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Enterprise and Productivity: Harnessing Competitive Forces - TPRP 08/04

Entrepreneurial activity: how does New Zealand perform?

A number of factors are important for the attractiveness of the business environment and the health of New Zealand’s firms. A climate that fosters a culture of entrepreneurship and risk-taking is an important base to produce the individuals who seek out new market opportunities. This needs to be supported with access to capital, a skilled workforce and a fertile public research base that can provide resources and ideas to enable individuals to identify and take advantage of new opportunities. Finally, this activity takes place within the context set by the policy framework, in particular the competition, regulatory and tax systems.

Given the broad definition of enterprise adopted, it is difficult to accurately measure entrepreneurial performance and there are a number of criteria on which New Zealand could be assessed and classified. Unfortunately, perfect measures are not available for many of these criteria. This paper therefore attempts to look at those areas where New Zealand can be assessed and where it also judges these to be important for New Zealand’s enterprise performance.

International benchmarks

New Zealand scores well in international benchmarks…

A variety of studies purport to measure the attractiveness of New Zealand’s competitiveness as a country or the quality of its business environment. These studies can focus on a broad or a narrow set of measures. The World Economic Forum’s Global Competitiveness Report ranks New Zealand 24th out of 131 countries, based upon a range of metrics from basic economic measures such as macroeconomic stability and the quality of infrastructure through to more specific efficiency enhancers such as higher education, financial market sophistication and innovation performance. New Zealand ranks highly for health outcomes, the quality of primary education, financial market sophistication, labour market efficiency, institutions and goods market efficiency. Other studies are more specific in nature, such as the World Bank’s Ease of Doing Business report, which focuses on regulatory obstacles to economic activity. In 2008, New Zealand ranked second in the world for the overall ease of doing business and third for the regulatory ease of starting a business. From the report, it can also be seen that there are a number of economies quickly catching up in this area.

However, these metrics only scratch the surface of New Zealand’s performance, and do not consider all factors that are necessary for the promotion of an entrepreneurial environment. To get a fuller picture of New Zealand’s climate for enterprise, the paper now looks at firm dynamics in New Zealand, the level of firm internationalisation and possible barriers to growth.

Firm dynamics: start-up, growth and large firm performance

…and provides the foundations for a high level of start up activity…

The enterprise culture is alive and well in New Zealand; almost one in seven adults in New Zealand are classified as entrepreneurs, one of the highest levels in the world (Frederick, 2004).[1]McMillan (2004) argues that the proportion of multi-millionaires that are self made rather than inheriting their wealth is higher in New Zealand than in Australia, Britain or the United States. Whilst this is also important for social mobility, McMillan uses this statistic to infer that the business environment is receptive to enterprising individuals.

The level of turnover: entry and exit, in New Zealand is high, but not significantly out of line with other countries. Roughly 24 per cent of firms will either enter or exit the market in any given year (Mills and Timmins, 2004). Law and McLellan (2005) find that between 1995 and 2003, the existence of exiting firms added to labour productivity growth. In other words, exiting firms had below average labour productivity growth, and by exiting the average productivity of the firms remaining increased. Ideally, entering firms would have above average productivity; however entering firms drag the average level of labour productivity down. This is also true of the United States and it does not necessarily imply a negative impact from entering firms in the long run. The statistic only looks at firms’ labour productivity in the first year of entry and, as such, may miss any growth that subsequently occurs. Alternatively, it may be caused by low barriers to firms’ entry in both New Zealand and the United States that gives rise to a culture of experimentation. That is, some new firms will not be based upon good ideas but by having a large quantity of new entrants, some will succeed.

New Zealand has a slightly higher number of small firms than the average OECD country but is not a significant outlier: 90.7 per cent of firms have less than 20 employees and account for nearly 30 per cent of all people employed, roughly consistent with other countries (Mills and Timmins, 2004). If the number of small firms is an indication of the business start-up culture in New Zealand, then New Zealand performs well. Therefore, whilst further improvements are likely to be possible, the evidence leads us to conclude that there is no significant barrier to starting-up a business in New Zealand as compared to other countries.

