of firms registered. Registered firms are legal entities that can incur in debts with the banking system, pay taxes and undertake legal transactions with other firms and the state. (c) The stage of business development. This approach sees entrepreneurship as a dynamic process and focuses on the stages of the process of business creation, development and consolidation. The Global Entrepreneur Monitor (GEM) publication that uses this measure focuses on early-stage entrepreneurial activity regardless of formal registration. The approach distinguishes between nascententrepreneurs and baby entrepreneurship; the latter counted as the proportion of the adult population that is currently involved in operating a business for less than 42 months. Each of these two approaches has some drawbacks. On one side, the WBES may underestimate actual entrepreneurial activity by excluding informal sector entrepreneurship. On the other side, the GEM method may overestimate new business creation since nascent firms may eventually not materialize in an actual firm and vanish from the market. As mentioned in chapter 2 , the Types of entrepreneurship also matter. A person (entrepreneur) is classified as entrepreneur by necessity when answering to the survey question ―what is the reason that makes you dedicate yourself to this business/firm/activity?‖ state that they do so because they cannot find a job; in addition, they would prefer to be employees rather than a self-employed if the choice were open to them. The rest of independent workers are classified as entrepreneur of opportunity. As discussed before the necessity entrepreneur is a 48 strategy of economic survival in bad times and their patterns of economic behavior are often different from the Schumpeterian idealization of an innovator and risk taker. The opportunity entrepreneur, in contrast, is motivated by the opportunity to earn higher incomes (an ambition element) besides the yearning for independence. In contrast with the necessity entrepreneur, he or she does not engage in entrepreneurial activities for the lack of a job or just to maintain a certain income level. Empirically, in the countries of this study, there are a greater proportion of entrepreneurs of necessity compared with entrepreneurs of opportunity. In the Argentina country study, two definitions of entrepreneurs are used: employer-entrepreneur (e.g. business owner) and self-employed entrepreneur. Total entrepreneurship (using both definitions) is estimated to be 9.2 percent of the employed-population in the country. In turn, two –thirds are deemed to be entrepreneur of necessity and one-third entrepreneur of opportunity. In Bolivia the authors of the country study adopt a somewhat different definition of entrepreneurship that reflects the economic and social realities of the country (with a cooperative movement along with a significant self-employment sector besides a purely capitalist sector). The study includes: (a) single-person entrepreneur, (b) cooperative-entrepreneur and (c) and owner entrepreneur . In turn, following the GEM criteria it is found a greater proportion of entrepreneurs in as early stage entrepreneurs.33 33 See Hernani-Limarino, Eid and Villarino, 2012. 49 In Colombia the authors define entrepreneurs as those who identify themselves as employers in the household survey.34 According to this definition the employer of an economic unit, professional practice or trade independently with one or more paid workers is an entrepreneur.35The study estimates that only 3.5 percent of the working population of Colombia were entrepreneurs in 2010 (511,000 entrepreneurs against 7.6 million employed workers). This underscores the much smaller proportion of people in the entrepreneurial option than in the employee option. The Ecuador study also uses the definition of self-employed individuals that work in a firm of at least two workers and reports that the overwhelming proportion (near 98 percent) of entrepreneurship activity generates between one to five jobs. This denotes a high degree of ―micro-entrepreneurship‖. In turn, this seems to be not a transitory phenomenon as the estimated probability of generating more than ten jobs within the first five years of operation of an economic unit is a paltry 6.3 percent. Thus, entrepreneurial activity is concentrated in micro-enterprises (defined as productive units with less than 10 workers)and with slim grow prospects. Moreover, necessity-entrepreneurship is the dominant type of entrepreneurship in the country.36 In Mexico, according to the Mexican Social Mobility Survey 2006 (MSMS-2006), that collects current and retrospective information on respondents and their parents, 8.3 percent of the individuals (males) in the sample are entrepreneurs ( selfemployed people hiring at least two workers) . In comparison with the whole 34 Living Standards Surveys of DANE, the Nation Statistical Office. 35 See Mejia and Melendez, 2012. 36 See Ordeñada and Ortega, 2012. 50 sample, entrepreneurs‘ household monthly income is 35 percent higher than the average of the sample. Once social classes are defined, 7.6 percent of middle class individuals report being entrepreneurs, 5.7 percent for the poor and 16.9 are upper class entrepreneurs.37 In the case of Uruguay the authors are only interested in entrepreneurs of opportunity, considered as business –owners that have paid-employees. They estimate that close to 5 percent of households are engaged in entrepreneurial activity. Those who are in charge of their business but do not have employees (self-employed) are probably necessity entrepreneurs and as such are left outside of the entrepreneurship definition. Summing –up, the size of the entrepreneurial sector is dependent upon the definition used. Using the self-employment/owner definition the average size across the six countries is less than 5 percent a number that can increase to near 10 percent (or more in some cases) using broader definitions of entrepreneurship. In any case, it is apparent we are referring to a relatively small percentage of the economically active population of the six countries that can be considered as entrepreneurs. In turn, it is worth remembering that we are measuring entrepreneurship in a given point in time. This does not imply we are referring necessarily to successful entrepreneurs, measured by profit generation, innovative capacity and so on over a certain time span. 3. Macro developments and Patterns of Entrepreneurial Activity The conventional wisdom says that entrepreneurial activity and private sector development will flourish in periods of macroeconomic and political stability and 37 The study uses the definition of middle class as a person that makes a daily income between U$ 10 and U$ 50 in PPP-2005. 51 market deregulation and declines in recessions or crisis. Reality seems to defy, partly, these simple characterizations. In Argentina, the percentage of entrepreneurs of the economically active population increased between 1974 and 1980 from around 10 percent to 13 percent, followed by a decade of relative stability in entrepreneurial activity, ending in an (unexpected) high peak in the hyperinflation years of 1989-1992 (see figure 1, draw from Anchorena, Ronconi, and Braun, 2012). This increase in entrepreneurial activity (unless it is completely dominated by necessity entrepreneurship) is surprising. As it is well known, the second half of the seventies and early eighties in Argentina was a period of high inflation, failed stabilization, erratic policies and autocratic rule, all (or most) elements that are expected to penalize (productive) entrepreneurship. From then on the measure of entrepreneurship declines from almost 13 percent to near 8 percent in 2011, a trend that starts in the early 1990s, a phase of big inflation followed by subsequent stabilization, the convertibility plan, and pro-market policies. That drift continues in the 2000s with more heterodox economic policies. Figure 1 – Argentina. Evolution of Entrepreneurship (as a share of the EAP), 19742011. 52 13 12 11 percentage 10 9 8 1970 1980 1990 2000 2010 Source: Argentina Country Study, Anchorena and Ronconi, 2012. Figure 2 separates employer entrepreneurs from self-employed entrepreneurs. We observe that between 1974 and 1980 the share of both types of entrepreneurs increased. In the next six to seven years, employer entrepreneurs diminished while self-employed entrepreneurs increased. In the critical period of 1988-1992 again both types of entrepreneurship increased. During the nineties entrepreneurial activity decreased until around 2004. Indeed, since 2005, the trend for employer entrepreneurs is increasing while the trend for self-employed entrepreneurs is decreasing. Figure 2 – Argentina .Evolution of types of Entrepreneurship (as a share of the Economically Active Population), 1974-2011. 