Why does the effect of new business formation differ across regions?

Small Business Economics, May 2011

We investigate regional differences in the effect of new business formation on employment growth in West Germany. We find an inverse U-shaped relationship between the level of start-up activity and employment change. The main variables that shape the employment effects of new businesses in a region are population density, the share of medium-skilled workers, the amount of innovation activities as measured by the proportion of research and development (R&D) employees, and an entrepreneurial character of the regional technological regime. In contrast, a high share of small-business employment has a negative influence on the employment effect of start-ups. Other indicators for education, innovation activity, and labor productivity do not prove to be statistically significant.

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Why does the effect of new business formation differ across regions?

Michael Fritsch 0 Alexandra Schroeter 0 JEL Classifications 0 0 M. Fritsch (&) A. Schroeter School of Economics and Business Administration, Friedrich Schiller University Jena , Carl-Zeiss-Str. 3, 07743 Jena, Germany We investigate regional differences in the effect of new business formation on employment growth in West Germany. We find an inverse Ushaped relationship between the level of start-up activity and employment change. The main variables that shape the employment effects of new businesses in a region are population density, the share of medium-skilled workers, the amount of innovation activities as measured by the proportion of research and development (R&D) employees, and an entrepreneurial character of the regional technological regime. In contrast, a high share of small-business employment has a negative influence on the employment effect of start-ups. Other indicators for education, innovation activity, and labor productivity do not prove to be statistically significant. - Recent empirical research strongly indicates that the effect of new business formation on economic development is of a long-term nature.2 It is found that start-up rates may have a statistically significant impact on growth for a period of up to 10 years (for an overview, see Fritsch 2008). Over this time span, the effect of start-ups on growth shows considerable variation that is in most cases (countries or regions) characterized by a wave-like pattern (see Sect. 2 for details). This wave-like pattern reveals that new businesses have a positive impact on economic development in the first 1 or 2 years after formation, but that the effect then declines and, in many cases, becomes negative. In many regions, the effect becomes positive again after about 5 years, and then 1 We are indebted to Oliver Falck (CES-ifo, Munich), Stephan Heblich (MPI, Jena), Antonio Garcia-Tabuenca (University of Alcala, Madrid), and two anonymous referees for their helpful comments on an earlier version of this manuscript. Oliver Falck also provided very valuable advice on econometric issues. 2 Acs and Mueller (2008); Andersson and Noseleit (this issue); Arauzo-Carod et al. (2008); Audretsch and Fritsch (2002); Baptista et al. (2008); Baptista and Preto (this issue); Bosma et al. (this issue); Carree and Thurik (2008); Dejardin (this issue); Fritsch and Mueller (2004, 2006, 2008); Koster (this issue); van Stel and Storey (2004); Mueller et al. (2008); van Stel and Suddle (2008). becomes insignificant after about another 5 years. Previous analyses also find that the magnitude of the wave, as well as the total effect of new business formation on growth, is shaped to a considerable degree by regional conditions. Some regions are able to achieve substantial employment growth from new business formation; however, the effect can even be negative in other regions (Fritsch 2008). In this paper, we analyze differences in the total effect of new business formation on regional development in West Germany. Unlike other work on this subject (Fritsch and Mueller 2004, 2008), we are not interested in the 10-year wave pattern as it occurs, but in the overall result after this process has ended. To what extent and why do the long-term effects of new business formation vary between regions? What characterizes those regions where new business formation leads to pronounced employment growth as compared with those regions where this effect is negligible, if it even occurs at all? What is behind these interregional differences? To answer these questions, we employ a panel approach in which we relate regional start-up rates and other regional characteristics to regional employment change over 10-year periods. This analysis allows us to identify the main factors that shape interregional differences in the effects of new business formation on economic development. Previous analyses of regional differences only compare the effects in different types of regions, such as agglomerations and rural areas or regions with high and low levels of productivity; however, our approach allows us to account simultaneously for several factors that may shape these effects, e.g., population density and productivity.3 3 E.g., Fritsch and Mueller (2008) find that the effect of new business formation on regional employment is relatively large in agglomerations and in regions with high levels of labor productivity. Since, in West Germany, most of the regions with high labor productivity are agglomerations and many of the low-productivity regions are rural areas (Fritsch and Mueller 2008, p. 22), a larger growth effect of new business formation in regions with high productivity levels could well be explained by their higher population density. In this paper (Sect. 5), we indeed find that the regional productivity level does not contribute to explaining the effect of new business formation on regional development when population density is included in the analysis. The following sectio (...truncated)


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Michael Fritsch, Alexandra Schroeter. Why does the effect of new business formation differ across regions?, Small Business Economics, 2011, pp. 383-400, Volume 36, Issue 4, DOI: 10.1007/s11187-009-9256-9