NTT- How does innovation impact on development? How, and under what conditions, do entrepreneurs in developing countries innovate? And what can be done to support innovation by entrepreneurs in developing countries.

Innovation is the driving force in development; without innovative entrepreneurs we would not have most of the tools and services that provide many of us with a prosperity today that far exceeds that of ancient emperors. From birth control to the internet, innovation has fundamentally changed the world.

Despite this, most of the work on understanding the process of innovation and its relationship to public policy has been conducted in economies at more advanced stages of development. Several authors have even downplayed the importance of innovation for developing countries. In a similar fashion there has been a resurgence of interest in the role of entrepreneurship in innovation, employment creation and economic growth, but in this literature the primary focus is on the advanced economies.

Together with Micheline Goedhuys, we edited a book, Entrepreneurship, Innovation and Economic Development, published in 2011 by Oxford University Press, which deals with these relatively neglected issues, and argued for a better understanding of the roles that entrepreneurs can play in innovation even in the poorest countries. The book focuses in particular on the entrepreneurship–innovation nexus in the context of development. In this article, we share some of the findings from the book.

Defining innovation

The Oxford Handbook of Innovation describes innovation as the putting into practice of inventions. In a narrow sense, innovation refers to product and process innovations, or technological innovation. In a broader sense, innovation is the development of new products, new processes, new sources of supply, as well as the creation and exploitation of new markets and the development of new ways to organize business.

Different types and degrees of innovation may take place across different stages of development. Many entrepreneurship scholars in the West believe (largely mistakenly in our view) that innovation is not really important for economic growth and development in less developed (so-called “factor-driven”) economies. We believe that these types of broad-brush generalizations about the nature of economic growth understate and underestimate the importance of innovation in earlier stages of development. One reason is that one should distinguish between incremental innovations and more radical innovations, and between innovation that is new to a country or firm and innovation that is new to the world. The former type of innovation is imitation, where developing country entrepreneurs adopt new products or processes from the rest of the world. Such innovation can play an important role in technological upgrading and increasing the utilization and the efficient allocation of production factors. China’s development achievement is an example of this – despite being classified by some Western economists as being in the factor or efficiency stages of growth, it is outperforming many rich countries in terms of innovation – more patents were for instance filed in China in 2011 than in the USA.

Another reason is that several developing countries have indeed experienced rapid economic catch-up – in a sense, leapfrogging development. They were able to absorb and creatively adapt international technological knowledge and thus to achieve accelerated growth. Such adoption of existing technologies goes beyond mere imitation – it is an example of creative and innovative behaviour and examples are provided in our book. Alice Amsden argues that privately owned, domestic firms in East Asia were better at adopting and absorbing technologies from advanced economies than foreign-owned firms. Erik Stam and André van Stel highlight how adoption of foreign technology provides entrepreneurs with a potential to create new markets and contribute to structural change and self-discovery.

Entrepreneurship and firms

Entrepreneurship refers to the discovery and exploitation of opportunities. It plays a potentially important role in development, including in cost discovery, gap filling, accumulation of human and physical capital, input completion, reallocation of resources from less productive to more productive resources, and supporting the process of structural change. In this book we focus in particular on incentives, policies and institutions that liberate the productive potential of entrepreneurship in development. Here, three strands of work on entrepreneurship are distinguished. The first strand defines entrepreneurship as a creative, dynamic characteristic of actors, be it the managers, owners of small enterprises, or heads of departments. In this strand there is hardly any distinction between entrepreneurship and innovation. The second strand of literature focuses on firm behaviour. Here we can make a clear distinction between innovative and non-innovative firms. The third strand of literature focuses on a subset of firms, namely owner-operated firms. Owner-operated firms are usually small and medium-sized but can also include large firms. In this strand we can also make the analytically desirable distinction between innovative and less innovative entrepreneurship。

An important question throughout the book asks who are the innovative actors in a developing country context. Are these large domestic firms, subsidiaries of multinationals, owner operated small and medium enterprises or micro enterprises? Alice Amsden points out that large private-owned enterprises are much more flexible and innovative than the subsidiaries of foreign-owned firms and that the importance of privately owned enterprises in East Asia explains the economic success of this region, as compared to the foreign-dominated economies of Latin America.

Other authors in our book emphasize the importance of small and medium-sized enterprises. They account for a very substantial part of employment in developing countries across the globe. Most small scale entrepreneurs however are survival entrepreneurs and are hampered by weak infrastructure, lack of finance and lack of capabilities. The systems of innovation are often not providing the best incentives for entrepreneurs to become more innovative. However, in our book, Jaap Voeten et al. provide an encouraging example of innovative behaviour amongst clusters of handicraft enterprises in Vietnamese villages, which are transforming themselves through new products or more advanced production techniques.

Policy implications

Promoting innovation by entrepreneurs across the stages of development therefore seems justified. But how? Answering this question first necessitates raising the question, why do entrepreneurs innovate? The answer is they are driven by profit motives. Adam Smith realized that although entrepreneurs act in pursuit of their own profits, they may generate benefits to the broader society in the process, and that there is a link between the degree to which the entrepreneur will engage in innovation and the size of the market. Markets can thus be seen as important drivers of growth and development.