53 8 7 6 percentage 5 4 3 1970 1980 Employer entrepreneur 1990 2000 2010 Self-employed entrepreneur The authors of the Uruguay country study, (Bukstein and Gandelman, 2012) report that during the 2002 Uruguayan crisis (closely related with the crisis in Argentina), income in households without entrepreneurial activity fell by 10 percent and in households with entrepreneurial activity fell by 15 percent. These numbers show more volatility in the incomes of entrepreneurs during a recession compared to the evolution of employees. It is apparent that the entrepreneurial activity involves substantially more uncertain incomes and risks than other occupational activities. The Uruguay study also reports a lower volatility of income of the independent self employed. The authors interpret these results as that ―they (the self-employed) are really not true entrepreneurs‖. Entrepreneurships and self employment with fixed workplace are pro-cyclical, a feature that could be expected of opportunity entrepreneurs. In contrast, the behavior of households self employed without fixed workplace is countercyclical. The lack of jobs destroyed during a recession force 54 many people to engage in independent activities to generate incomes; precisely the main feature of necessity entrepreneurs. In turn, when the economic situation improves they will likely prefer to be employees in a salary-based relation. 4. Main Socio-Demographic and Productive Features of Entrepreneurial Activity. The Argentina study shows that the incidence of informality (that is, lack of business registration for tax and banking purposes) is pervasive among entrepreneurs in this country. Close to 40 percent of entrepreneurs are deemed to be in informality; a high percentage indeed for a country with the development level of Argentina (among the highest per capita income country in Latin America along with Chile and historically a leading country until the 1930s). In turn, as it could be expected, the incidence of informality is much higher for self-employed entrepreneurs (54.4 percent) than for employer entrepreneurs (11.5 percent). In addition, most of the employer entrepreneurs are male. The mean age is higher for independent workers (entrepreneurs and self-employed) than for employees rendering additional support to the hypothesis that entrepreneurs might start as employees (in their twenties) to later become entrepreneurs (in their thirties and forties). This life-cycle dynamics of occupational choice suggests a sequential decision process over time rather than a discrete choice at one time-point. The choice may not be of the type:‖I have to decide today whether I am an employer or entrepreneur for the rest of my (working) life‖.38 Rather, it seems that individuals tend to prefer a more gradual and cautious approach starting their occupational life first as an employee and consider later switching to entrepreneurship if the conditions are ripe for that decision. However, as discussed in chapter 2 we seem 38 Incidentally, it is interesting to note that a similar broad pattern of employee/entrepreneurial choice observed in Argentina is found in a study of technological entrepreneurs in the United States (see Wadwha, V., R. Aggarwal, K. Holly and A. Salkever,2009, quoted in chapter 2). 55 to know little about the reverse (or return) switch from entrepreneurship to employee and the different skills required in that transition. Regarding education levels, on average, employer entrepreneurs have higher schooling than employees, s segment that, in turn, have, on average, higher schooling than self-employed workers. Most of the entrepreneurs work in small firms in Argentina, a common feature of the productive structure of Bolivia, Colombia, Ecuador, Mexico and Uruguay. On average, employer-entrepreneurs manage firms of nine workers, while selfemployer- entrepreneurs work in firms of three persons. In contrast, employees work in firms of around 120 employees or more. The income differentials between entrepreneurs by opportunity and entrepreneurs by necessity can be in the order of one to four/five.39 In Bolivia entrepreneurs also tend to work in small firms, the education level of the employer-entrepreneur (proxy for opportunity entrepreneur) is higher than for selfemployed entrepreneur, and also higher than for the cooperative entrepreneur and informal paid workers. Also there is a positive relation between wealth levels and type of entrepreneurship with opportunity entrepreneurs displaying higher access to productive and financial assets. The Bolivia study also shows a tendency for higher (or at least not lower) average incomes for employer-entrepreneur over formal sector employees. In turn, self-employed entrepreneurs, cooperative workers, informal sector employees all tend to have lower average incomes than formal employees. In Colombia entrepreneurship is concentrated in the middle class. Female participation is much lower among entrepreneurs than among employed workers and this holds true for all social classes. Like in Argentina and other countries in 39 see Anchorena, Ronconi and Braun, 2012. 56 our sample of six countries, entrepreneurs are on average older than their employed counterparts. The mean middle class entrepreneur obtains a monthly income that is nearly 30 percent higher than the mean middle class employee. A somewhat smaller difference persists for individuals in the lower and upper classes. On average females have lower labor incomes than males (a gender wage differential). In turn, labor income is increasing in age and education for both entrepreneurs and employees, with entrepreneurs doing better than employees of similar characteristics. Perhaps unsurprisingly the upper class entrepreneurs have the largest concentration of individuals in the highest levels of schooling attainment albeit the difference with employees is small (79 percent of upper class entrepreneurs and 77 percent of upper class employees completed technical or higher education). In turn, 10 percent of middle class entrepreneurs have primary education or less; 41 percent only completed high school; and 42 percent have a technical education or higher (see Melendez and Mejia, 2012). Like in other countries of our sample, in Colombia entrepreneurs are concentrated in smaller firms than employees. Lower class and middle class entrepreneurs concentrate in businesses of ten employees or less; upper class entrepreneurs in businesses of more than 51 workers are rare. While a majority of entrepreneurs in all social classes are in wholesale and retail trade activities, employees work more in services. In Ecuador middle class entrepreneurs are predominantly men (68 percent), are 42 years old on average, have a household with four members and have significant levels of college education (50 percent). Predominantly they come from a middle 57 class background (59 percent) and lower class (33 percent) background.40 In line with the findings of other countries in this study and in the United States, in Ecuador most entrepreneurs were employees before becoming an entrepreneur, 41 suggesting that entrepreneurship comes at a later stage during the working lifecycle in line with the hypothesis of a sequential choice of employee-entrepreneur status. In turn, the male-bias of entrepreneurship is more accentuated in the upper classes, and their average age is slightly higher, than middle class entrepreneurs. In fact, 75 percent of upper class entrepreneurs are men, have an average age of a 44 years old, have a household with an average of four members and , in a significant proportion, come the from the middle class (58 percent). In turn, 55 percent of them came from a national firm and 20 percent were independent professionals. According to a survey of 203 entrepreneurs survey conducted in Guayaquil, Quito and Cuenca the two main motivations for a middle class entrepreneur to start a business were to be independent (86 percent) and improve their economic status (85 percent). Thus, the quest for independence and the lure of higher income are a common motivation of opportunity entrepreneurship that is common across different studies and theories (see chapter 2).42 The average firm owned by a middle class entrepreneur is a family business (69 percent) with an average of six- years of continuous operation. They are focused on the domestic market, mainly in wholesale or retail commerce and business 40 See Ordeñana y Arteaga (2012). 41 43 percent of them worked at a national company and 30 percent as an independent professional before turning to entrepreneurship. 42 The most important skills for middle class entrepreneurs, are achieving goals, creative thinking and decision making. Upper class entrepreneurs value significantly decision making, problem solving and creative thinking. Achieving goals and communication skills are significantly more mentioned by the middle class entrepreneurs compared to the high class ones. 58 services –such as real estate and consulting companies. They have an average of four employees and annual sales of US$100,000. The initial investment averaged US$10,000, funded mainly by own resources (75 percent), and only 25 percent received funds from family and friends. 