New Business Formation and Regional Development-A Survey and Assessment of The Evidence

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New Business Formation and Regional Development—A Survey and Assessment

of the Evidence
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DOI: 10.1561/0300000043
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Foundations and Trends R
in
Entrepreneurship
Vol. 9, No. 3 (2013) 249–364

c 2013 M. Fritsch
DOI: 10.1561/0300000043
New Business Formation and Regional

Development: A Survey and
Assessment of the Evidence
By Michael Fritsch
Contents
1 The Link Between New Business

Formation and Growth 251
2 Emergence of the Research Field 253
3 Theory: The Role of Entrepreneurship in Economic

Development 256
3.1 The Nature of Entrepreneurship 256

3.2 The Industry Perspective: New Firms and
the Evolution of Markets 259
3.3 Growth Theory 264
3.4 Entry, Competition, and Growth:
An Eclectic Explanatory Approach 267
3.5 Summary and Conclusions 281
4 Results of Empirical Research 285

4.1 Methodological Issues 285
4.2 The Direct Contribution of New
Businesses to Employment 290
4.3 The Overall Effect of New Business Formation on
Employment and GDP Growth 294
4.4 Indirect Effects of New Business Formation 299
4.5 The Quality of Entry 307
4.6 Regional Differences in the Effects of New Business
Formation on Economic Development 315
4.7 Is New Business Formation a Cause or a Symptom
of Regional Development? 329
4.8 Summary of the Empirical Evidence 332
5 Implications for Entrepreneurship Policy 334
6 Avenues for Further Research 337
7 Final Remarks 344
Acknowledgments 346
References 347
Foundations and Trends R
in
Entrepreneurship
Vol. 9, No. 3 (2013) 249–364

c 2013 M. Fritsch
DOI: 10.1561/0300000043
New Business Formation and Regional

Development: A Survey and
Assessment of the Evidence
Michael Fritsch
Friedrich Schiller University Jena, School of Economics and Business

Administration, Carl-Zeiss-Str. 3, D-07743 Jena, Germany,
m.fritsch@uni-jena.de
Abstract
This monograph reviews the current state of knowledge about the
effects of new business formation on regional development. These effects
are diverse and include the creation and destruction of employment,
introduction of innovations, structural change, and increasing produc-
tivity, among others. Theory particularly emphasizes the role that some
new businesses play in the diffusion of knowledge and innovation as
drivers of economic growth. I provide an explanatory approach that
highlights the competitive challenge that start-ups pose to incumbent
firms and discuss important implications. The overview of empirical
research particularly deals with the development of start-up cohorts,
identification of different types of indirect effects and their magnitude,
differences based on characteristics of entry, and regional variation. A
general conclusion is that the diverse indirect effects of new business
formation on development are much more important than the growth
effects created by newcomers. The diverse indirect effects of entry on
development are currently less than fully understood. Finally, I draw
conclusions for policy and put forward a number of important questions
for further research.
Keywords: Entrepreneurship, new business formation, employment,

regional development
JEL Codes: L26, M13, O1, O18, R11

1
The Link Between New Business
Formation and Growth
The belief that new business formation is a source of economic

growth has been a strong motivation for a great deal of research in
entrepreneurship. It has also motivated politicians in many countries
to devise strategies aimed at stimulating the formation of new firms.1
However, the theoretical and the empirical foundation for this belief
are remarkably weak. Empirical research on the issue started late and
only recently have researchers begun to assess the effects of new busi-
nesses on economic development in detail. The effect of new business
formation on regional development is an important field of research.
This type of research can provide insight into the relationship between
business dynamics and the different aspects of development, such as the
growth and decline of employment, structural change, innovation, pro-
ductivity increases, well-being, and the like. A proper understanding of
these relationships may provide important input for policies aimed at
stimulating growth.
1 See,
for example, Wennekers and Thurik (1999), OECD (2003), Commission of the
European Communities (2003, 2010), Reynolds et al. (2005), and the contributions in
Audretsch et al. (2007) and Leitao and Baptista (2009).
251
252 The Link Between New Business Formation and Growth
This monograph provides an overview on the current state of

knowledge about the effects that new businesses have on regional devel-
opment. The focus is on regions because geographical units of observa-
tion are much better suited for such an analysis than are industries (see
Section 4.1). The reasoning behind this statement is that if industries
follow a life cycle (Klepper, 1997), then the number of entries and the
start-up rate will be relatively high in the early stages of the life cycle
when the industry is growing, and comparatively low in later stages
when the industry is in decline. In such a setting, the positive corre-
lation between the start-up rate and the development of the industry
in subsequent periods can hardly be regarded as evidence for a posi-
tive causal effect of entry on growth but it may be appropriate to view
entry as a symptom of industry development. Accordingly, the results
of empirical analyses at the regional level can be considerably different
from those found in an analysis at the industry level (see Fritsch, 1996).
Regional growth is a complex process that involves large numbers
of start-ups in diverse industries, firm exit, and growing and declining
incumbent firms. The determinants of the effects that new business
formation has in this complex process may be rather different from
those factors that make individual start-ups either a success or a fail-
ure. Hence, this survey does not concern itself with the determinants of
individual firms’ success or failure. It begins with a brief sketch of the
extant research on this topic (Section 2). Section 3 reviews the main
theoretical approaches that may provide insights and explanations and
combines them “more eclectically” in an attempt to explain the effects
of start-ups on development. This eclectic approach particularly high-
lights the competitive challenge that start-ups pose to incumbent firms
and the important role played by the regional environment. Section 4
reports the available empirical evidence on the different effects that new
business formation might have on regional development. Policy impli-
cations are discussed in Sections 5 and 6 outlines important questions
for further research. Section 7 concludes.
2
Emergence of the Research Field
Theoretical attempts to explain why and how entrepreneurship and