In the poorest developing countries, markets unfortunately fail to fulfill this driving role. Developing country markets are often small, fragmented and imperfect, due to lack of infrastructure, low per capita incomes, misguided policies and institutional constraints. The political stability, predictability and transparency, peace and other institutional prerequisites for the functioning of markets are often absent. With fragmented, small and uncertain markets there is often insufficient incentive for entrepreneurs to innovate. Where markets are restricted because of barriers to trade (either natural barriers such as lack of infrastructure or man-made barriers) it is difficult for innovations to spread. Through the ages, international trade has exposed traders and merchants to new ideas, and technologies. This is one of the reasons why trade functions as an engine of growth. Where markets are restricted by inappropriate regulations or strangled by predatory governments or monopolies, there is no incentive for entrepreneurs to introduce innovations that are new to the firm. And where inappropriate property rights and contract enforcement makes any returns on innovative activity risky, there will be little incentive for entrepreneurs to invest in innovations, new to the domestic market or new to the world.

While broadening the market may be one of the necessary conditions for innovation, it will often not be sufficient. The reason is that innovation is increasingly knowledge and skill-intensive. Because of the positive externalities inherent in investment in knowledge, technological advance and human capital, public policy has been increasingly recognized as having an important complementary role to play in fostering entrepreneurial innovation. Innovation requires not only highly knowledgeable, experienced, and skilled entrepreneurs, but also highly skilled labour. Thus, educational policies and capability-building are important public policies.

Without the latter, well-meaning donor and development organization policies may fail to stimulate innovation. For instance, trade liberalization is often prescribed for small developing countries as a development strategy, assuming that knowledge will automatically and without friction flow to these countries, not taking into account the need for absorptive capacity. Donors often promote competition through private sector development programmes, not realizing that with too much competition, there may be little opportunity for entrepreneurs to recoup investments in innovative activities, particularly if domestic financial markets are underdeveloped and entrepreneurs have to finance innovation out of profits. Thus, in the absence of careful government interventions and policies, the operation of markets may result in underinvestment in knowledge and innovation. Nowadays, ‘innovation policy’ and ‘national innovation systems’ have become a standard part of the economic growth discourse in both advanced and developing economies.

The interplay between market development, systems of innovation and government science, technology and innovation policies is an important theme of this book. For instance, Sunil Mani shows that in India the emergence of private institutions and initiatives to complement government support programmes for innovation, as well as an increased availability of skilled labour, were essential for the fast growth of the country’s ICT sector.

Many developing country governments have in recent years attempted to overcome some of the weaknesses in the institutional environments by supporting business incubators. Semih Akçomak provides a discussion of incubators as tool for innovation in developing countries. He proposes eight dimensions of a good incubator policy, including clarity of mission and purpose; clear selection, entry and exit criteria; managerial capacity and incubator management skills; engagement in constant monitoring and performance evaluation of participating firms; strategic selection of services; minimization of start up costs and red tape; a focus on intangible services rather than tangible services such as office space or infrastructure; promotion of networking as a deliberate strategy; and lastly, financial sustainability.

Finally, there is the puzzle of how many entrepreneurs succeeded in innovating in often deeply adverse environments, characterized by over-regulation, high cost of doing business, weak enforcement of property rights, poor capital markets and underdeveloped markets. India is a case in point, as discussed by Suma Athreye. In India it seems, adversity promoted creativity. She finds that the very success of the software industry was a source of subsequent improvement in the institutional environment – not brought about by government taking the lead, but by institutional entrepreneurship. As she puts it, the “impetus for institutional reform has not come from government, international institutions or their advisors, but primarily from the business sector itself.”

There are three general lessons from our book. First, the impact of innovation is important across countries and institutional contexts. Entrepreneurs in developing countries provide innovations that are important for firm and country growth. Innovation can play an important role in catch-up and growth in a global economy. This is so, first and foremost, through the varied innovations of local entrepreneurs, but also through the role of entrepreneurs in advanced countries where innovations are generated and applied in to developing country context.

Second, large and small firms can be equally innovative, but in different ways. In our book there is a strong emphasis on small and medium enterprises, as these predominate in developing (and many advanced) countries but which also face particular constraints to innovation. Often such small firms contribute to growth, but not optimally, since they lack innovativeness. Here, characteristics of the entrepreneur (education, age, experience, networks), the region (location), and the sector (technological intensity) were identified to be important determinants of innovation.

Third, the policy and institutional environment is an important determinant of entrepreneurs’ innovative behaviour. Governments need to support innovation directly and indirectly. This can take many forms – from reform of the environment for doing business, to providing venture capital, to tapping into migrant workers and diasporas, provision of technical and managerial education, infrastructure, and state–private sector partnerships. Sometimes, even an adverse environment can spur innovative behaviour, and entrepreneurs may become the drivers of policy and institutional change.