43 Regarding entrepreneurial training, most entrepreneurs get it from their university education. However, when it comes to managing a business, 32 percent (for both middle class and upper class entrepreneurs) trust private seminars or short courses to obtain the needed skills. Mexico. According to economic census data and a national entrepreneurial survey, a total of 7.6 percent of middle class individuals report being entrepreneurs (the number is slightly below the one quoted from the mobility survey). That share is 5.7 percent for the poor and 16.9 percent for the rich. Years of schooling increase according to the class origin of the entrepreneur. Poor entrepreneurs have an average of 5.6 years of schooling, middle class entrepreneurs have 8.1 and the rich ones have 12.6.The Mexican study shows that most entrepreneurs are owners of micro-enterprises, that is, firms with less than 10 employees. In the case of middle class entrepreneurs, 33 percent report having only one employee, 36 percent have two to four employees and 13 percent have five to nine employees. 44 That is close to 70 percent of middle class entrepreneurs are concentrated in very small firms, say with less than five employees. This suggests the prevalence of necessity entrepreneurs. 43 The average firm owned by a upper class entrepreneur is also a family business with an average of 8 years of continuous operation. They are also focused on the domestic market, mainly in services and wholesale/retail trade. They have an average of 7 employees and annual sales of US$240.000. The initial investment averaged US$50,000 obtained mainly by own resources (84 percent). 44 This distribution is similar for poor entrepreneurs (42 percent, 33 percent, and 9 percent, respectively). For upper class entrepreneurs the distribution is (14 percent, 51 percent, and 15 percent, respectively). 59 Entrepreneurship is mostly concentrated in trade followed by industry, a feature that extends also to middle class and lower and upper class entrepreneurs. The least common are in the Construction and Transport sectors (4 percent and 6 percent, respectively). A larger proportion of poor entrepreneurs (35 percent) own enterprises in the agriculture sector than middle class (10 percent) and upper class entrepreneurs (5 percent). Finally, around one third of rich entrepreneurs own firms in the services sector while less than one sixth of middle class and poor entrepreneurs own firms in that sector. Uruguay. As mentioned before only in 5 percent of households the main income provider is an entrepreneur (remember that in the Uruguay study opportunity entrepreneurs is the only category of entrepreneurship). Most entrepreneurs belong to the middle class (above 70 percent in 2010). In terms of share of the social class of origin only 1-2 percent of the disadvantaged (lower class or poor) are entrepreneurs while entrepreneurship among the middle class is 5-8 percent and among the affluent (upper class or rich) is 15-16 percent.45 The class-bias of opportunity entrepreneurs is apparent and they tend to come from the upper classes. Besides the level differences, entrepreneurship is clearly pro-cyclical for the affluent and middle sectors, a result we highlighted before when discussing the evolution of entrepreneurship in Uruguay during the crisis of 2002-03. In terms of socio-demographic characteristics, entrepreneurs have on average 1.8 more years of education that the rest of the population. In 2010 they are also somewhat older than non entrepreneurs and they trend to concentrate in the capital city of Montevideo.46 The study also finds that it takes time until an individual is able to 45 The study defines the middle sectors as those individuals whose household per capita income is between 50 percent and 150 percent of the median per capita income (they also use the U$ 10-50 rage definition). Those below 50 percent of median income are considered as the ―disadvantaged‖ sector and those above 150 percent are the ―affluent‖ sector. 46 Gandelman and Roban (2012). 60 start his own business and that the first working experiences of people are as workers (employees) rather than launching their own business. This confirms again the notion of a sequential choice between being a paid- employee and becoming an independent entrepreneur. It is worth noting that this is ―average behavior‖. Individual stories vary. Some individuals just inherit a family business while others choose at the start of their occupational careers to become an entrepreneur.47 5. Entrepreneurs ―versus‖ Employees. An important question of this book is shedding some light on the determinants of occupational choice. Is engaging in entrepreneurial activities a better ticket for richness, prosperity and a higher social status, say compared to be an employee status? Is entrepreneurship --versus ―intrapreneurship‖, say pursuing a career within a firm-- a better vehicle for overall occupational satisfaction? To the extent that the empirical evidence allows answering this complex question, it is clear that this depends on various factors. For example an executive of a big corporation is bound to be a much more prestigious position and better paid than a small shop owner although the former is an employee and the latter an ―entrepreneur‖. So the type of entrepreneurship, the size of the firm and the quality of jobs all matter a good deal. Second, individual preferences and motivations are also of critical importance. We noted previously that besides independence a main motivation of becoming an entrepreneur-- and face the risks the entrepreneurial activity inherently entails --is the lure of obtaining higher incomes and improve the economic possibilities of their children and grandchildren. The empirical evidence emerging from the country studies and additional international evidence shows that the choice is sequential in time and individuals can experience both types of 47 In the case of family business it is often the case that until the retirement of the older family members that the family allows the newcomers to take over the management of the business. 61 occupations during their economically active histories, although of course the choice remains. 6. Entrepreneurship and Social Mobility: Empirical Possibilities. Besides the question of occupational choice another critical question is to what extent entrepreneurship is a good vehicle, at macro and micro levels, for upward social mobility given its small quantitative importance (relevant at macro level) and the risks involved in this activity (relevant at micro level). Most of the country studies of this project analyze both short term (intra-generational) mobility and medium to long run (e.g. inter-generational) mobility. For that purpose they use at least one of the following empirical methods to gauge mobility: a) Time-dependence approach. Econometrically-oriented studies of mobility make a distinction between unconditional and conditional mobility (or convergence). Typically in a simple regression framework of unconditional convergence in which current income, y(t), is regressed against lagged income, y(t1), and a random term, the coefficient of lagged income lies in the interval [0-1]. In the case of full income convergence, say y(t)=y(t-1), ( lack of social mobility), the coefficient of y(t-1) would be equal to 1. In turn, a coefficient of 0 would mean a lack of persistence in incomes and thus a high degree of income mobility: past incomes would have no effect in predicting current incomes. In turn, conditional convergence adds to the regression a set of determinants of current income (e.g. age, human capital, asset ownership, a productivity variable and so on). So income convergence is conditional on the variables determining income. Most of the empirical studies follow this framework for assessing entrepreneurial mobility in their respective countries. It is importance to note that the analysis of time dependence tell us only the degree of (in) mobility of an income processes. It does 62 convey information whether people are more likely to ascend or to descend along the overall income distribution or different economic and social strata. b) Positional mobility is an analysis of the degree to which the individual position in the income distribution in the past determines his position in the present; this is a natural complement to an analysis of time- dependence. In this approach typically origin-destination transition matrices are constructed (estimated) to analyze the transition between social classes or incomes levels across individuals (say from poor to poor, from poor to middle class, from poor to rich and so on for other social classes). Ideally, for studying social mobility issues (in our case the mobility of entrepreneurs) we would like to have a long longitudinal survey of the same individuals over time to track their actual (rather than model-predicted) income evolution over time and infer thereby patterns of upward and downward mobility. In the absence of such longitudinal studies, which is the case in the Latin American region, there are two empirical methodologies that set to assess mobility. (i) The Pseudo-Panel Approach. This method was originally developed in Deaton (1985). It allows applying the convergence methodology by constructing pseudopanels using a series of repeated cross sections. A pseudo-panel, an indirect method (when longitudinal data is not