new business formation should drive economic development are some-
what fragmented. The literature identifies Joseph A. Schumpeter as the
first to recognize the importance of entrepreneurship and new business
formation for economic development. In his book, Theory of Economic
Development, published first in German in 1911,1 and again in his 1939
book Business Cycles, he investigated the sources of economic devel-
opment in economic history. He put forward a number of empirical
examples of growth and structural change being initiated by some new
businesses founded by dynamic entrepreneurs. Schumpeter was par-
ticularly interested in these rare dynamic entrepreneurs who made a
strong impact on the economy by introducing radical innovation. He
described their personalities and the resistance they had to overcome
on the road to success.
One result of Schumpeter’s writings was the emergence of business
history as an academic discipline dealing with the development of firms
1 The English edition of this book was published in 1934, more than 20 years later, and was
based on a considerably revised and particularly shortened version of the original German
text.
253
254 Emergence of the Research Field
and, thereby, with entrepreneurship (McCraw, 2007). However, in the

first decades following Schumpeter’s work, entrepreneurship did not
attract a great deal of attention. Although the occurrence of relatively
large groups of innovative new businesses, for example, in the Silicon
Valley of California, attracted some interest in the issue (see, for exam-
ple, Roberts, 1969; Morse, 1976), the real starting point of systematic
empirical analyses of the effects of new business formation on economic
development was a study by Birch (1979, 1981, 1987) claiming that new
businesses are the main job generator in the U.S. economy. This claim
received responses ranging from enthusiastic praise for a new solution
to employment problems to pronounced skepticism (for a review of ini-
tial reaction to the Birch study, see, for example, Storey 1994).2 Most
importantly, however, the study stimulated numerous follow-up analy-
ses for the United States as well as for many other countries. The shift
of attention toward small firms and entrepreneurship was stimulated
by numerous empirical studies finding that such firms could be quite
competitive and economically successful.3 Indeed, many of the indus-
trialized countries experienced a growing share of employment in small
firms at that time (see, for example, Audretsch and Thurik, 2001, and
the contributions in Acs and Audretsch, 1993).4
One main innovation of the Birch study was its analysis of longitu-
dinal micro-level data that covered nearly the entire U.S. economy. In
investigating the development of the U.S. economy, the study followed
the development of business cohorts of a certain age or size over the
years. Unfortunately, reliable information on new business formation
and longitudinal micro-level data, which would have allowed employ-
ment in firms and establishments5 to be tracked over the years, was
2 Wennekers and Thurik (1999) suspect that the enthusiastic reactions to the Birch study
may be partly explained by a shift in policy toward supply-side economics at that time
when the overall economic situation in many countries was characterized by stagflation
and high unemployment.
3 For example, Acs (1984), Acs and Audretsch (1990), Brock and Evans (1986), Piore and
Sabel (1984), Sengenberger et al. (1990), and Storey and Johnson (1987).
4 Carree and Thurik (2010) provide an overview on the possible reasons for this development.
5 A start-up can be either a new firm or a new establishment of a multiplant enterprise.
The term “new business” is used here as an overall category that encompasses the setup
of new headquarters as well as the creation of a new subsidiary establishment.
255
rarely available at the time,6 and considerable effort was expended on

making existing data sources accessible for research and on the creation
of new ones. In this respect, also, the Birch study had an enormous
impact.
The bulk of the empirical research motivated by the work of David
Birch is comprised of micro-level studies that focus on the development
of young and small firms. These studies make it clear that small firms
do not generally grow faster than larger firms; some small firms do,
but most continue with only a few employees and face a relatively
high risk of exit. A number of studies find that the age of a firm is
much more important in explaining its development than is its size
and that younger firms seem to have higher growth prospects than older
ones.7 This recognition directed attention to newly founded businesses
and, consequently, to entrepreneurship. Compared to the micro-level
studies of business development motivated by the work of David Birch,
analyses on a more macro level that related new business formation to
the development of industries and regions as a whole are relatively few,
many of them conducted only recently.
6 Birch (1979) used microdata from the Dun & Bradstreet credit rating agency for the
United States in the 1969–1976 period.
7 Audretsch et al. (2004), Evans (1987), Davis et al. (1996), Sutton (1997), Haltiwanger
et al. (2010), and Stangler and Kedrosky (2010).

3
Theory: The Role of Entrepreneurship in
Economic Development
The following overview of theoretical approaches that may contribute

to explain and predict the effects of new business formation on economic
development first reviews the specific entrepreneurship literature and
what it says about the impact of new businesses on innovation and
growth (Section 3.1). Section 3.2 summarizes main results of approaches
that deal with the effect of market entry on competition and the devel-
opment of industries. Growth theory is the subject of Section 3.3. Based
on these theories and other considerations, I then present a more eclec-
tic approach to explaining the effects of new business formation on
regional development that combines elements of the different strands of
theory (Section 3.4). Section 3.5 summarizes the results and concludes.
3.1 The Nature of Entrepreneurship

In the eighteenth and nineteenth centuries, early writers on
entrepreneurship, such as Richard Cantillon and Jean-Baptiste Say,
described the role of the entrepreneur as an organizer of often risky
business endeavors, but it was Joseph A. Schumpeter (1911/1934, 1939)
who began to recognize the importance of entrepreneurship and new
256
3.1 The Nature of Entrepreneurship 257
business formation for economic development. According to Schum-

