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Entrepreneurship Dynamics, Market Size and Fiscal Policy

It is anticipated that the world's economies will be faced with severe macroeconomic challenges over the next decade. The global financial crisis and the resulting global recession led to the closure of many firms, rising unemployment and high levels of public debt in most developed countries. Despite the end of the recession, fears for the future growth of demand remain. The need to reduce public sector deficits, built up partly as an initial response to the crisis, through increases in taxation and reductions in government expenditure have led some to predict that growth will remain low, and unemployment high, for many years to come.

Against this macroeconomic backdrop, entrepreneurs and entrepreneurship (in this case identified by rates of new firm entry and exit) have been identified as a potentially important factor needed to drive future growth and employment in many countries. The evidence to support this as a possibility is relatively plentiful. Leonard (1988) for example estimates that the creation of new firms accounts for 11 per cent of the total outflows from unemployment, while Bartelsman et al. (2005) find that employment levels in some entrants expands rapidly.

The process of creative destruction has also been found to play an important role in generating productivity growth at both an industry and economy-wide level. For the United States, Foster et al. (2001) calculate that 35 per cent of productivity growth over a five year period is attributable to firm births and deaths. Similar evidence exists for Canada, where Baldwin and Gu (2002) find plant turnover contributes 15-25 per cent of labour productivity improvements between 1973 to 1997. Finally, for the UK Disney et al. (2003) estimate that 49 per cent of total labour productivity growth in the manufacturing sector between 1980 and 1992 is explained by the net-entry of firms.

Yet, while that confirms the potential for entrepreneurship as a future driver of employment and growth, it leaves open the question of whether the present macroeconomic conditions of weak (domestic and foreign) demand and fiscal retrenchment may themselves reduce the level of entrepreneurship that takes place, thereby undermining the role that entrepreneurship may play in any macroeconomic recovery. To develop an answer to that question in this paper we explore what, if any, is the relationship between fiscal policy (taxation and expenditure), the growth of demand (domestic and foreign) and entrepreneurship dynamics (the rate of new firm entry and exit). For this task we use data for entry and exit rates covering 28 2-digit industries (both manufacturing and services) in 17 OECD countries over the period 1998 to 2005.

Entrepreneurship Dynamics, Market Size and Fiscal Policy