Competencies and Institutions Fostering HGFs

1. Competencies and Institutions Fostering HGFs Magnus Henrekson, IFN Based on joint work with Dan Johansson forthcoming in Foundations and Trends in Entrepreneurship 9(1), 2009 November 2008

2. Motivation and purpose • Gazelles/HGFs by some found to contribute disproportionally to growth and job creation • Seems to be the case in the U.S. • But generally less true in Europe • What institutional conditions most likely to be conducive to HGFs? • Talented entrepreneurs supply effort • Incentives to expand if potential • Harmonization of diverse competencies and agents • Identify key agents

3. Key agents: the competence bloc • Entrepreneurs • Inventors and Innovators • Industrialists • Skilled labor • Venture capitalists • Business angels • VC funds • Agents on the secondary (exit) market • Competent customers

4. The Competence Bloc Competent customers Agents on secondary markets Commercial-ization Development of viable idea Build large industrial firm Entrepreneurs Industrialists Entrepreneurs Inventors Entrepreneurs Skilled labor VC agents

5. Rich countries: Why conditions for HGF? • Bartelsman et al. (2005): “Firms in the U.S. enter with a smaller employment size than their counterparts in Europe but, if successful, expand much more rapidly to reach a higher average size.” • Sternberg and Wennekers (2005): “These findings may have important implications for entrepreneur-ship policy in highly developed economies. At least from an economic growth perspective, policy should focus primarily on potentially fast growing new firms and not new enterprise in general.”

6. The tax code • Key rates and schedules insufficient to characterize the tax code • Tax code does not acknowledge categories in Competence bloc (income from e-ship etc) • Key agents interact in complex ways; details in the tax system likely to be of great importance

7. Different taxes and their effects Labor taxation • level and degree of progressivity • EITC/exemptions • social security contributions • level and degree of actuarialness • capped/non-capped/differentiation Sales/consumption taxation • degree of uniformity • exemptions

8. Taxation of current capital income • dividends • interest income • exemptions Capital gains taxation • uniform/progressive • differences across assets • differences based on holding period

9. Taxation of stock options capital or labor income? tax on realized or imputed gain? tax due at receipt of option, when stock called or when stock sold? differences based on holding period effect of employment clause

10. Corporate taxation statutory rate S-corporations or other measures to eliminate two-tier taxation accounting measures to lower effective taxation treatment of holding companies domestic/foreign single- or multi-level taxation

11. Taxation at owner’s level differential across types of owner exemption levels/threshold effects VC/PE firm taxation

12. Taxation of asset holdings wealth tax/property tax Inheritance/gift tax Taxation of return on savings differences across instruments preferential treatment of pension savings differences across agents

13. Effective marginal tax rates for different combinations of owners and sources of finance: Sweden 1980 (real pre-tax return 10%).

14. and in 1994

16. Labor market institutions • Enormous churning (every 7th job disappears every year) • Wage-setting arrangements • degree of centralization and formalization • miminum wage laws • wage compression ”deprofessionalizes” service sector • Labor security mandates weigh more heavily on smaller and younger firms and on those with high business risk (HGFs) • Labor security mandates hamper the reallocation of workers, jobs and capital • High compensation for irregular work schedules, strict seniority rules and employment security, and responsibility for rehabilitation etc. disfavor many service industries with many potential HGFs

17. Product market regulations • Many product regulations. We deal with/analyze regulations disturbing the the entrepreneur-customer link, by restricting market entry by private entrepreneurs and by restricting private customers’ ability to choose a (private) provider. • The less certainty and political stability the more it benefits large incumbent firms. • The extent to which sectors of high income elasticity of demand are open for private production and private purchasing power: education, personal care and health care.

18. Three types of regulations • production is contestable, but only government financing of purchases is allowed; • production is monopolized by government, but private financing is allowed; and • production is monopolized and financed by government. The benchmark case is private production and private financing

19. Product markets and the prevalence of competence blocs and HGFs – most important effects

20. Design of the savings and social insurance systems etc • Degree of institutionalization • Design of pension systems: public and private • Tax favoring of certain kinds of saving? • Social benefits tied to current employment? • The degree of actuarialness of firm-based complementary systems • ”Soft” government? • Intermediate size firms likely to suffer the most

21. Institutions Favoring Sclerotic Capitalism or Dynamic Capitalism

24. Conclusions • HGFs/Gazelles key to growth and job creation • Many complementary competencies and agents in complex interaction to take firm from small to large • Impossible to pick winners ex ante • Key institutions to harmonize incentives • The tax system: have to get the details right! • Labor market regulations and wage-setting institutions; do not tie entitlements to long-term tenure • Savings systems and social insurance as facilitators • Product market regulations enabling entrepreneurial process and product innovation