peter, there are a few types of dynamic entrepreneurs who initiate
structural change and economic growth by introducing radical innova-
tion. His examples of this type of innovative entrepreneurship include
the emergence of the cotton industry in England, the introduction
of the mechanical loom and the steam engine during the Industrial
Revolution of the eighteenth century, and construction of a railway
system in the nineteenth century that extended the geographic scope
of markets, thereby stimulating mass production and a much more
intensified division of labor. More recent examples of start-ups playing
a major role in radical innovation include the software industry, semi-
conductors, biotechnology (Zucker et al., 1998), and information and
communication technologies (Jorgenson, 2001).
Schumpeter (1911/1934, 1939) specifically highlights the indirect
effects these cases of innovative entrepreneurship had in different parts
of the economy. On the one hand, he shows how the radical innova-
tors created new markets that opened up entrepreneurial opportunities
for numerous follow-up entrepreneurs and subsequent innovation. On
the other hand, he also describes the competitive pressure that these
innovations exerted on incumbent firms through lower prices and supe-
rior products that often led to a sharp reduction in the demand of old
products and forced many of their producers to exit the market. This
process of “creative destruction” was by its very nature a boost to com-
petition caused by certain types of entrepreneurs who often came from
outside the incumbent industry.
Schumpeter recognized that such dynamic entrepreneurs are rare,
and that the absence of entrepreneurship could be regarded as an
important barrier to economic development. However, this focus on
these rare cases of dynamic entrepreneurship resulted in Schumpeter
virtually ignoring the more commonplace, less dynamic and revolu-
tionary businessman. Clearly, the Schumpeterian entrepreneur is at
an extreme end of the spectrum of real-world entrepreneurs, where
the opposite pole can be described as routine entrepreneurship, which
is a certain type of management (Leibenstein, 1968). In the vast
majority of cases entrepreneurship involves imitating innovations
introduced by others or seizing opportunities that result from market
258 Theory: The Role of Entrepreneurship in Economic Development
imperfections and inefficiencies. Obviously, these more ordinary types

of entrepreneurs, who are variously described as “imitators” (Minniti
and Lévesque, 2010), “arbitrageurs” (Kirzner, 1997), “gap-fillers,”
or “input-completers” (Leibenstein, 1968), can make important
contributions to economic development. Their impact, however, may
depend on the properties of the venture and the characteristics of the
respective market.
One important effect of entrepreneurship, particularly of innova-
tive new businesses, is that they produce new knowledge about the
economic viability of business concepts and, specifically, reveal con-
sumer preferences that may lead to the creation of new markets that
provide new entrepreneurial opportunities (Kirzner, 1997, 2009). This
entrepreneurial function of discovery particularly requires an alertness
to opportunity, judgment, initiative, and the ability to bear risk. The
characteristics of entrepreneurship, however, can vary considerably in
many respects, such as the abilities of the entrepreneur, his or her per-
sonality and creativity, and the innovativeness of the venture.
Baumol (1990) has introduced a distinction between different types
of entrepreneurship based on their effect on economic development. In
this classification of entrepreneurship, the “productive” entrepreneurs
clearly have a positive effect on economic development, while this con-
tribution is insignificant in case of “unproductive” entrepreneurs and
“destructive” entrepreneurs have a negative effect.1 Baumol (1990) con-
jectures that the proportion of people with an entrepreneurial personal-
ity is more or less the same across countries and time periods but that
the share of these entrepreneurial persons who engage in productive
entrepreneurship varies considerably dependent on the incentive struc-
ture in the society, which, in turn, is crucially dependent on the type of
governing institution in place. Accordingly, the appropriate design of an
institutional framework is an importing starting point for a policy that
1 The productive entrepreneurs comprise the innovative entrepreneurs that Schumpeter

had focused on as well as imitative entrepreneurs, arbitrageurs, and input-completers.
Examples of unproductive entrepreneurship include tax evasion and rent-seeking activi-
ties. Destructive entrepreneurship could be engaging in war, theft, and the like. All these
types have in common that they require the recognition of a potentially profitable oppor-
tunity, the initiative and capability to seize this opportunity, and the ability to bear deal
with uncertainty and the risk of failure.
3.2 The Industry Perspective: New Firms and the Evolution of Markets 259
aims at stimulating the productive type of entrepreneurship (Boettke

and Coyne, 2009; Henrekson, 2007).
3.2 The Industry Perspective: New Firms and

the Evolution of Markets
The industry perspective focuses on the process of competition among
suppliers of certain goods. In this view, a start-up is the entry of a
new competitor in the respective market that poses a challenge to the
incumbent suppliers by contesting their established market position.
The effects of entry emerge through this competitive process. Generally,
one can expect that new competition leads to enhanced industry per-
formance by stimulating improvements on the side of the incumbents
as well as through market selection, that is, the success or failure of the
competing firms based on survival of the fittest. These effects should
be particularly pronounced in the case of innovative entry that involves
new products or processes. Several studies find a significantly positive
impact of entry (and exit) on average productivity at the industry
level.2 That this productivity increase often becomes visible only after
several years suggests that the market process requires some time to
achieve the positive effects of competition on market performance.
The theories that try to explain this competitive process are diverse
and include the standard neoclassical textbook model of perfect com-
petition as well as approaches that regard firm size and market power
as conducive to innovation and economic performance (see, for exam-
ple, Carlton and Perloff, 2005). The requirements for successful market
entry vary with the characteristics of the market, such as minimum effi-
cient size, intensity of competition, and level of market-specific knowl-
edge, as well as the stage of the industry “life cycle.” The effects of
new business formation on industry evolution may range from insignif-
icant and negligible to the creation of a completely new industry by a
start-up that introduce a radically new product.
The evolution of many industries, particularly in manufacturing,
follows a life cycle pattern in which at least three stages can be
2 For
example, Baldwin (1995), Caves (1998), Disney et al. (2003), Foster et al. (2001, 2006),
and OECD (2003).
distinguished: an early exploratory stage, an intermediate stage, and a

