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Jamaica vs. Singapore

Thursday, November 19, 2009

In 1965 the two nations were equal in wealth. Four decades later, their standing was dramatically different. What accounts for the difference?

Silicon Valley, Singapore, Tel Aviv—the global hubs of entrepreneurial activity all bear the marks of government investment. Yet, for every successful public intervention spurring entrepreneurial activity, there are many failed efforts, wasting untold billions in taxpayer dollars. When has governmental sponsorship succeeded in boosting growth, and when has it fallen terribly short? Should the government be involved in such undertakings at all? These issues are particularly timely, given the many billions of dollars governments spend worldwide to prop up troubled industries such as automobiles, as well as the urgent public efforts to encourage “green shoots” in areas such as clean-tech in hope of stimulating an economic recovery.

Programs to boost new ventures might seem like an esoteric corner of public policy, far less important than the big issues of war and peace and health benefits, not to mention the rescue of giant firms that are on the ropes. But this perception can mislead because of the magnitude of changes that can occur when venture programs are done well.

To understand their importance, we can contrast Jamaica and Singapore. Both are relatively tiny states, with under 5 million residents apiece. Upon Singapore’s independence in 1965—three years after Jamaica’s own establishment as a nation—the two nations were about equal in wealth: the gross domestic product (in 2006 U.S. dollars) was $2,850 per person in Jamaica, slightly higher than Singapore’s $2,650. Both nations had a centrally located port, a tradition of British colonial rule, and governments with a strong capitalist orientation. (Jamaica, in addition, had plentiful natural resources and a robust tourist industry.) But four decades later, their standing was dramatically different: Singapore had climbed to a per capita GDP of $31,400 (2006 data, in current dollars), while Jamaica’s figure was only $4,800.

The World Bank's analysis suggests that the total cost of complying with all tax laws in Jamaica amounts to just over one-half of gross profits for the typical entrepreneur.

What accounts for the amazing difference in growth rates? There are many explanations: soon after independence, Singapore aggressively invested in infrastructure such as its port, subsidized its system of education, maintained an open and corruption-free economy, and established sovereign wealth funds that made a wide variety of investments. It has also benefited from a strategic position on the key sea lanes heading to and from East Asia. Jamaica, meanwhile, spent many years mired in political instability, particularly the disastrous administration of Michael Manley during the 1970s. Dramatic shifts from a market economy to a socialist orientation and back again, with the attendant inflation, economic instability, crippling public debt, and violence, made the development and implementation of a consistent long-run economic policy difficult.

But in explaining Singapore's economic growth, it is hard not to give considerable credit to its policies toward entrepreneurship. The government has experimented with a wide variety of efforts to develop an entrepreneurial sector:

–  Providing public funds for venture investors seeking to locate in the city-state

–  Subsidies for firms in targeted technologies

–  Encouraging potential entrepreneurs and mentoring fledgling ventures

–  Subsidies for leading biotechnology researchers to move their laboratories to Singapore

–  Awards for failed entrepreneurs (with a hope of encouraging risk-taking)

While much of the initial growth in Singapore can be attributed to sound macroeconomic policies, political stability, and various other factors, the nation’s entrepreneurship initiatives have played an increasingly important role in stimulating growth.

The contrast with Jamaica is striking. Jamaica has long had a high rate of subsistence entrepreneurship: for instance, the 2006 Global Entrepreneurship Monitor survey placed it among the highest of the 42 nations it examined in various rates of entrepreneurial activity. Yet other data collected by the Monitor—and corroborated in anecdotal accounts—suggests that early-stage entrepreneurship is translated into full-fledged business activity at a very low rate. On this measure, the island nation ranked among the lowest nations (28th among the 35 countries ranked by the Monitor in 2005).

Some of the reasons for the inability of Jamaican entrepreneurs to grow can be seen in the World Bank’s reports on the barriers to entrepreneurs. The "Doing Business" series assesses, across 178 countries, the obstacles faced by an entrepreneur in performing various standardized tasks (thereby avoiding some of the subjectivity associated with other attempts to rank entrepreneurship). In several critical indicators, Jamaica ranked extremely low in the World Bank’s 2008 analysis. These suggest some of the barriers that hold back the growth of entrepreneurial enterprises:

–  Of the 178 countries studied, Jamaica ranked 170th in the burden of complying with tax regulations. The ranking reflects not just the cost of the taxes themselves, but also the administrative burdens associated with complying with the tax code. The World Bank's analysis suggests that the total cost of complying with all tax laws in Jamaica amounts to just over one-half of gross profits for the typical entrepreneur. Numerous studies have suggested that one of the most important sources of financing for the typical entrepreneur is cash flow generated by the business itself, which is plowed back into the business. If so much of entrepreneurs’ income is going to meet tax obligations, business owners are unlikely to have the resources to invest in their enterprises. By way of contrast, Singapore ranked second worldwide, with a burden of just 23 percent.