…with no strong evidence that firms face significant barriers to growth

While New Zealand has a high level of start-ups and a good base of small firms, it has been suggested that New Zealand has a higher than average number of small firms with low levels of employment in each (Simmons, 2004). This could indicate that there are significant barriers to growth facing small firms following start-up that prevent them from growing into medium or large sized firms. New Zealand’s high level of firm turnover has been used to give greater support to this conclusion, arguing that barriers to growth lead to higher levels of exit for small firms.

More recent evidence is refuting the strength of this conclusion. As shown above, the number of small firms in New Zealand is broadly comparable internationally, and whilst the number of employees per firm, especially in the manufacturing sector, is low, New Zealand is not a significant outlier. At 13.7 employees per firm, the average firm size is smaller than many countries, such as the USA with 25.6 employees per firm and Germany with 17.7 employees, but it is certainly not an outlier, as both Finland and Italy have smaller average firm sizes (Mills and Timmins, 2004).

Firm turnover in New Zealand is relatively strong. However, while creative destruction is a productivity enhancing force that reallocates labour and capital to more productive uses, it is also necessary to consider whether there are barriers to growth that lead to New Zealand’s higher levels of turnover and potentially restrict growth for small firms. If barriers to growth were creating this then it should be apparent in the growth and survival rates for New Zealand firms.

McMillan (2004) concludes that growth rates for small firms in New Zealand, whilst behind the United States, are comparable to those in the United Kingdom and other OECD countries. Although there is some evidence that employment growth in surviving firms is low after two years, this picks up after four and seven years (Mills and Timmins, 2004). Law and McLellan (2005) show that conditional on survival, the firms who entered in the years 1995 to 1999 had average labour productivity growth of between three per cent and 12 per cent depending on the year of entry. Figure 1 below shows the growth of cohorts of entering firms in the years 1995 to 1999 conditional on the firm having survived to 2003.

Figure 1: Growth of entering firms, conditional on survival in 2003
Figure 1:  Growth of entering firms, conditional on survival in 2003.
Source: Law and McLellan (2005)

The empirical data do not provide robust support for the theory that small firms face significant barriers to growth, as compared to other countries. A more likely explanation for the high level of turnover in New Zealand is the ease of starting and closing a business. Low regulatory barriers, compared to other countries, may partly explain the higher level of start-up activity, some of which will inevitably fail. This supports the theory that this churn is productivity enhancing: individuals should be given every chance of starting a new business, but if it turns out to be a poor performer, policy should not prevent its demise.

Some questions over the performance of large firms…

There is some evidence to suggest that the performance of large firms is poor by international comparison and that New Zealand lacks the very large firms that can be found in a number of other OECD countries. Simmons (2004) argues that, as measured by returns on assets or value added, large firms have been performing poorly in New Zealand. The strength of this conclusion is still unclear and there are no certain explanations for why this might be. Possible explanations are a low level of competition for some types of large firm and a lack of managerial talent, both of which are discussed further below.

In addition, New Zealand lacks the very large firms seen in a number of other OECD countries. There is no discernible barrier that prevents firms from getting to 100 employees; among firms with 50 to 99 employees in 1995, 22 per cent had grown to over 100 by 2002 (McMillan, 2004). However, the size of very large firms appears to be constrained within New Zealand; the average size of a firm with greater than 500 employees in New Zealand is 1594, compared to 2532 in the UK and 3321 in the USA (Mills and Timmins, 2004). This suggests that there may be barriers for large firms reaching an efficient scale, perhaps due to New Zealand’s domestic market size combined with difficulties faced by firms seeking to export.

With the exceptions of some question marks over the performance of New Zealand’s largest firms, the business environment looks strong and firm dynamics in New Zealand are similar to other OECD economies. Frederick (2004) notes that New Zealand has both a high level of individuals engaged in creating their own business and a high number of existing firms that are introducing new innovative products and services to the market. Combined, these firms produce roughly half of all the jobs created per year.

The paper now turns to the number of firms that successfully internationalise as a potential indicator of underlying problems with New Zealand’s business environment.

Notes

  • [1]Entrepreneurial activity is defined as involvement in early stage business start-up activity.
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