3 Skills as determinants of firm productivity
A range of skills are utilised within the firm. Three broad categories of skills are considered here: entrepreneurship that identifies and responds to market and innovation opportunities; the managerial capabilities associated with overseeing production activities; and the technical skills required to undertake production processes. These roles, while being presented as distinct for the purposes of this discussion, in reality probably exist along a continuum. They may be undertaken by separate people, or combined in the one individual, especially in smaller firms. This section explores in more detail some of the attributes of each of these categories of skills, and the factors that influence their contribution to firm productivity.
Following Baumol (1993, p3), entrepreneurship is distinguished from management. The entrepreneur chooses the output and the technology, and is responsible for the marketing strategy. The manager, given these settings, chooses the labour and capital inputs, and the organisational structure and management practices, in order to produce and market that output. Entrepreneurship might be viewed as pushing out the production frontier, while the role of management is to remove inefficiencies and move the firm outwards towards its production frontier. As a result, both of these roles are clearly important in improving firm productivity. There is inevitably some fuzziness at the boundary of these activities in terms of the pursuit of market opportunities, utilisation of technology, choice of organisational structure, and development of an innovative culture.
Bowles et al (2001) identify a similar set of skills required within the firm. Skills may be “Walrasian” in that human capital is viewed as a factor in the production process in the neoclassical sense. The attributes required by the parties in moving to equilibrium are not considered. They may be “Coasean”, reflecting the capabilities to generate and work within different organisational structures. “Schumperterian” skills relate to the abilities needed to seek out opportunities, adapt to change, and respond to markets in disequilibrium. However, Acemoglu (2002) considers that the Schumpeterian and Coasean ideas are similar, in that an important dimension of skills may be adaptability to working in different production environments.
3.1 Entrepreneurship
Entrepreneurial skills influence firm performance through the choice of final outputs. Their role is in recognising and pursuing unexploited market opportunities. Different measures of entrepreneurship have been used. Some of the literature on the subject associates entrepreneurship with small business activity and firm entry. For example, Audretsch and Thurik (2001) look at the link between entrepreneurial activity in a country, as measured by the self employment rate and the share of economic activity accounted for by small firms. Carree and Thurik (2003, p445) cite literature indicating that small enterprises serve as the engine of innovative activity in some industries. However, Baumol (2004) sees two types of entrepreneurship: breakthrough inventions undertaken disproportionately by smaller independent inventors and entrepreneurs; and cumulative, incremental improvements by larger firms with substantial R&D activities. It therefore appears more useful to think of entrepreneurship as a general activity, rather than the functions performed by particular people or firms.
Differing views exist about the set of key functions that entrepreneurs contribute. They involve varying combinations of the recognition of market opportunities, risk taking, R&D and innovation, the re-allocation of resources amongst firms, arbitrage, and market coordination. Formaini (2001) and Rima (2002) set out the development of understanding and treatment of the entrepreneur in economics. For Rima (2002), the entrepreneur is “someone who specializes in taking responsibility for and making judgment decisions that affect the location, form and use of goods, resources or institutions”. Rigotti, Ryan, and Vaithianathan (2001) build a model of entrepreneurial innovation and risk aversion, with types of firms led by bulls and bears who interpret imprecise risk information in more optimistic or pessimistic ways. The model developed by Blanchflower and Oswald (1996) finds that the probability of self-employment rises with receipt of an inheritance or gift. They posit that entrepreneurs perceive business opportunities that are not seen by others, but are constrained in taking them up by limits on borrowing. Kirzner (1997) reviews the more general coordinating role of entrepreneurs in markets as moving the economy towards equilibrium.
Lazear (2002) views entrepreneurs as “jacks of all trades who may not excel in any one skill, but are competent in many”. They differ in this regard from specialists. His model tested whether entrepreneurs (those who reported starting a business) had a broader skill base that was built up from more diverse studies and/or a wider range of work experiences. He used data on alumni from Stanford Graduate School of Business, and found that entrepreneurs are more likely to have held a number of prior roles, and taken a more dispersed set of courses. The “jack of all trades” label also applies to senior managers. A similar study by Charney and Libecap (2000) explores how entrepreneurship education contributes to the sales and employment growth of small firms. It also appears to contribute to the transfer of technologies from universities to the private sector. Bowles et al (2001) note that, while part of the skill set of entrepreneurs is amenable to development through training (such as analytical ability), other elements may be innate (such as imagination and attitudes to risk), while others (such as foresight, or soundness of judgment) may be honed through learning-by-doing.
Baumol (2004) contrasts the very different (but complementary) modes of operation of the smaller independent inventors responsible for a disproportionate share of breakthrough inventions, and of those larger firms involved in cumulative, incremental research. The skill sets utilised are very different, which is reflected in their educational backgrounds. Break-through inventions require originality and imagination, and tend to be provided by those who have had little formal training. In contrast, the incremental advances in the large firm’s R&D activity require researchers to be highly equipped in extant knowledge and analytical methods. While the teaching practices required for the mastery of current knowledge and practices are well known, Baumol notes that much less is known about the appropriate training for those generating breakthrough inventions.