–  Similarly, when the cost of registering property is compared, Jamaica ranked 108th out of 178: the cost of registering property equaled 13.5 percent of the value of the property. (By comparison, the ratio in the United States is 0.5 percent of the value.) The high cost of registering property means that fewer people register their holdings, which in turn leads to less-secure property rights. Most critically, entrepreneurs who do not hold a firm legal title to property are unlikely to be able to borrow against this holding from a bank. Once again, this comparison suggests that entrepreneurs have fewer resources for growing their enterprises.

One of the most visible manifestations of this lack of activity may be in Jamaica’s productivity: from 1973 to 2007, the nation actually experienced negative productivity growth. Even more striking about this poor performance is the fact that during this period developed nations experienced substantial growth through implementing information technology, and many developing markets experienced even faster growth as they caught up with technologies adopted earlier in the West.

While much of the initial growth in Singapore can be attributed to sound macroeconomic policies, political stability, and various other factors, the nation’s entrepreneurship initiatives have played an increasingly important role in stimulating growth.

This disparity may change in future years: Jamaica enjoyed a surge in income with the rise of energy and commodity prices, and the most recent prime ministers have shown a greater awareness of, and willingness to lower, barriers to entrepreneurship. But the disparate experiences of Singapore and Jamaica over the past four decades demonstrate why all of us should care about public efforts to stimulate entrepreneurship.

Thus, while the dollars spent each year on entrepreneurship programs—though significant on an absolute basis—pale compared to defense and healthcare expenditures, the picture changes when we consider the long-run consequences of policies that facilitate or hinder the development of a venture sector: that is, the impact on national prosperity of a vital entrepreneurial climate. In the long run, the significance of entrepreneurial policies looms much larger

What public policies are most effective in encouraging the growth of a venture economy? Three principles in particular seem critical as guideposts.

Remember that entrepreneurial activity does not exist in a vacuum. Entrepreneurs are tremendously dependent on their partners. Without experienced lawyers able to negotiate agreements, skilled marketing gurus and engineers willing to work for low wages and a handful of stock options, and customers willing to take a chance on a young firm, success is unlikely. But despite the importance of the entrepreneurial environment, in many cases government officials hand out money without thinking about other barriers that entrepreneurs face. In some cases, crucial aspects of the entrepreneurial environment may seem tangential: for instance, the importance of robust public markets for young firms to spur venture investment. It is critical to take a broad view and address not just the availability of capital, but other components of a productive arena in which entrepreneurs could operate.

When the cost of registering property is compared, Jamaica ranked 108th out of 178: the cost of registering property was equal to 13.5 percent of the value of the property. By comparison, the ratio in the United States is 0.5 percent of the value.

Let the market provide direction. Two successful efforts have been the Israeli Yozma program and the New Zealand Seed Investment Fund. While these programs differed in details—the former was geared toward attracting foreign venture investors; the latter encouraged locally based, early-stage funds—they shared a central element: each used matching funds to determine where public subsidies should go. In using the market for guidance, policy makers should keep in mind that these initiatives should not compete with independent venture funds or finance substandard firms that cannot raise private capital. Emulating successful initiatives in the past, programs should require a substantial amount of funds be raised from nonpublic sources. To be sure, in encouraging seed companies and groups, leaders should be aware that extensive intervention may be needed before they are “fund-able.” Programs may need to work closely with the organizations to refine strategies, recruit additional partners (perhaps even from other regions), and identify potential investors. But only through a market-based system are the critical flaws that have doomed so many earlier programs likely to be avoided.

Resist the temptation to over-engineer. In many instances, government requirements that limit the flexibility of entrepreneurs and venture investors have been detrimental. It is tempting to add restrictions on several dimensions: for instance, the locations in which the firms can operate, the type of securities venture investors can use, and the evolution of the firms (e.g., restrictions on acquisitions or secondary sales of stock). Government programs should eschew such efforts to micromanage the entrepreneurial process. While it is natural to expect that firms and groups receiving subsidies will retain a local presence or continue to target the local region for investments, these requirements should be as minimal as possible.

The promotion of new business ventures is of critical importance to all of us. While the challenges facing government initiatives may seem arcane and technical, well-considered policies are likely to profoundly influence our opportunities, as well as those of our children and grandchildren. Misguided policies, unfortunately, will also help determine the future. However challenging the encouragement of entrepreneurship may seem, it is truly too important to leave to the policy specialists!

Josh Lerner is the Jacob H. Schiff Professor of Investment Banking at Harvard Business School.

This essay is adapted from Lerner’s book, Boulevard of Broken Dreams: Why Public Efforts to Boost Entrepreneurship and Venture Capital Have Failed—and What to Do about It.

Image by Darren Wamboldt/Bergman Group.

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