available), yield synthetic observations obtained from averaging observations from groups of individuals (usually called cohorts) with similar time-invariant characteristics in a sequence of repeated cross sectional data sets. The most used of these characteristics is the birth year (although it may also be combined with gender, region of residence and/or 63 educational level or other characteristic the household). This way, the cohorts can be thought to be ―followed‖ over time the same way individuals are followed over time in true panel data, hence the name ―pseudo-panel‖. (ii) The Social Mobility Index (SMI) Approach. This methodology was initially developed by Behrman et al. (1999) and provides a way of measuring social mobility in the absence of data that follow the same individuals through time. The SMI approach48 uses surveys in which respondents are asked to self-assess the wealth and income of their parents as an indirect or subjective measure of the intergenerational transmission of educational attainment between parents and children. The SMI calculates for a family with children, an indicator of future opportunities for them, based on the characteristics of the household in terms of income and parental education. The basic notion in this methodology is that if family background (parents' education and income) is important in determining opportunities for children, then social differences tend to be perpetuated over time, i.e. there is a low level of inter-generational mobility in the society. On the contrary, if family background is not decisive in explaining education outcomes, social mobility can be enhanced and the education system is functioning as an equalizing device allowing for larger social mobility. In this methodology schooling gaps (SG), are constructed to assess intergenerational mobility and degree of equality of opportunities. The school gap is often defined as the difference between the years of schooling that a child should have, as predicted by the model (based on parental background conditions according to his/her age), and the actual years of schooling. Results 48 This method was followed in the Uruguay and other studies along with the time-dependence method. 64 Xxxxxxxxxxxxxxxx May 3 xxxxxxxxxxxxxxxxx For investigating middle class entrepreneurship, most of the studies use an absolute income definition of middle class individuals (see chapter 2). These are those with a daily income in a rank between U$ 10 and 50 dollars (2005-PPP). Some of the studies (e.g Uruguay) combine the above absolute income criteria with relative definitions relative to mean income. The more widely used definition of entrepreneur is of the business-owner that hires at least two workers. The data sources vary across studies but most of them use national census, household surveys combined with entrepreneurs or other ad-hoc appraisal for a specific year. In Argentina, the majority of entrepreneurs (65.3 percent) were born in a middle income family. In turn, 20 percent of the actual entrepreneurs come from rich families and 14.7 percent from poor families. The responses to self-assessment surveys that include recall questions indicate a relationship between parental wealth and actual occupation: people born in richer families are more likely to become entrepreneurs, and people from poorer families are more likely to end up working as either employees or independent self-employed. But the differences are small.49 That is, parental wealth is a predictor of entrepreneurial activity, but not a very strong one. Moreover, the results indicate that people whose parents were entrepreneurs (owners of a firm) are more likely to become entrepreneurs compared to those whose parents were not owners of a firm. Although the relationship is not perfect, it is stronger compared to the correlation between parental wealth and entrepreneurship. In fact, the probability of becoming an 49 13.4 percent of people born in a rich family became entrepreneurs compared to 11.9 percent and 7.1 percent of people born in middle and poor families. Entrepreneurs coming from upper class households are likely to have received a better education, have access to a network of influential people, and their parents could finance their start ups. 65 entrepreneur is 15.8 percentage points higher if your parents were owners of a firm, while it is only between 1.5 and 6.3 percentage points higher if your parents were rich (relative to middle class and poor), see table 2 from Anchorena, Rondoni and Braun, 2012. This result suggests a greater importance of role models effects—than parental wealth—in the choice of entrepreneurialism. Table 1. Argentina .Parental Occupation of Entrepreneurs, Self-Employed and Employees Actual Occupation Your parents were owners of a firm when you were 15 years old? Yes No Difference Entrepreneur 25.0 9.2 15.8*** Self-employed 14.7 14.8 -0.1 Employee 60.3 76.0 -15.7*** Total 100 100 - Note: *** Significant at the 0.01, ** 0.05 level. Source: Anchorena, Rondoni and Braun, 2012. In line with the importance of parental models, the probability of becoming an entrepreneur is almost three times higher among those individuals whose parents were entrepreneurs. The authors argue that this is so because entrepreneurs 66 emphasize certain qualities among their children (i.e., responsibility, tolerance and respect, independence, determination and perseverance and imagination) that are more conductive to entrepreneurship. This explanation resorts to the role of values and attitudes in nurturing entrepreneurship, an issue we take up below in this chapter. 50 The Bolivia study investigates social mobility using various approaches such as estimating the parameters of time-dependence equations, positional transition matrices and steady-state class distributions as equalizers of long run incomes. A main result obtained is that the degree of social mobility depends on the type of entrepreneurs. (Employers-opportunity) entrepreneurs that use hired labor in production experience higher mobility relative to self-employed workers (cooperative and own account) and also to paid-employed workers (formal and informal). This result appears to be robust to different measures of economic mobility such as time independence, positional movement and mobility as equalizer of long-term incomes. In addition, the study finds that employers exhibit significantly lower unconditional and conditional time dependence coefficients in labor earnings, are significantly more likely to move upward in both labor and overall income distributions, and much more likely to end-up in the upper incomeclass relative to other types of self-employed workers and even relative to paidemployed workers. Still, we have to remember that the segment of (employers) entrepreneurs is small on Bolivia (as well as in other countries) as a proportion of the working population. Therefore their higher potential for social mobility may 50 The study also shows that entrepreneurs that were born in a low income family earn substantially less incomes than entrepreneurs born in middle and high income families (i.e., their earnings are less than half and they are less likely to hire workers). The data suggests that this is in part because they have less human and social capital (entrepreneurs from poor families have on average between three and four years less of schooling compared to entrepreneurs from higher income families). The study also includes a methodology of endogenous cut-offs points for defining social classes. 67 not trickle-down much to reach larger segments such as independent self-employed workers and paid-employees that constitute the majority of the economically active population.51 The Colombia case study investigates whether middle class entrepreneurs have more social mobility than the average paid-worker. For that purpose it uses microeconomic data about individuals and their parents‘ education available from household surveys at national level for 1997, 2003, 2008 and 2010. The study looks at transition matrices in which parents‘ schooling attainments are associated with their adult children‘s education levels. Transition matrices are computed for each year in which the survey is available, restricting the sample to the middle class, and separately for entrepreneurs and employees. The study finds that entrepreneurship is scarce and is socially segmented: it is more frequent in the upper class than in the middle or lower classes. In turn, middle class entrepreneurs are on average better off than middle class employees of similar characteristics. Nevertheless, there are significant differences between middle class and upper class entrepreneurs regarding schooling attainment, by the size of the businesses they run, and by their outcomes. While entrepreneurs appear to have more intergenerational income mobility (lower income persistence) than the average worker, the study fails to find ―middle class particularism‖ in entrepreneurship. In other words, this mobility of middle class entrepreneurs is not systematically higher than the mobility of lower class and upper class entrepreneurs. Therefore, social mobility in Colombia seems to be associated with entrepreneurship in general, irrespective of the social origin of the entrepreneur. The study also concludes that the middle class entrepreneurs succeed at making a living from their businesses but 51 On school attainment, the study finds that a person has a below-average probability of being an employer if he has not complete at least six years of schooling and an above-average probability if he has complete a university degree, while other self-employment types (cooperative and own account) exhibit opposite patterns. On wealth, the study suggests that the availability of assets exert a significantly and quantitatively important effect on the ―opportunity‖ to be an employer. 