Entrepreneurship Ecosystem Policy: Three Key Challenges

This is the second in a series of three blogs discussing entrepreneurship ecosystem policy. You can find the first blog here. The third blog is here.

Many governments talk about entrepreneurship ecosystems. While this is great, few have paused to think through the policy implications of this phenomenon. How do you design policies to facilitate entrepreneurship ecosystems? To understand this challenge, we first need to understand how policy design works.

The notion of market failure is at the centre of modern policy design: the government steps in when the market fails to create some desirable activity on its own. The classic example is investment in R&D. R&D is risky: it is difficult to know beforehand whether the project will succeed. One is therefore tempted to let others take the risk and then simply copy successful projects. If everyone thinks this way, however, no one will invest in R&D. This is why governments offer all kinds of subsidies to lessen the risk for individual firms.

R&D subsidies address a specific, well-defined market failure. However, it is much less clear what the market failure is that entrepreneurship ecosystems correct. In other words, what is the desirable outcome that entrepreneurship ecosystems create? Many thought the answer was more entrepreneurs and hence subsidised new firm creation. But more entrepreneurship does not necessarily mean better entrepreneurship, if the new firms fail to innovate and grow. Subsequently, governments discovered high-growth entrepreneurs and thought this to be the secret. But supporting high-growth firms is not trivial. We know that governments are notoriously bad at picking winners!

High-growth entrepreneurs are only one output that entrepreneurship ecosystems create. The ultimate ‘service’ provided by entrepreneurship ecosystems is more general: it is the allocation of resources towards productive uses. Entrepreneurs pursue opportunities. Successful ones will generate new wealth. This implies that something is done more productively than before. The net outcome of high-quality entrepreneurial churn is enhanced productivity, and therefore, economic growth.

Productivity-increasing entrepreneurial churn is the defining characteristic of well-functioning entrepreneurship ecosystems. But this outcome, or the lack of it, is not easily traced back to specific activities and well-defined market failures. This is what differentiates the policy challenge posed by entrepreneurship ecosystems from more traditional policy-making. We cannot easily pin down specific market failures in entrepreneurship ecosystems, because they are so complex. They incorporate many different stakeholders who interact in myriad different ways. It is difficult for the policy-maker (or anyone, for that matter) to understand how exactly the ecosystem works and what the reasons might be for poor performance. This complexity explains why most attempts to copy the Silicon Valley phenomenon have failed.

We suggest that the complexity of entrepreneurship ecosystems creates three distinctive challenges for policy:

Understanding how the entrepreneurship ecosystem actually works. To design effective policy for entrepreneurship ecosystems, the first challenge is to understand exactly how the ecosystem works. This goes beyond simply describing the static structure of the ecosystem. The real challenge is uncovering  how the ecosystem stakeholders interact and influence one another to produce ecosystem outcomes – i.e., understanding what drives the ecosystem dynamic. Here, it is critical to recognise and understand the bottlenecks that hold back ecosystem performance.

Avoiding unintended consequences. Sometimes policies backfire. They backfire exactly because it is so difficult to fully understand complex entrepreneurship ecosystems. Poorly designed policy interventions that do not address the real bottlenecks of the ecosystem may create more harm than good.

Overcoming ecosystem inertia. Another consequence of complexity is that entrepreneurship ecosystems tend to have high inertia. Once the ecosystem is set in a given more of operation, it is difficult to nudge it into another, possibly better mode. Changing the ecosystem dynamic is difficult, and isolated policy initiatives risk producing no discernible difference in this dynamic. To overcome ecosystem inertia, it is important to both identify the appropriate policy interventions for a given ecosystem and implement these in a coherent, well-orchestrated manner. Only well-orchestrated policies that address real bottlenecks of the ecosystem can hope to enhance the ecosystem dynamic.

Because of these three challenges, ‘hard’ data describing ecosystem inputs, outputs, and resources is not likely to be sufficient to inform entrepreneurship ecosystem policy. For example, even with its 30+ variables, the Global Entrepreneurship Index can only hint at where the ecosystem bottlenecks might be lurking. To overcome the three challenges, ‘hard’ data needs to be complemented with participative approaches that extract ‘soft’ insights from ecosystem stakeholders. In my next blog I will discuss how this can be achieved.