Entrepreneurial activity is essential to the process of innovation and adaption to market opportunities. Their contribution to the productivity of firms is in finding new ways of carrying out economic activities, and developing new market opportunities. Schumpeter saw the entrepreneur as the main player in the process of competitive rivalry, through creative activities such as the opening of new markets, and the introduction of new goods or production processes. These confer monopoly power and profits for a time, and engender a process of creative/destruction. Baumol (1993) also sees this role as enhancing the dissemination of new technologies and knowledge through an industry, by looking for new or non-standard ways of doing things. While not all entrepreneurial activities are successful, in terms of firm dynamics they are responsible for firm entry, and a significant part of the resource re-allocation occurring within and between firms.
Baumol (1993) argues that entrepreneurs can act in productive or unproductive ways, depending on the structure of payoffs that they face, and that this is important for growth. They respond to the profit objective on the basis of the “rules of the game”. Consequently, they can act in ways that improve efficiency and spur growth, or engage in rent-seeking. Three broad groups of regulatory policies affect the structure of payoffs: product market regulations; policies that affect the costs to the firm of entering or exiting the industry; and access to financial resources.
In terms of product market settings, the OECD (2003b, Chapter 3) argues for pro-competitive regulations to improve productivity performance and stimulate entrepreneurial activity. Increased product market competition provides more scope for risk takers to explore new business opportunities, and stimulates the process of creative destruction (firm entry/exit). Here innovation is the primary means whereby rivals maintain their market share. Competition also acts to constrain rent-seeking and eliminate slack in the use of inputs. Conversely, restrictive regulatory policies make catching up to technology leaders difficult. Cross-country OECD work has shown that over half of labour productivity gains come from within firm resource reallocation. The OECD notes that entry is important in industries where the technology is changing, as in the case of the uptake of ICT. Gains also come from low productivity firms closing down.[6]
Policies influencing the costs to the firm of entering or exiting the industry can also affect entrepreneurial activity. Such policies influence the scope for resource re-allocation. They include employment protection legislation (EPL) (see OECD (2003b), where there is some evidence that high hiring and firing costs weakens incentives to innovate and affects productivity performance. The adjustment costs associated with stricter EPL relative to the costs of internal retraining can also influence the adoption of new technologies. Other costs of firm entry/exiting are those associated with firm registration and bankruptcy, and the rules around mergers, takeovers, foreign direct investment (FDI). The OECD (2001, Chapter V) considers the effects of regulations around firm registration and bankruptcy. If administrative barriers prove to be excessive, complicated or protracted, entry can be discouraged.[7] Black and Strahan (2004) provide a case study, looking at business formation following US banking deregulation.
Access to financial resources is also important to support firm creation and entrepreneurial activity. The OECD (2001, Chapter V) comments on the role of well developed and regulated financial markets, in relation to the availability of risk-capital for firms starting up. Lack of finance is viewed as potentially being an important impediment to the entry of innovative new firms. Kreft and Sobel (2003) examine the relationship between entrepreneurial activity and access to venture capital in US states. They explore which side of this relationship local government strategies should focus on, by investigating the direction of the causal relationship. They compare two measures of entrepreneurial activity (sole proprietorships and patent activity) with a measure of venture capital investment. Their results show a one-way causal effect flowing from entrepreneurship to venture capital investment, suggesting that higher entrepreneurial activity in a state causes an inflow of funds. There is a question of whether sufficient controls included for omitted variables to allow conclusions to be drawn at this level of aggregation.
The case study by Lerner (2004) looks at the rationale for, and effectiveness of, the government being involved in the practice of subsidising small high-tech firm start-ups. He explores the two assumptions underlying such interventions: that the private sector will provide insufficient capital to start-up firms, and that governments can identify profitable investments. He notes that such start-ups are inherently risky, and that the providers of financial resources face severe informational asymmetries. If venture capitalists often pick losers, can governments do better? Lerner then evaluates the rationale for government involvement, in terms of certifying these firms to venture capitalists, and generating technological spillovers. He then considers the challenges of designing interventions to achieve the aims and limit the risks involved.
Audretsch and Thurik (2001) look at the link between entrepreneurial activity in a country (as measured by the self employment rate and the share of economic activity accounted for by small firms) and growth performance. They find increases in entrepreneurial activity occurring where industry structure is moving to a greater role for smaller firms. They argue that high levels of uncertainty associated with technological change, deregulation and globalisation have shifted industry structure towards less concentration and decentralisation. They also argue that, because of the inherent features of knowledge such as uncertainty and knowledge spillovers, entrepreneurship becomes more important in a knowledge economy. Further, entrepreneurial firms become an important vehicle for the transmission of those spillovers. Their policy prescription emphasises approaches that enable the creation and commercialisation of knowledge, such as encouraging R&D, venture capital and firm start-ups.
The Global Entrepreneurship Monitor (Reynolds, Bygrave and Autio 2003) provides a periodic assessment of national entrepreneurial activity. GEM provides two measures of entrepreneurial activity. The Total Entrepreneurial Activity (TEA) index measures the proportion of start-up firms in their first 42 months of operation, on the basis of population telephone surveys. The Firm Entrepreneurial Activity (FEA) index provides a measure of entrepreneurial firms amongst existing firms, on the basis of a survey of experts. The latest GEM (2003) puts New Zealand in the top bracket for both indices, along with a number of other non-OECD countries. (There are some questions about the robustness of subjective assessments used in the indices, and the comparability of this data across countries.)