mature stage (Vernon, 1966; Utterback and Abernathy, 1975; Klepper,
1997). The first firm that constitutes a new industry — frequently a
start-up (Baumol, 2004) — is followed by other firms that also recognize
an entrepreneurial opportunity. During the early stage of the indus-
try life cycle there is no one dominant design; instead, several designs
compete for dominance and it usually is not possible at this stage to
predict with any certainty which of the alternative design will become
the standard. At this stage, there is not only relatively high uncer-
tainty with regard to technological developments, but also about future
demand. Often, most of the suppliers are small in terms of employ-
ment or turnover. Since entry by newcomers under these conditions
tends to be relatively frequent, this stage has been characterized as the
“entrepreneurial regime” (Audretsch, 1995; Winter, 1984). Progress-
ing standardization of products and production processes during the
early stages of an industry may result in a “shakeout,” that is, a sharp
reduction in the number of suppliers so that net entry becomes neg-
ative (Klepper, 1997; Klepper and Simons, 2005; Sutton, 1997). After
the shake-out, the industry is characterized by a “routinized regime” in
which large firms dominate R&D. At this stage, successful entry into
the industry tends to be difficult and rare. Figure 3.1 shows the typical
pattern of business dynamics along the industry life cycle.
The life cycle perspective is a good illustration of Schumpeter’s
innovative entrepreneurship. It suggests that market entries may be
important for the creation of a new market and may act as a main
driver of market dynamics during the first stages of its development.
The approach helps understand the evolution of industries and the role
that market entry can play in this process. It also explains the variation
of market conditions, for example, the intensity of competition and the
importance of particular parameters such as price and quality in the
competitive process over the life cycle. Moreover, it may be helpful
for making predictions about the success of entry in different stages
of the life cycle. However, the life cycle approach is far less suited to
explain and predict the development of an industry once it has been
created by the first supplier of the new product. Since markets for those
industries that follow a life cycle are not limited to regions or countries,
Number of firms
‘Entrepreneurial’ regime ‘Routinized’ regime
Shake out
Number of entries
Number of firms
Number of exits
Time
Net entry
Fig. 3.1 Stylized paths in the numbers of entries, exits, and firms over the industry life
cycle.
the approach may also be regarded as of limited relevance for explaining

the development of certain regions.3
The notion of an equilibrium rate of business ownership (Audretsch
et al., 2002; Carree and Thurik, 1999; Hartog et al., 2010), sometimes
also referred to as a market’s “carrying capacity” (Hannan and Free-
man, 1977), allows predictions about the divergent effects of entry
under different market conditions. According to this view, a market
can sustain only a certain number of competitors in the longer run.
Hence, “excessive entry” that goes beyond this equilibrium number of
firms may imply “market overcrowding.”4 As a consequence, business
3 Empirical research, however, shows that many innovative industries tend to be clustered
in space and that the development of such industry clusters can play a main role in
the development of these regions. Empirical examples, such as the Silicon Valley or the
automobile industry in Detroit (Klepper, 2010) clearly, demonstrate that a main vehicle
for the emergence of geographic clusters is the formation of spin-offs from incumbent firms,
which tend to locate in close geographic proximity to the incubator (Klepper, 2009).
4 The common explanation for why entrepreneurs enter markets that are already crowded
is that they are overconfident with regard to their chance of success and ill-informed or
unaware of the risks (Arabsheibani et al., 2000; Koellinger et al., 2007). And, indeed,
overconfidence does seem to be common among firm founders; one could even argue that
it is a necessary ingredient of new ventures, given the high risk of failure that would
ownership rates that exceed the equilibrium are expected to be unsta-

ble and to decline toward the equilibrium. This implies that the effect
of new business formation on growth depends on the actual number
of competitors as compared to the equilibrium number. Accordingly,
the approach predicts that if the actual number of firms in a market is
equal or greater than the equilibrium number, positive net entry will
not lead to an increase in long-term overall employment among the
firms operating in this market. However, entry may lead to growth if
the actual business ownership rate is below the equilibrium (Audretsch
et al., 2002; Hartog et al., 2010).
Despite some empirical evidence (most of which is on the whole-
nation level rather than covering a smaller region or a particular
industry5 ) in support of this market “overcrowding” idea (Audretsch
et al., 2002; Carree et al., 2007; Hartog et al., 2010), the concept suf-
fers from a number of severe drawbacks. First, many markets are geo-
graphically much larger than a region or a country and it thus may be
questionable whether one can determine an optimal number of firms
for a certain region or country. Second, the assumption that a market
has a given carrying capacity is based on a static view in that it implies
given product characteristics as well as constant levels of product, costs
of production, prices, and demand. These assumptions ignore possi-
ble effects of new businesses on productivity and may be appropriate
chiefly in the case of non-innovative entry. However, if entry is innova-
tive, that is, the new firm introduces new products or better methods
of production or distribution that stimulate innovation by incumbent
firms, it may induce considerable change in the equilibrium number
of firms. Clearly, for the case of innovative entry, the notion of exces-
sive entry and overcrowding is of limited value, and even in the case
of non-innovative entry, the argument is weak, especially in the event
that incumbents respond to the newcomers’ challenge by engaging in
innovation.
otherwise deter entry (Arabsheibani et al., 2000; Koellinger et al., 2007). Excessive entry
can occur in markets with low barriers to entry (for example, certain service industries) or
if public subsidies are available that lead to reduced costs of venture creation. Individuals
particularly prone to founding such types of business may be those individuals who face
relatively low opportunity costs, for example, due to being unemployed.
5 An exception is the analysis by Carree and Thurik (1999) of the Dutch retailing sector.
Acemoglu et al. (2006) and Aghion et al. (2009) put forward a

