Making Cities Entrepreneurial

There’s an industry of consultants offering advice to city, county and state policy makers on how to generate more entrepreneurs in their locales. Much of this advice is based on research that looks at what’s different about places that have more entrepreneurs from places that have fewer of them.

Many governments are following this advice without looking deeply enough at the research behind it. A brief glance shows four problems with using much of the analysis to develop public policy.

1. The evidence doesn’t always support the theory. Consider, for example, the argument made by economic development guru and consultant, Richard Florida, that increasing demographic diversity will increase entrepreneurial activity. Florida’s own research fails to show that places with more diversity have more entrepreneurs. His diversity index, which measures the share of the population that is gay, and his melting pot index, which captures the foreign born share of the population, have no statistical relationship to the rate of new business formation when other factors are also considered. The theory that increased demographic diversity will lead to more entrepreneurship isn’t supported by the evidence.

2. The causality is often backwards. Again consider Professor Florida’s research. It shows that places with more amenities tend to have more entrepreneurship. But the direction of causality of this relationship is unclear. Does having more amenities lead to more entrepreneurship or does more entrepreneurship result in the creation of more amenities? Because the former interpretation suggests a policy action – build amenities – while the latter does not, policy makers have assumed that more amenities leads to more entrepreneurship and have built amenities in the hope of attracting more entrepreneurs.

3. The studies often focus on only a few types of new businesses. Consider, for example, a new report by Edward Glaeser and William Kerr with the catchy title “What Makes a City Entrepreneurial?”

In their study, the authors defined “entrepreneurship” as the formation of new independent manufacturing establishments with employees. While that definition sounds reasonable, these businesses account for only one percent of all new companies.

Drawing conclusions from a one percent sample wouldn’t be a problem if the places that have a lot of new manufacturing employers also have lots of other types of new businesses. But they don’t. Glaeser and Kerr write, “Our entry metric has a 0.36 … correlation with the 2000 self-employment rates at the city … level.” That is, cities with the highest self-employment rates aren’t the ones that have lots of new independent manufacturing establishments with employees.

Recent research conducted by Larry Plummer for the Office of Advocacy of the U.S. Small Business Administration provides further evidence for why drawing conclusions about entrepreneurship on the basis of new business formation in manufacturing is problematic. Looking at the rate of new independent establishment formation from 1990 to 2006, Plummer found that the rate in manufacturing correlated only 0.33 with the overall rate. Moreover, it correlated only 0.16 with the rate in retail trade, 0.13 with the rate in high tech, and 0.06 with the rate in business services.

Moreover, the top places for new manufacturing business creation are not the same as the superstars for new firm formation in other economic sectors. Of the 20 counties with the highest rate of creation of manufacturing establishments from 1990 to 2006, only one, San Juan, Colorado, was in the top 20 counties for overall rate of new business formation.

4. The factors that stimulate one type of entrepreneurship often dampen others. Consider, for instance, the factors that enhance entrepreneurship in manufacturing and high tech. Plummer’s study showed that places with more college graduates had fewer manufacturing start-ups, but more new high tech businesses. Many would argue that we should increase the number of college graduates in a region, even if that comes at the expense of number of manufacturing businesses started, especially if the rise in the number of degree holders leads to a boost in high tech start-ups.

In short, academic research doesn’t provide strong evidence of specific policies that increase rates of entrepreneurship in a locale. Maybe government officials should take the money that they are using to implement the academics’ recommendations and give it to the entrepreneurs they are trying so hard to create.

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Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

6 Reactions
  1. Thanks for that data, Scott.

    As a fellow Clevelander, I’m curious as to your take on the supposed economic value of us having a star like Lebron James here.

    (Ok. He WAS here)

    Supposedly, he brought millions of dollars to our economy. Sorry, I don’t see it, or feel it.

    What was built or done in Cleveland because of Lebron, that’s helped this dying city come of age?

    The Franchise King

  2. Scott,

    Your perhaps tongue in cheek final comment could very well be a reasonable prescription. Cities looking to promote entrepreneurial activity (and with all net job growth in the last 30 years coming from entrepreneurial firms – who wouldn’t want to promote such formation?) should perhaps look at more direct actions designed to support actual entrepreneurs.

  3. Gents, there seems to be an assumption by policy-makers that promoting entrepreneurship is a naturally good thing. Who doesn

  4. Wow, Chris, this is a great point. A tough one to deal with — in many ways. Many people might not start out with the skills or resources but could get them or acquire them. I mean look at microlending in developing nations. These folks who have little have a burning desire to improve their lives and they figure it out, and fast. It is a hard slog.

    Perhaps we use the term entrepreneur synonymously with small biz owner (either is tough and a slog). In my mind, entrepreneurship is tougher in you are creating something totally new (or an iteration of something that is still relatively new), whereas I could create a keymaking shop or a buy a franchise or open a cafe.

    That isn’t entrepreneurship, in my opinion, although that owner might still be entrepreneurial. I think it is more than semantics — are you creating a new way of doing things? Maybe an example would be the Creme Brulee Man in San Fran. He’s opened a food stand, but markets only via Twitter. That would achieve my last comment — traditional biz with new way of doing biz.

  5. As a certified business coach and owner of a franchise – The Growth Coach, I often feel more money is needed to help current business owners who need to better develop their plans and strategies and take that leap of faith to grow their business and hire more employees.

    The franchise was the idea of CPA who saw a need. Our concept is to coach business owners, managers, and the self-employed to become more strategic and focused and grow their businesses whether it be the technician now business owner or an owner of a large company.

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