Building an Entrepreneurial Ecosystem in Declining Regions

The production and application of new knowledge is often seen as pivotal to economic growth and prosperity. This idea forms the basis for several policies intended to ignite the engine of economic progress in both growing and declining regions.  These developments—coupled with deregulation, pension fund reforms that gave rise to institutionalized venture capital and the reorganization of most corporate R&D activities—have been followed by decades of unprecedented economic dynamism.

Indeed, whereas in the early post-war period innovation tended to be carried out by large firms in capital-intensive, concentrated industries characterized by highly differentiated goods, the last two decades have been characterized by a different entrepreneurial ecosystem in which innovation is carried out primarily by new firms in highly knowledge and skilled-labor intensive clusters (information and communication technologies and biotechnology). For example, the performance of small companies versus large ones (measured by the price of small capitalization stocks relative to the S&P) is about equal from the end of World War II to the late 1960s and then rises dramatically to a 4:1 ratio by the mid-1980s.

This structural transformation of the United States’ economy, among others, emphasizing the contribution of new firms suggests that the production and application of knowledge, although a necessary condition, is not sufficient alone for economic growth in regional economies. Instead, it seems that any general knowledge available in the economy must be actively converted into economically useful knowledge through an entrepreneurial ecosystem. Moreover, the conversion of knowledge seems a highly localized process given evidence that the flow and diffusion of knowledge is spatially constrained.

However, while growing regions rely on a mix of new and existing firms, the question of whether this is also applicable to declining regions has remained a policy question for some time. Should declining regions be revitalized by propping up and transforming existing industries and firms or should they be allowed to exit and new firms encouraged to penetrate the ecosystem? This question is at the heart of smart specialization in European regions and the application to European Union Cohesion Policy. [1]

Smart specialization assumes that context matters for the potential technological evolution of the entrepreneurial ecosystem. Entrepreneurs will search out the entrepreneurial opportunities within their regions. Finding ways to enhance these entrepreneurial search processes is essential as it is these that drive the identification and exploitation of entrepreneurial opportunities that capitalize on the potential advantages of regions.

But what evidence to we have that the process actually works in backward, restructuring or declining regions? A recent paper looking at the state of Ohio (that is similar to Sweden in population and industrial structure) has shown that new firms are more proficient at penetrating the ecosystem than are incumbent firms.[2]

Ohio, comprised of 88 counties, is a mid-western state with a rich history of industrial dominance and has experienced economic decline in recent decades. Ohio’s gross state product kept pace with the United States average until 1979 and began to lag considerably thereafter.  Colorado, by contrast strongly surged ahead of the US average increasing the gross state product by a factor of 40 during the same time period. The new study explores the role of both new and incumbent firm for a panel of ten years using spatial panel estimation techniques to provide a robust finding. The study regresses total personal income growth on the stock of knowledge, number of incumbents and new ventures as well as interactive terms with knowledge*new ventures and knowledge*incumbents. The paper suggests that:

  • New Ventures and Knowledge: New firms and the interaction of knowledge*new ventures have a positive impact on economic growth in declining regions.
  • Existing (large) firms and Knowledge: Incumbents and the interactive term of incumbents*knowledge has a negative effect on income growth. In other words, incumbents will not be able to absorb new knowledge.
  • Entrepreneurship and Growth: When knowledge is interacted with new ventures, knowledge is positive and significant and new ventures and incumbents become insignificant. In other words, once you control for the interaction between knowledge and new ventures, other ventures and existing incumbents do not contribute to growth.

These results suggest that new ventures, smart specialization and knowledge are important for economic growth in declining regions and growing ones alike. Therefore, strengthening the entrepreneurial ecosystem is important for economic growth regardless of economic status. Failing to strengthen these systems will just reinforce a downward spiral. What counts? It appears that knowledge, knowledge spillovers and regional absorptive capacity top the list. Without the creation of new knowledge and its exploitation regions will continue to decline.

[1] McCann, P., R. Ortega-Argiles, “Smart Specialization, regional Growth and Application to European Union Cohesion Policy, Regional Studies, 2013.

[2] Acs, Z, L., Plummer and R., Sutter: Penetrating the knowledge filter in “rust belt” economies, Annals of Regional Science, (2009) 43: 989-1012.