hypothesis about the reaction of incumbent firms to the challenge of
new competition by entries that are close to the technology frontier.
The technology frontier is established by those firms with the highest
productivity level. Acemoglu et al. (2006) and Aghion et al. (2009)
argue that the distance of an industry or firm from the technologi-
cal frontier plays a significant role in determining how it will react to
challenging entry. According to this view, firms or industries that are
relatively advanced and can be regarded as close to the technologi-
cal frontier tend to react to a competitive challenge with innovation
(escape-entry effect), whereas new competition discourages more back-
ward firms or industries from innovation. Aghion et al. (2009) present
empirical evidence on the effects of entry by foreign competitors for a
sample of U.K. firms that support this hypothesis.
Minniti and Lévesque (2010) complement the picture by high-
lighting the role of imitative entrepreneurship (see also Section 3.3).
They distinguish between research-based entrepreneurs and imitating
entrepreneurs. Research-based entrepreneurs attack established market
position by introducing product and process innovation; “the exis-
tence of imitative entrepreneurs threatens the rent of research-based
entrepreneurs and gives them incentives to continue innovating to stay
ahead of competition” (Minniti and Lévesque, 2010, p. 309). In this
way, not only innovation but also imitation can drive growth. It should
be noted, however, that both types of challenge are of rather different
importance. Clearly, since innovation is a necessary precondition for
imitation, research-based entrepreneurship has the key role. Moreover,
the prospect of fast imitation may severely reduce the expected returns
from innovation activity, thereby lowering the incentive to innovate.
Hence, although a certain level of imitation may stimulate innovation,
“too much” imitation may harm economic growth.
In summary, the industry perspective provides crucial insight into
how new business formation affects economic development. Central to
this view is the competitive process between start-ups and incumbent
firms. Accordingly, it can be assumed that the effect of new business
formation depends on the challenge that the new businesses pose to
incumbent suppliers, on the incumbents’ reaction to this challenge, and
on the operating mode of the market. In this competitive process, the

innovativeness of the entry and the ability of incumbents to react are of
key importance. However, by mainly focusing on the competitive pro-
cess in a particular market, the industry perspective tends to neglect
the consequences of entry for other markets, particularly input markets
and markets for complementary products, as well as for the organiza-
tion of economic activity and the division of labor.
3.3 Growth Theory

Although scholars have long agreed that innovation is the main driver of
economic development, it was not until the arrival of the “endogenous
growth theory” in the 1980s that knowledge and innovation became
explicitly included in formal theorizing about economic growth. These
macroeconomic models highlight knowledge and innovation as a key
driver of economic development (Romer, 1986, 1990; Barro and Sala-
I-Martin, 1995; Aghion and Howitt, 1992). However, they say nothing
about how knowledge is transformed into economic value. A main can-
didate for this function, and one touted by Schumpeter (1911/1934) is
entrepreneurship.
There have been several attempts to explicitly include entrepreneur-
ship into growth theory models (for an overview, see Braunerhjelm,
2008; Carree and Thurik, 2010). Here, I restrict my discussion to two
approaches that I regard as particularly interesting in the context of
the relationship between entrepreneurship and growth. The first of
these approaches is the knowledge spillover theory of entrepreneurship
(Audretsch et al., 2006; Acs et al., 2009) that particularly stresses the
role played by the regional knowledge base in innovative entrepreneur-
ship. The second approach is a model by Minniti and Lévesque (2010)
that distinguishes between two types of entrepreneurs, innovative and
imitative.
The knowledge spillover theory of entrepreneurship follows
Schumpeter in highlighting the role of innovative start-ups for economic
development. It is based on the observation that many radical innova-
tions have been introduced by new and small firms (Baumol, 2004),
while incumbent firms tend to focus on incremental improvements.
3.3 Growth Theory 265
Hence, a key assumption of this approach is that radical innovation

emerges from a combination of knowledge and entrepreneurial talent.
The knowledge that leads to the recognition of an entrepreneurial
opportunity and may induce the decision to start an innovative firm is
generated by incumbent firms and other organizations such as univer-
sities and non-university public research institutes (Acs et al., 2009).
Since the economic value of new knowledge is highly uncertain, the
expected value of any new idea will vary across economic agents. Hence,
if an employee in a firm assigns a much higher economic value to a new
idea than does the management of that firm, the employee may be
motivated to start an own business based on this knowledge.6 Because
new knowledge is not easily communicated or traded on a market, it
is frequently the employee7 who becomes the founder of a new innova-
tive firm. For the employee, starting an own business is often the only
way to exploit an idea that is being ignored by incumbents and would
otherwise remain dormant and unused. Hence, without entrepreneurial
spin-offs, a great deal of economically relevant knowledge within incum-
bent firms and, particularly, within public research organizations would
not be commercialized. Via spin-offs, knowledge of the incubator firm
spills over to the newly founded firm, and thus the knowledge base
of the incubator firm can have a significant effect on the success of a
spin-off.
The knowledge spillover theory of entrepreneurship sees innovative
start-ups as a key mechanism by which the knowledge of incumbent
organizations spills over to a new organization. (Audretsch et al., 2006,
p. 191f) describe this process of entrepreneurial knowledge spillover as
6 Empirical research shows that many founders of innovative firms acquired the relevant
knowledge by working in a research organization or in an incumbent firm (Klepper, 2009).
A main motivation of many of these founders is to commercialize certain knowledge not
being exploited at their former workplace. A quite common pattern is that the management
and the potential entrepreneur disagree about the realization of an idea, be it because of
different perceptions of the economic potential of this idea, the risk involved in bringing
the innovation to the marketplace, or for other reasons (Klepper, 2009).
7 In the literature it is assumed that recognition of entrepreneurial opportunities is partic-
ularly likely by persons who have respective technological knowledge or knowledge about
customers’ wants and markets, such as R&D employees or sales managers. See Shane
(2003) and Eckhardt and Shane (2011) for a more detailed discussion.
“creative construction,” as opposed to Schumpeter’s notion of “creative

