Entrepreneurship and Weak Institutions in Latin America.

Author:Lecuna, Antonio
  1. Introduction

    This study suggests that high-growth entrepreneurial activity does not thrive in an institutional context of voids and barriers (Klapper, Laeven, and Rajan 2006; MacMullen, Bagby, and Palich 2008). The arguments presented here are consistent with those advanced by Baumol (1990), who suggested that institutional voids and barriers may encourage unproductive and destructive forms of entrepreneurship and breed negative societal attitudes toward entrepreneurs (Baumol 1990).

    Identifying the institutions that support entrepreneurship may provide further insights for policy makers (Estrin, Mickiewicz, and Stephan 2013b). By focusing on high-growth entrepreneurs, this paper contributes to the argument that bureaucracy erodes the foundations of institutional trust that are necessary to foster entrepreneurial growth in developing economies.

    Entrepreneurship is very important, as it is linked to economic growth (Baumol 1968; Kirzner 1997; Minniti 1999), innovation (Schumpeter 1934), well-defined private property rights (Williamson 2000), effective and beneficial political and economic institutions (Rodrik 2000), solid and unbiased business regulations (Parker 2007), the production and introduction of new products (Baumol 1990), and high-net foreign direct investment (FDI) as a percentage of GDP (Ovaska and Sobel 2005).

    On the contrary, corruption is associated with increased consumer price inflation (Cukierman, Edwards, and Tabellini 1992), higher interest rates (Bahmani-Oskooee and Nasir 2002), wider socioeconomic inequalities (Gupta, Davoodi, and Alonso-Terme 1998), unproductive public policy choices such as less spending on education and more spending on defense (Mauro 1998), weak institutions in subnational governments (Lecuna 2012), less governmental legitimacy to the point of instigating civil wars (Klitgaard 1990), and additional costs to businesses that can be thought of as an arbitrary tax significantly inhibiting investment (Wei 1999) and economic growth (Mauro 1995).

    Although a growing body of research has demonstrated a uniformly positive relationship between decreased corruption and improvement in a variety of important indicators, the specific relationship between entrepreneurial activity and corruption as measured across nations remains a topic of debate. Research to date tends to argue that corruption plays an important role in decreasing the rates of entrepreneurship across developed nations. For instance, Ovaska and Sobel (2005), Anokhin and Schulze (2008), Tonoyan et al. (2010), and Aidis, Estrin, and Mickiewicz (2012), among others, laid the foundation to bridge entrepreneurship and corruption as two relevant subdisciplines of management and political economy that have evolved in relative isolation.

    Anokhin and Schulze (2008) controlled for wealth (measured as the log of per capita GDP), net inflows of foreign direct investment as a percentage of GDP, foreign trade as a percentage of GDP, and the log of population. The sample used by Tonoyan et al. (2010) included transitional and mature market economies and one measurement of entrepreneurial activity (for the year 2000). Aidis, Estrin, and Mickiewicz (2012) focused on entrepreneurs instead of incorporated firms (using data for the 1998-2005 period) and employed the Heritage Foundation and the Wall Street Journal (HF/WSJ) to measure the institutional indicators, including "freedom from corruption" as the key variable of interest. Furthermore, whereas Ovaska and Sobel (2005) examined ten postsocialist transition economies, the two measurements of entrepreneurial activity were outdated: the number of active private enterprises per 1,000 population in 1995 and the average annual growth rates of both private enterprises and patent trademark applications per capita for 1995-2000.

    This paper contributes to previous research in three ways: (1) by using seven independent measures of entrepreneurial activity as dependent variables and including a larger set of controls over a more homogenous data set and a more recent time period; (2) by introducing the moderating effect of bureaucracy, measured by the days and the procedures required to start a business; and (3) by reintroducing--in light of the weak rejection of the first hypothesis--the possibility of the "grease the wheel" effect, in which greater corruption leads to greater entrepreneurial activity. Latin America's widespread corruption may need some "grease" to get things done.