68 the empirical evidence does not find support for the hypothesis that their activity is a strong engine of economic growth. On the contrary, the findings suggest that the types of businesses they run are low-productivity businesses; the majority (over 60 percent) work in productive units with one to three workers and their export orientation is minimal. In light with these findings the authors do not recommend designing policies tailored to promote, directly, middle-class entrepreneurship. For them these policies would be misguided. Instead, policy efforts should be directed towards facilitating social mobility more generally. In their view, better education for the (lower and) middle class individuals would be ―a cradle for true entrepreneurship in the medium and long run‖. The Ecuador study sets to address the important question: Is entrepreneurship successful in improving social mobility? For addressing this query, the authors construct a pseudo panel to analyze the dynamic effect of entrepreneurship on the Ecuadorian household incomes during the period 2002 – 2010. Using three estimation scenarios, the study finds a significant level of unconditional and conditional mobility of entrepreneurship. The results of the estimations reveal that entrepreneurship not only reduces income convergence (increasing mobility) but also increases future average cohort income. This means that entrepreneurship not only affects positively income generation, on average, but also makes it easier to generate such increase. However, the authors highlight an important methodological point, already mentioned in chapter 2: that by omitting failed entrepreneurs (those who abandoned or went bankrupt) the results may somewhat overestimate the contribution of entrepreneurship to future incomes. Another interesting result is when women entrepreneurs are the head of household they tend to experience more income mobility (both upward and downward). This feature along with the fact that women´s income is significantly lower than those of male 69 households because of gender-discrimination or other causes is a clear indication of vulnerability of households with women playing critical entrepreneurial roles. Mexico .What is the role played by entrepreneurship in fostering social mobility in Mexico? The Mexican Social Mobility Survey 2006 (MSMS-2006) is used to examine intergenerational social mobility associated with entrepreneurial activity. It is important to note that the MSMS-2006 only provides information on income for the generation of respondents (not for the parent, thus it is not a longitudinal survey). The study thus resorts to wealth to measure inter-generation mobility and wealth persistence over time. Three main exercises are conducted. First, it is analyzed if entrepreneurs experienced greater upward social mobility than selfemployed or employees. Secondly, discrete-choice econometric models (probit) are used to identify if predetermined characteristics are main determinants of the decision of becoming an entrepreneur. And third, the effect of entrepreneurial activity on income is estimated using the propensity score matching method (PSM). In line with the other country studies, the results for Mexico show that entrepreneurs have more options for upward social mobility, than independent selfemployed and employees but this result is conditional on the socio-economic characteristics of the parents. In fact, for entrepreneurs coming from families with poor parents it is more difficult to move upward in the socio-economic ladder compared with those entrepreneurs with parents who belonged to the middle or upper class. Secondly, the probability of becoming an entrepreneur increases when the respondents‘ father was also an entrepreneur, (a strong role model effect) a result in line with those obtained for Argentina and other countries. This variable (father´s occupation) is more important than initial wealth and education. Thus, a family-transmission effect of occupational values (e.g. to become an entrepreneur) seems at work here. And finally, it is found that the mean effect of entrepreneurial 70 activity on income is positive and bigger for those with parents who belonged to the lower and upper classes of the socioeconomic distribution. The Uruguay study reports a decline in inter-generational social mobility between 1982 and 2010 a proximate cause of increased social segmentation and inequality in the country. Inter-generational mobility is measured as the relationship between parents‘ schooling and income on children‘s schooling. The study finds that the probability that the children of those more educated remain among those more educated has increased over time. A similar trend is observed for the less educated. These results suggest strong persistence in the education levels of different generations reducing the degree of social mobility particularly for the disadvantaged individuals in society. The computation of an index of social mobility shows no significant changes in the Index in the case of mandatory education (primary school and first three years of secondary school). In contrast, there was a decrease in mobility for non-mandatory education (last three years of high school and then university). Family background variables play a small role in determining schooling outcomes for families of entrepreneurs and for middle sector families. According to the authors the public system in Uruguay successfully provides primary education for everybody and to a lesser extent the first years of secondary school. Nevertheless, there are important differences in the quality of education for children of entrepreneurs and middle sector. Finally, the study argues that entrepreneurship is indeed a channel for higher inter-generational social mobility. This finding is interestingly connected with the migration process. In fact, evidence points to immigrant‘s individuals that were scarcely educated but with tremendous creative spirits that progressed, ascended socially and provided better living conditions for their descendants. Although Uruguay stopped long ago to receive large contingents of immigrants, the potential of entrepreneurship as a mobility device, similar to immigration, is still there. 71 Finally, intra-generation mobility is studied using time-persistence approach and pseudo-panels. The pseudo panel provides evidence of low unconditional convergence both when using an absolute measure of income and a relative measure of income that controls for income growth. The authors note the prevalence of entrepreneurship in small firms with modest productivity levels. In this perspective they recommend that policies to foster entrepreneurship should have productivity and efficiency orientation rather than a social assistance motivation. 8. Values and Entrepreneurship The previous section establishes the overwhelming importance of the role model played by the father or mother entrepreneurs in shaping the choice of becoming an entrepreneur in their children. This effect is stronger than parental wealth and suggests the importance of values and perceptions in entrepreneurship. Values are transmitted through generations and the family plays a critical role in this transmission besides the general cultural environment, the type of social practices and public policies in society. The World Values Survey (WVS), a dataset with more than 50,000 interviews in more than 50 countries, for the 2005-2007 is often used for investigating issues related to values. A main value question is ―qualities that children can be encouraged to learn at home‖. Respondents have to choose up to five of ten alternatives: independence, hard work, feeling of responsibility, imagination, tolerance and respect for other people, thrift (saving money and things), determination and perseverance, religious faith, unselfishness, and obedience. It is worth considering that several of the values listed in the World Value Survey are common to many endeavors and not only entrepreneurship. As discussed at length in chapter 2, theories chiefly associated with Max Weber, 72 point-out to the importance of delayed gratification (patience), hard work, perseverance, and the propensity to save in fostering entrepreneurship. The extent this is a plausible characterization of the values of the entrepreneur is subject to debate. In the 1930s John Maynard Keynes emphasized more ―animal spirits‖ rather than family inherited values or