destruction,” because “by spillover of knowledge investments that
might otherwise remain uncommercialized, entrepreneurship takes lit-
tle away from the incumbent enterprises, but instead creates alterna-
tive opportunities for employment.” However, even if such knowledge
would have remained unexploited by the incubator organization, cre-
ative destruction may occur if the newly founded firm takes away mar-
ket share from the incumbent.
In this process of entrepreneurial knowledge spillover, the regional
dimension is relevant for at least two reasons. First, new knowledge
does not flow freely across space but tends to be regionally bounded
(Asheim and Gertler, 2005; Boschma, 2005). Second, founders show a
pronounced tendency to locate their firm in close spatial proximity to
their former workplace or to the place where they reside (Figueiredo
et al., 2002; Dahl and Sorenson, 2009). Hence, innovative entrepreneur-
ship is somewhat of a “regional event” (Feldman, 2001; Sternberg,
2009), meaning that the regional knowledge stock and the regional
workforce, as well as the regional conditions for entrepreneurship are
important factors in the emergence of innovative new businesses. Mar-
ket success and growth of spin-offs and their incubators can then create
agglomeration economies that contribute to further economic success.
Clearly, the key factors in such growth processes are knowledge and the
commercialization of this knowledge by innovative start-ups.
In an attempt to link this knowledge spillover theory of
entrepreneurship to economic growth, Audretsch and Keilbach (2004)
and Audretsch et al. (2006) propose extending the usual macroeco-
nomic production function by adding the factor of entrepreneurship.
Using a Cobb–Douglas-type production function, this approach gives
Yi = Kiβ1 Lβ2 β3 β4
i R i Ei ,
where Y represents output, K is physical capital input, L is labor

input, R is knowledge, and E is “entrepreneurship capital.” The authors
use the regional start-up rate as a measure for the entrepreneurship
capital. The subscript i refers to the region and the βs denote the
partial production elasticities of these input factors. The authors per-
form a number of empirical tests of this approach and analyze the
3.4 Entry, Competition, and Growth: An Eclectic Explanatory Approach 267
contribution of entrepreneurship capital to the growth of regions in

West Germany that showed a significantly positive effect (see Sec-
tion 4.3 for an overview of the results).
Minniti and Lévesque’s (2010) model of economic growth distin-
guishes between two types of entrepreneurs, imitative (the Kirznerian
arbitrageur) and innovative, research-based entrepreneurs. The authors
particularly highlight the role of the imitative entrepreneurs, who
create incentives for further innovation by threatening the rent of the
innovators (see also Section 3.2). Hence, both types of entrepreneurs
can pose a competitive challenge to each other and initiate growth.
Minniti and Lévesque (2010) argue that there is a “right” mixture of
both types of entrepreneurship that is important for economic growth.
They state that the appropriate mixture of entrepreneurship for growth
depends on the development stage of the economy. In particular, they
assume that a country or region whose economy operates close to the
technological frontier will need technological discoveries and, therefore,
research-based entrepreneurship in order to remain competitive. In
contrast, poorer countries or regions with large amounts of unused
resources may be able to increase their wealth by using their resources
to engage in imitative entrepreneurship, that is, by copying technology
developed elsewhere. According to Minniti and Lévesque (2010), this
“right” mixture of the two types of entrepreneurship depends critically
on the cost of innovation and on the cost of entrepreneurship, that is,
how much it costs to set up and operate a business, among other factors.
3.4 Entry, Competition, and Growth:

An Eclectic Explanatory Approach
Based on the different theories reviewed in the previous sections, I now
suggest a more eclectic approach for explaining the effects of new busi-
ness formation on regional development. The key mechanism in this
approach, which brings together elements from different fields and levels
of analysis, is the competition between new businesses and incumbents.
Section 3.4.1 outlines the basic relationships and effects. Section 3.4.2
reviews a number of factors that may determine the magnitude of the
impact of new business formation on the regional economy.
3.4.1 The Basic Relationships

My more eclectic approach for explaining the effect of new business
formation on economic development views the competition between
entries and incumbent firms as the key mechanism that transforms
new business formation into growth. In line with the industry perspec-
tive (see Section 3.2), new business formation is viewed as a challenge
to incumbents that result in intensified competition. Due to this com-
petition and the induced market selection, only a fraction of start-ups
survive for very long, and those that do succeed may displace incum-
bents. Two types of market exit may result from the entry of new
businesses. First, a considerable number of new businesses fail to be
sufficiently competitive and thus are forced to leave the market. Sec-
ond, displacement of incumbents by new competitors leads to declining
market share or market exit. Such crowding-out effects may occur in
the output market because the entrants gain market share, as well as
in the input market due to additional demand for resources by new
businesses, which can lead to scarcity of inputs and increasing factor
prices. The overall effect of new business formation on development
results from this competitive process. It includes not only the develop-
ment of the start-ups — the direct effect — but also the development
of the incumbent firms caused by entry of the newcomers — the indi-
rect effect (Figure 3.2). These indirect effects are influenced by diverse
factors that can be specific to the respective firms, markets, or regions
(see Section 3.5).
As will be shown when reviewing the results of empirical analysis
(Section 4.4.2), the indirect effects of new business formation on
Direct
New effect
businesses
Growth
Incumbent
firms Indirect
effect
Fig. 3.2 Direct and indirect effects of new businesses on growth.

incumbents tend to be considerably larger than the direct effects.