    The following section reviews the literature on entrepreneurship and government institutions, particularly in relation to corruption, and frames the current state of the literature by formulating a set of hypotheses. Then, we describe the methodology, including the selection of the sample, and report a series of statistical tests and highlight, including the most significant findings. Last, we discuss the significance of the results and addresses the practical implications and main limitations of the study. II. II.

  2. Theoretical Definitions and Hypothesis Development

    Given that organizations owe their existence to the opportunities provided by the institutional framework (North 1991, p. 109), we believe that institutional theory is particularly relevant for understanding the impact of internal and external influences on entrepreneurial activity. Moreover, because the positive effects of entrepreneurship mostly depend on its institutional arrangements (Baumol 1990), an institutional approach allows research to open up the black box of formulating enterprise policy without having to add layers of complexity to explanations at an individual level (Arshed, Carter, and Mason 2014).

    Lin and Nugent (1995, pp. 2306-07) broadly define institutions as "a set of humanly devised behavioural rules that govern and shape the interactions of human beings, in part by helping them to form expectations of what other people will do." North (1990) adds that institutions consist of both informal constraints (sanctions, taboos, customs, traditions, and codes of conduct) and formal rules (constitutions, laws, property rights). Following Arshed, Carter, and Mason (2014), this study recognizes the government as the formal institution.

    Formal institutions are defined in statistical tests using five governance dimensions from the World Bank's Worldwide Governance Indicators (WGI): (1) "regulatory quality" reflects the government's ability to formulate and implement sound policies and regulations that permit and promote private sector development; (2) "political stability and absence of violence" reflects the likelihood that the government will be destabilized or overthrown by unconstitutional or violent means, including politically motivated violence; (3) "voice and accountability" reflects the extent to which a country's citizens are able to participate in selecting their government as well as freedom of expression and freedom of association; (4) "government effectiveness" reflects the quality of public services, the quality of the civil service and the degree of its independence from political pressures, the quality of policy formulation and implementation, and the credibility of the government's commitment to such policies; and (5) "rule of law" reflects the extent to which agents have confidence in and abide by the rules of society, particularly the quality of contract enforcement, property rights, the police, and the courts. The scores range from approximately -2.5 to 2.5, with higher values corresponding to better governance.

    In addition to the WGI dimensions of governance, formal institutions are controlled from two additional perspectives: the "institutions" pillar by the Global Competitiveness Index (GCI) data set from the World Economic Forum (WEF) and the "monetary freedom" index of economic freedom by the HF/WSJ. The GCI "institutions" pillar consists of twenty-one indicators, including property rights, diversion of public funds, irregular payments and bribes, judicial independence, and reliability of police services. "Monetary freedom" combines a measure of price stability with an assessment of price controls. It argues that price stability without microeconomic intervention is the ideal state for the free market.

    Following Ovaska and Sobel (2005, p. 16), we specifically define corruption using the "corruption perception index" (CPI) by the anticorruption NGO Transparency International (TI) as the main institutional factor in entrepreneurship. Corruption is defined by TI as the abuse of entrusted power for private gain. The CPI relates to perceptions of the degree of corruption as seen by business people, academics and risk analysts and ranges from 10 (highly clean) to 0 (highly corrupt). The external validity of the main independent variable of interest is tested using a bivariate correlation analysis between the CPI and the "control of corruption" indicator by the World Bank, which is defined as the perception of the extent to which public power is exercised for private gain, including the extent to which the state has been "captured" by elites and private interests. As expected, the correlation value between these two variables is very high (over .81), indicating the high external validity of this study's main independent variable.

    1. Definition of Entrepreneurial Activity

      The effect of corruption in entrepreneurship is tested against seven dimensions of entrepreneurial activity as the dependent variables, each of which measures a different and specific aspect of entrepreneurship. We begin by measuring entrepreneurial activity using the "new entry rate," which is defined by the World Bank's annual Doing Business report as the number of newly registered firms as a percentage of an economy's working-age (15-64 years) population normalized by 1,000 (World Bank 2011). The units of measurement are private, formal-sector companies with limited liability.

      The remaining dimensions of entrepreneurial activity are all...

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