a cold calculation of costs and benefits in driving investment behavior. Frank Knight stressed the role of entrepreneurial personality in managing and coordinating multiple tasks and dealing with risk. As the economic structures and institutions vary over time it is bound to expect that the values of the entrepreneur will change as well over time. For example, now we speak of ―social entrepreneurs‖, ―intellectual entrepreneurs‖ denoting the importance of private non-for profit initiative in these activities. Also the role of thriftiness in entrepreneurship, strongly emphasized in the 19th century literature on the subject, has come into question in the 21st century given the separation between saving generation and financial intermediation and the entrepreneurial function in a modern economy. Anchorena, Ronconi and Braun, (2012), using the WVS, investigates the value issue for Argentina in comparative perspective with other countries in Latin America (Brazil, Chile, Colombia, Mexico, Peru, and Uruguay), and resource-rich nations such as Australia/New Zealand. The authors find that the ―Argentinean society has values better aligned with entrepreneurship than the rest of Latin America‖. According to the authors the data shows that Argentinean society promotes six values supportive of entrepreneurship: higher responsibility, higher tolerance/respect, higher independence, lower obedience, lower religious faith, lower thriftiness, and higher imagination. However, while Argentinean society 73 may promote entrepreneurial values it does so less than some successful, natural resources abundant economies, such as Australia and New Zealand. 52 7. External and Internal Obstacles for Entrepreneurship There is a growing literature that emphasizes the impact of restrictions, obstacles and policy-induced or big- corporation induced hurdles for the development of entrepreneurship and business creation, particularly in the small size firms sector. Kantis, Federico and Trantsberg (2012) identify three main problems facing middle-class entrepreneurs: (i) to get qualified employees, (ii) to get clients and (iii) to equilibrate the cash flow. These restrictions focus on the functions of human resource management, market access and financing, clearly three critical dimensions in any productive endeavor. Moreover, the evidence highlights that these obstacles to entrepreneurship are more acute for poor and middle class entrepreneurs than those for the upper classes. To overcome these problems, middle-class entrepreneurs tend to rely on their networks. In addition, middleclass entrepreneurs tend to use information acquired in previous jobs and/or by networking to identify their business idea. However, in the Latin American region, their networks seem to be less professionalized and business specific than in the case of high-class entrepreneurs and also when compared with their middle class colleagues from other regions of the world. Tables 2 and 3 presented below, drawn from the Ecuador study, show the external and internal factors that hinder the entrepreneurial process for both middle and high class entrepreneurs in Ecuador. These problems are bound to be qualitatively 52 In particular, the authors point-out that Argentinean society values relatively little determination and perseverance and relatively high, obedience. 74 similar in other countries. Among several factors, paperwork (bureaucracy) and tax policy are two important common external problems affecting both middle and upper class entrepreneurs. Moreover, middle class business people find more difficulties in obtaining adequate financing and inputs than upper class entrepreneurs. In turn, the lack of access to competitor information, apparently a less important factor for middle class entrepreneurs, is a key barrier for entrepreneurship for the upper class. Table 2. Ecuador. External Factors that Hinder the Entrepreneurial Process External Factors Extensive paperwork (bureaucracy) Tax policy Difficulties in obtaining financing High costs of materials, human resources and inputs Difficulties in obtaining human resources Difficulties in obtaining appropriate suppliers Duties on imports Difficulties in access to competitor information Difficulties in finding adequate facilities Difficulties in obtaining information and telecommunications infrastructure Difficulties in access to the information of the target or potential market Middle 55% High 51% 40% 38% 43% 28% 27% 22% 35% 39% 19% 20% 13% 11% 12% 29% 18% 10% 6% 10% 9% 9% 75 size Lack of basic services infrastructure (communications, electricity, etc.) Difficulties in obtaining machinery and equipment 9% 8% 4% 10% -------------------Source. Ordeñana and Arteaga, 2012. 76 Table 3 highlights the importance posed by managing functional areas of the firm: finance, human resources and advertising/marketing as a set of internal factors that hindered the entrepreneurial process for both middle class and high class entrepreneurs. Another important internal factor is the difficulty of networking, a common problem for Latin American markets. Table 3. Ecuador. Internal Factors that Hinder the Entrepreneurial Process Internal factors Managing human resources Lack of knowledge in managing advertising and marketing Lack of networking, that caused difficulties to get customers Managing finance issues Lack of knowledge about how to start a business Managing the business tax aspects Inexperience in the context of the business Inadequate planning Inexperience in sales Managing available financial resources Lack of knowledge about their target segment Lack of knowledge about how to define their income model Middle 40% 33% High 30% 40% 36% 35% 28% 20% 24% 13% 26% 38% 23% 15% 13% 18% 1% 9% 30% 8% 5% 7% 3% 5% 77 The report underscores the importance of social capital – mainly in the form of family, friends and community organizations- in determining the dynamism of a business and as a way to solve the multiple obstacles facing the entrepreneur. The authors recommend that public policy should help entrepreneurs in accessing financing and new technologies allowing them to have more impact on their business. 8. Summary Entrepreneurs represent a small proportion of the economically active population in our sample of six Latin American countries. They tend to be male, middle-age and their education level comprises secondary and, often, tertiary education. They also tend to come from families in which a parent is or was also an entrepreneur, highlighting the importance of role models in this activity. In fact, the occupation choice of the father, or mother, is more important in the decision to become an entrepreneur than the parent´s wealth, income or education although these variables tend to be correlated among themselves. Middle class entrepreneurship tends to dominate the sample in part since this is the majority class in society. However, as percentage of each social class, entrepreneurship tends to be higher in upper class, followed by the middle and lower class. Entrepreneurs concentrate in the segment of micro enterprises with a strong dominance of productive units below five employees. Their social mobility is greater than employees and the selfemployed but this mobility is not always in the upward direction. Their average incomes are higher than employees and self-employed but also the variance of their incomes is superior. Opportunity entrepreneurship tends to be pro-cyclical: it increases in booming periods and fall in recessions, downturns and crisis situations. The values of the entrepreneur are a topic subject to controversy. Good qualities as high work, responsibility, imagination, tolerance and others are common to success in any activity not only in entrepreneurship. Thriftiness and 78 saving-orientation may not be required as a fundamental characteristic of the entrepreneur as those that save are not the same that those that invest and innovate in a modern economy; although common sense and historical experience suggest a reliance on internal funding (savings) and low to modest levels of indebtedness are salutary features for sustainable entrepreneurship.53 The super rational calculator of costs and benefits may not be a good description of the actual entrepreneur of the real world subject to changes in mood, herd behavior, manias and panics. The entrepreneur is faced to multiple obstacles of an internal and external nature. External factors such bureaucracy, burdensome tax procedures, lack of financing mechanisms, access to markets, market-dominance by big firms, corruption and others pose a challenge to the desire for growth and profits. Internal obstacles are often related to the ability of the entrepreneur to attract adequate human resources, manage new technologies, and get costumers, lack of supportive networks and the like. The evidence shows that support of family and friends and a modicum of social capital can be very valuable traits to cope with external and internal obstacles to the entrepreneurial function. A next step in the study of entrepreneurship is to examine its impact on critical variables such as contribution to value added, employment creation, innovation, exports and positive linkages with other sectors of the economy to assess their impact on growth and development. 