Hence, disregarding indirect effects on incumbents is not a forgiv-
able oversight, but a mistake so big that it may render the analysis
meaningless! The indirect effects of new business formation on growth
encompass displacement of incumbent employment and all develop-
ments of the incumbents resulting from competition with the newly
founded businesses, such as higher efficiency, process and product inno-
vation, adjustment to structural change, and learning about consumer
preferences, as well as knowledge about and the viability of business
concepts. There may also be “second-round” indirect effects in that the
regional growth caused by new business formation leads to agglomera-
tion economies and diseconomies that shape the competitiveness of the
regional economy. Furthermore, regional growth due to new business
formation could stimulate further start-ups in the region, and so on.
I limit the discussion to the consequences of new businesses for growth
and ignore possible “second-round” effects of growth on new business
formation here (see Section 4.7 for a more in-depth discussion of this
issue).
How will competition between new businesses and incumbents
impact economic development? Given that competition and market
selection are based on survival of the fittest, firms with relatively high
productivity will remain in the market, whereas those with low pro-
ductivity will either have to reduce their output or exit.8 This type
of market selection leads to an overall productivity increase, so that
fewer resources are needed to produce the given amount of goods and
services. Hence, for regional output to remain constant, the increased
productivity due to new business formation should cause a decline in
employment instead of the creation of additional jobs. Thus, the effect
of new business formation on the number of jobs will not necessarily
be positive but could just as well be negative.
8 Diverseempirical studies confirm that low productivity firms are more likely to exit than
firms with relatively high productivity. See, for example, Baldwin (1995), Carreira and
Teixeira (2011), and Wagner (2009). These studies, however, also find exit of relatively
high productivity firms, suggesting that low productivity is not the only reason for exit.
On average, young firms do not have higher but productivity levels than incumbents (van
Praag and Versloot, 2007). Some studies (for example, Wagner, 2009) find relatively low
average productivity levels in new firms compared to older firms.
Start-ups or market entries Supply-side effects

(indirect):
Securing efficiency
Acceleration of
Market process (selection) structural change
Amplified innovation
Greater variety
New Exiting
capacities capacities Improved
(direct effect): (indirect effect): competitiveness
Development Decline or
of new closure of
Growth
businesses incumbents
Fig. 3.3 New business formation and the market process.
However, a well-functioning market process is not a zero-sum game

in which the gains of one actor are necessarily at the expense of the
other actors. There are several ways competition by entry of new busi-
nesses can stimulate competitiveness on the supply side of the econ-
omy.9 Such supply-side improvements can attract increasing demand
that leads to the growth of output and employment. Main supply-side
effects of entry could include (cf. Figure 3.3):
• Securing efficiency and stimulating productivity by contesting

established market positions. Not only actual entry but also
the very possibility of entry can force incumbents to perform
more efficiently (Baumol et al., 1988).
• Acceleration of structural change. Frequently, structural
change is mainly accomplished by a turnover of economic
units, that is, by the entry of new firms and the simul-
taneous exit of established incumbents. In this case, the
incumbents do not make the necessary internal changes, but
9 The supply-side effects include all consequences for the competitiveness of the regional
economy. Accordingly, the demand of new businesses for resources such as labor may be
labeled a demand-side effect. However, empirical analyses suggest that such demand-side
effects are rather small so that they can be almost ignored (see Section 4.4.2 for details).
are substituted for by newcomers.10 This type of process is

emphasized in J. A. Schumpeter’s (1911/1934, 1942) concept
of creative destruction and by Marshall’s (1920) analogy of
a forest in which the old trees must fall to make way for new
ones.
• Amplified innovation, particularly the creation of new
markets. There are many examples of radical innovations
introduced by new firms (Audretsch, 1995; Baumol, 2004).
One major reason for this pronounced role of new firms in
introducing radical innovation could be that incumbent sup-
pliers are more interested in exploiting the profit possibilities
of their extant products than in searching for new opportuni-
ties, particularly if the new products may compete with their
established ones (Klepper and Sleeper, 2005; Klepper, 2009).
Due to the reluctance of these types of incumbent firms to
adopt new ideas, setting up one’s own business may appear
to be the only or the most promising possibility for inventors
seeking to commercialize their knowledge (Audretsch, 1995;
Klepper, 2009).
• Greater variety of products and problem solutions. If the
products of a newcomer differ from those of the incumbents,
or if an entrant introduces significant process innovation,
the result will be a greater variety of available goods and
problem-solving methods. Such increased variety implies a
higher probability of customers finding a better match for
their preferences. Increased variety due to new supplies may
intensify the division of labor, as well as follow-up innova-
tion, and, therefore, may generate significant economic devel-
opment (Boschma, 2004; Saviotti and Pyka, 2004). Greater
variety can particularly mean a diversification of the regional
industry structure and the respective knowledge base that
10 Such a process was observed in the transformation of the former socialist economies of
Central and Eastern Europe, where new firms — the bottom-up component — had a con-
siderably strong impact on structural change (cf. Brezinski and Fritsch, 1996; Pfirrmann
and Walter, 2002).
may make regions more resilient to external shocks (Boschma

and Frenken, 2011).
Like the displacement effects, the supply-side effects are indirect

in nature. They are not necessarily limited to the industry to which a
start-up belongs, but may occur in completely different industries, such
as those that use the improved supply as an input. Neither are these
effects restricted to the region in which entry occurs; they can manifest
in other regions, for example, regions where competitors are located.
The indirect supply-side effects are the drivers of competitiveness in
the respective industries and regions, which may induce employment
growth and increasing welfare by attracting additional demand. They
are why one may expect positive employment effects of new business
formation, thus turning “creative destruction” into “creative construc-
tion” (Audretsch et al., 2006).
It is important to note that the occurrence of supply-side effects
of new business formation does not necessarily require the newcomers
to be economically successful and survive. As long as entry induces
improvements by incumbents, it will lead to enhanced competitive-
ness in the respective region or industry even if most of the new busi-
nesses fail and exit the market soon after entry. If new or incumbent
firms fail, their knowledge is not necessarily lost; instead, it can be
further diffused by the persons who were engaged in the failed firm
(Hoetker and Agarwal, 2007; Stam et al., 2008). Hence, even failed
start-ups can make a significant contribution to growth. A high failure
rate for new businesses, however, can also have a discouraging effect
on potential entrepreneurs and this possibility should not be ignored.
Moreover, if new business formation leads to regional growth, this
may induce “second-round” indirect effects such as reinforced agglom-
eration economies and agglomeration diseconomies in general or for
certain industries (clusters), the emergence and recognition of further
entrepreneurial opportunities, or the stimulation of additional start-ups
inspired by entrepreneurial role models, and so forth.
The above review of the different impacts of new business formation
on market processes makes very clear that the evolution of start-ups
is only a portion of their total effect on development. Many important