53 See Solimano and Gutierrez (2009). 79 Chapter 4. Public Policy Implications for Fostering Entrepreneurship in Heterogeneous Societies and Issues for Future Research. The results reviewed in this chapter suggest important public policy implications for the promotion of entrepreneurship in society. A reasonably well designed public policy should answer the difficult question of ―what should be promoted‖? Is it productive entrepreneurship, personal economic autonomy, business creation and consolidation, economy-wide growth, innovation, employment generation or a combination of all these factors? This book alerts on two critical characteristics of entrepreneurial activity that will matter at the time of formulating public policies for the promotion of entrepreneurship: (i) the small quantitative importance of entrepreneurship in the economically active population (of course the impact of this minority activity can be high) and (ii) the heterogeneity of the entrepreneurial function. In fact, entrepreneurial traits -- such as a propensity to envision opportunities, mobilize resources, take risks and innovate -- are not widely distributed among the population at large. Therefore, pro-entrepreneurial policies will hardly be ―massive policies‖ in spite of their apparent objective of creating a majority of entrepreneurs (los emprendedores) in the population and extend the reach of ―popular capitalism‖ to the middle class and the poor. The heterogeneity of the performing of the entrepreneurial function between a small group of large scale entrepreneurs with access to credit, technology and market and innovative capacities and a much larger group of small and medium size entrepreneurs and micro-scale ―necessity entrepreneurship‖, with much reduced access to these capabilities makes the targeted segment -- ―the entrepreneur ― --potentially diffuse, elusive and very heterogeneous. Trade Offs in Pro-Entrepreneurial Policies. 80 These considerations highlight the various trade-offs implicit in the objectives of policies oriented to the promotion of entrepreneurship. On the one hand, entrepreneurial policies oriented to promote economic autonomy, employment and income generation may collide with entrepreneurial policies oriented to promote objectives such as innovative capabilities, new products, new technologies and economy- wide economic growth. In the first case, entrepreneurial policies call for supporting micro, small and medium scale entrepreneurship in activities with low technological sophistication but with a capacity of employment generation and that provides means of economic survival for those out of the reach of social protection policies. In the second case, policies may require to support technological entrepreneurs and larger scale entrepreneurship. Should public policy discriminate in favor of middle class and lower class entrepreneurship, putting the social origin of the entrepreneur as a valid criterion for entrepreneurial policy? Some argue that promoting pro-middle class entrepreneurial policy can be ultimately a misguided policy. A similar argument could be extended to policies oriented to promoter lower class entrepreneurship. Democratizing Entrepreneurship These arguments against (directly) pro-middle class entrepreneurship and pro-poor entrepreneurship can be evaluated on at least two accounts. First, fostering entrepreneurship in the middle class and the poor may be a compensatory policy that helps leveling the playing field of general entrepreneurship in view that nonrich entrepreneurs often start from disadvantageous conditions regarding education levels, parental support, lack of role models, lack of financing and other impediments to fulfill entrepreneurial motivation. We have to ensure that entrepreneur´s functioning and capabilities 54are turned into actual realizations by 54 Extending Amartya Sen´s framework to entrepreneurship. 81 providing supportive factors such as training, financing and other forms of support. Second, public policy can also help democratize entrepreneurship when markets are dominated by few big players that impede entry and competition of small and middle size participants through de –facto barriers such as their superior access to funding, economies of scale, better technologies, and greater lobby capacities to policy-makers and so on. Once an agreement is reached on the need to have some entrepreneurial policy that cut across individuals from different social class and ethnic backgrounds --and not only having policies catered to entrenched, rich, entrepreneurial elites -- it is important to develop clear guidelines and operational criteria to design and evaluate the type of entrepreneurship that we want to promote. Reasonable criteria for such entrepreneurial policy can include the contribution of entrepreneurship to firm-creation, productivity, innovation, employment generation, incomes to the poor and the middle class, resource mobilization and export orientation to list main positive factors. The important thing is to realize is that there is trade-offs among these objectives. Role Models, Gender Biases and Capacity Shortages The results of the country studies in Latin America we have presented in chapter 3 suggest some interesting considerations for the design of entrepreneurial policies: (a) Exploit the importance of role models for encouraging entrepreneurship. These role models often come from family parents but they also may come from outside the family. The likes of Steve Jobs, to name some successful entrepreneurs, and others constitute implicit role models for new generations of entrepreneurs can contribute to disseminate their experiences and lives as entrepreneurs. (b) The country studies show a male gender- bias in entrepreneurship in the Latin American region. This can be a reason for promoting a greater incorporation of women to entrepreneurial activities. In the case of mothers it is important that these 82 policies promote also a reasonable balance family-work framework, given the critical importance of the mother in raising and nurturing children in the household. (c ) The studies show that internal obstacles to entrepreneurship such as a shortage of capacities of many entrepreneurs and managers to deal properly with human resource and technology management issues and cash flows. The empirical data show that these obstacles are particularly acute in middle class and popular class entrepreneurs given their comparatively lower social and political contacts and comparatively lower educational levels. This calls for level playing –field equalization in the design of entrepreneurial policies oriented to help entrepreneurs to strengthen internal capacities to manage enterprises. Red-Tape, Investment Climate and Regulations. In recent years the concept of the ―cost and ease of doing business‖ has been put forward and empirically assessed to denote the obstacles to entrepreneurship and business creation and consolidation. The conceptual underpinnings of this line of work are related to the importance of investment climate and regulations as a key set of considerations for investment and entrepreneurship. Since 2003 the World Bank Group has been publishing an annual report called Doing Business. In 2011 the report included 182 countries. The report gauges measures such as time, number and costs devoted to comply with regulations rendering to the easiness or difficulties of doing business in a vast array of countries of different per capita incomes levels and stages of development. The Doing Business methodology focuses on variables such as the requisites for starting a business, dealing with construction permits, employing workers, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts, closing a business and getting electricity. In general the country rankings of (easiness) of doing business are closely correlated with the per capita income of 83 countries. Typically these rankings countries are headed by high income OECD nations. Conversely, in the bottom of the rankings we find Sub-Saharan African economies preceded by South Asian countries. The Latin American and Caribbean region is often in the lower- middle of the ranking in terms of easiness of doing business using the variables we mentioned before. The Report also regularly provide updates progress made by countries in reducing red-tape and stifling regulations and these reforms take place in very different countries without a clear pattern related to development levels. The studies reviewed in this book highlight that red-tape and bureaucracy is certainly an external obstacle of entrepreneurship, although is not the full story. Reforms to facilitating the process of creating a firm in some Latin American countries are a step in the positive direction. Reducing the time and cost of legal incorporation of a firm will favor the creation of new enterprises. In several Latin American countries, the cost of closing a firm and going-out of business is often high due to the stringent bureaucratic procedures to stop a firm from functioning. Policy-makers have to keep in mind that when the costs of exit are high, the entry of firms is also penalized. Throwing sand to the process of firm-creation and firmclosing can be harmful to the entrepreneurial function. Bankruptcy procedures have to be reviewed. The high pecuniary and legal costs of bankruptcy procedures that prevail in several countries tend to impede the reallocation of resources after the failure of a business. In addition, the social stigma of going bankrupt seems higher in the Latin American culture than in Anglo-Saxon cultures. Education, Training and Entrepreneurship. The role of education and training in nurturing entrepreneurship is an important but largely unsettled topic. Promoting the entrepreneurial option and skills‘ development processes through the educational system may help also to compensate disadvantageous situations associated to the social origin at the very 84 beginning of the entrepreneurial career. However, if the access to the educational system is strongly correlated with the socio-economic level of the student, a reality in many developing countries, the education system will tend to reproduce-- more than correct-- existing inequalities of income and wealth and is unlikely to contribute to democratize entrepreneurship. In any case, if university level training in entrepreneurship is pursued then it is important to engage public universities in this effort since middle classes and low income students have a greater access to public universities than to private universities. Universities in Europe and North America in recent years have been increasingly promoting courses and master programs oriented to nurture and provide tools for effective entrepreneurship. These programs seek to differentiate themselves from the standard Masters in Business Administration (MBAs) that are oriented to produce managers and not necessarily entrepreneurs. This trend started to spread also to Latin America with a proliferation of short courses and diplomas catered to foster ―el emprendimiento‖ (entrepreneurship) as the new mantra for growth and development. It is important to ensure that training and education efforts are in line with the vocation and interests of the students and appropriate systems of detecting and nurturing entrepreneurial traits are developed. Financing, Networks, Social Capital and Entrepreneurship Beyond education and training, it is important to consider carefully what empirical studies show as the main constraints and obstacles facing entrepreneurs particularly those belonging to middle class and poor family background. The lack of financing is an almost perennial obstacle that faces non-upper class entrepreneurs and this can be extended also to the children of the affluent that do not automatically inherit the wealth and contacts of their parents. Many funding schemes through public banks and second tier commercial banks are probably far 85 from a resounding success in Latin America and other parts of the world. Still some positive cases also exist and lessons from success and failure have to be considered in this area. Public policy can make an effort in securing external financing to the firm and connecting the demand and supply of loan funds markets. Policies to monitor the cost of credit in markets and lack of financial education facing many poor and middle class entrepreneurs is essential in markets plagued by asymmetrical information and unethical lending practices. The studies also show that deficits in attracting and managing human resources, securing clients, manage new technologies, improve accounting and financial management are all internal factors critical for impeding entrepreneurship. Also the studies show the growing importance played by networks and family, friends and community institutions to overcome these obstacles and give way to sound and vibrant entrepreneurship at all social levels. Promoting social capital and facilitating communication and networking can have a significant pay-off as a non-conventional entrepreneurial policy. Finally, entrepreneurial policies must address the cost of entry and exit and creating and closing firms. Entrepreneurship is a dynamic process in a capitalist economy. However, many times industrial and entrepreneurs policies adopt a static view of the firm. Issues of Future Research Entrepreneurship is an important topic that cut across different fields of knowledge. An expansion of inter-disciplinary vistas of the topic can be rewarding. Inviting dialogue and joint research among business experts, economists, psychologists, labor market experts, industrial relations, venture capital and talent specialists can have an interesting pay-off. Basic issues such as the definition and measurement of entrepreneurship need additional work. A similar comment can be made to the measurement of the 86 middle class. The use of measures of ownership, self-employment, size of firm, business creation to gauge entrepreneurship shows the topic is still in a nascent phase from an empirical viewpoint. In turn, the lack of longitudinal studies in Latin America for properly tracking the family and occupational history of individuals over long time spans is a limitation for the study of entrepreneurship in this region. This is bound to be applicable also to other developing regions. However, empirical methods that overcome this lack of longitudinal data are used as reviewed in this book. Also more research is needed in areas such as the values of the entrepreneur. The classic depiction of a frugal individual willing to postpone consumption and endure sacrifices for materializing his vision of business formation may remain valid but the role of sophisticated capital markets and family inheritances change the picture somewhat. In addition, the role of generalist traits and multi-task capacities versus specialization and technical knowledge abilities in the entrepreneurial function deserves more analysis. The theme of how to manage risk and embark in productive ventures in uncertain contexts remains as critical topics. More work is needed in understanding and measuring the intergenerational transmission of values at family level given the importance found for parental family roles in the propensity for entrepreneurship detected in the empirical studies. It is important also to study more the important of role models outside the family in shaping entrepreneurship. Understanding the determinants of the gender component of entrepreneurship, strongly biased to maleentrepreneurship in Latin America, is an important emerging subject matter. We need to understand better the influence of family factors, exclusion patterns, the female participation rates in the labor force in shaping the role of women in entrepreneurial activities. More work is needed also on occupational dynamics and its impact on social mobility. The empirical studies show the sequential role of employee first and 87 entrepreneurship latter prevalent in the occupational stories of individuals. These studies identify age ranges lying between the late 30s and early 40s for the switch between employee-status to entrepreneurial-status. Nevertheless, we need to know more of how robust is this age-threshold to changes in occupation samples across time and space. The influence of the age-level on the ability to take risks is an interesting albeit largely neglected topic. A similar question can be extended to the influence of class and ethnic background in the tolerance for risk-taking and entrepreneurship. An important question is the evolving form of internal and external constraints on entrepreneurship. The growing importance of information technology in business management and the importance of networks for gathering a client base and human resource recruitment decision is a new topic for entrepreneurship. Another important topic is the influence of cities, location and international mobility of talent on entrepreneurship is a critical topic. Most of entrepreneurial activity takes place in cities, rather than in isolated places, but there are also important differences in entrepreneurial density across cities of relatively similar size. The concepts of ―ecosystems‖, ―bottom-up innovation‖, ―clustering‖ in the literature on entrepreneurship all denote the importance of favorable contexts, interdependence, location, decentralization and spontaneity in the entrepreneurial function. The role of consumer base, human resource accessibility, inputs availability and the supply of entrepreneurial capacities are all dimensions in the growth of cities that point to a dynamic, mutually causal, interaction between cities and entrepreneurship. The international mobility of talent is a critical feature of globalization and part of this talent pool engages in entrepreneurial activities.55 The role of international differences in regulation policies, ease of doing business, 55 See Solimano (2008). 88 immigration regimes, availability of credit and venture capital and growth prospects are all factors that affect the international allocation of entrepreneurship among nations. 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