influences that start-ups have on growth and employment are of an indi-
rect nature and occur on the supply side of the market. If the market
is indeed based on survival of the fittest, the direct employment effects,
that is, the growth of new businesses, as well as the displacement of
incumbents, should actually result in a decline in employment. Under
a properly functioning market regime, growth from new business for-
mation can only be expected from improvements on the supply side. If,
however, the process of market selection is not working properly and
allows relatively unproductive competitors to survive, the economy’s
competitiveness will decline and, thus, cause the supply-side effects to
become negative.
3.4.2 Factors Determining the Effects of New Business

Formation on Development
The basic argument outlined above is that it is the interaction between
newcomers and incumbents that determines the magnitude of the effect
of new business entry. The character of this interaction and its outcome
depends on a number of factors, which will be discussed in the following
sections. These factors are:
• the type of new business and the intensity of the challenge it

poses to incumbents (Section 3.4.2.1),
• the incumbents’ reaction (Section 3.4.2.2),
• the industry characteristics (Section 3.4.2.3), and
• the regional environment (Section 3.4.2.4).
All these factors, particularly the emergence of challenging new

businesses and the regional environment, are affected by the overall eco-
nomic situation, such as the development stage of the region and nation,
as well as by the institutional framework (Baumol, 1990; Boettke and
Coyne, 2009). This overall economic and institutional background may
have an effect on the quality of start-ups and on the incumbents’ reac-
tion, and will particularly shape the regional environment.
3.4.2.1 The type of new business, its quality, and the

challenge it poses to incumbents
It is plausible to assume that the type and intensity of the challenge
posed by new businesses critically depends on their characteristics or
quality. One important facet of a new business’s quality is the qual-
ification and knowledge of the entrepreneur, particularly his or her
entrepreneurial skills and motivation and the resources that he or she
has available for the venture. Another important aspect is the degree
of innovativeness or newness of its products and services. Therefore,
the entry of innovative businesses led by well-prepared entrepreneurs
who have the requisite knowledge and necessary resources available
can be expected to have a stronger effect and, particularly, lead to
larger supply-side improvements than entry by non-innovative busi-
nesses run by persons lacking appropriate skills and unsuccessful at
sufficiently accessing the relevant factors of production. High-quality
start-ups that successfully challenge incumbents may then experience
considerable growth and generate much employment.
Poor-quality start-ups that do not pose much of a challenge to
incumbents may explain the phenomenon known as the “revolving
door” growth regime (Audretsch, 1995; Audretsch and Fritsch, 2002).
The term is descriptive of the situation in certain industries or regions
where the vast majority of entries exit the market rather quickly with-
out having any significant effect on development.
There are a number of indicators that can be used to measure the
potential of a start-up to challenge the incumbents. Examples of such
indicators include:
• The entrepreneur’s qualifications, measured by level and type
of education (for example, years of education or academic
degree), the work experience (for example, in management
or in the respective industry), or the combination of skills
(“skill balance”).
• The main motivation for starting a business (for example,
“opportunity” vs. “necessity” entrepreneurship, or part-time
vs. full-time entrepreneurship).
• The founder’s growth ambitions (for example, “high-growth
expectation” entrepreneurship).
• The amount and quality of the employed resources (for

example, size of start-up, team start-up, and qualification
of personnel).
• The innovativeness of the supplied goods and services (for
example, “new product market-oriented” entrepreneurship).
If data for individual firms are available, the share of
inputs or value added devoted to research and development
(R&D) or the number of patented inventions of the founder
could be used to measure innovativeness.11 A frequently
applied method for distinguishing between innovative and
non-innovative businesses is based on their industry affilia-
tion (see, for example, OECD, 2005).12
• Venture capital (VC) investment in a firm. Venture capital
investors normally make a detailed assessment of an innova-
tion project before risking money. Hence, start-ups receiving
venture capital should be of relatively high quality, particu-
larly with regard to innovation.
• The productivity of a start-up compared to incumbents.
• The ability of the new business to survive in the market for
a certain period of time and to grow.
Since competition can be multifaceted, new businesses may challenge

incumbents on several fronts. For example, new businesses need not
necessarily introduce their own research-based innovations but may
pressure incumbents by pure imitation (Minniti and Lévesque, 2010).
Each of the indicators for the quality of a start-up listed here describes
only a part of this challenge and will not be equally appropriate for all
industries or types of market conditions. Many aspects of new business
quality will be particularly shaped by the development stage of the
country or region and by governing institutions (see Section 3.4.2.4).
11 Since it is not entirely clear what inputs or activities should be counted as R&D and
because not all innovations require any significant R&D, this method of defining an
innovative firm or start-up is somewhat imprecise.
12 Because there are innovative and not so innovative firms in all industries, a classifica-
tion based on industry affiliation leads to only a diffuse picture of innovative and non-
innovative entries. Given the limited availability of data on innovation, however, this is
often the only feasible way to identify such new businesses.
3.4.2.2 The Incumbents’ Reaction

The willingness and ability of incumbents to respond to challenging
entry in a productive manner can be regarded as a main factor in
determining the effects of new business formation on economic develop-
ment. Generally, it is expected that the effects will be relatively strong
in markets subject to highly intense competition because there will be
more pressure to make improvements. This willingness or ability to
respond innovatively to the challenge of entry may critically depend on
how close to the technological frontier both the start-up and the incum-
bent are (Acemoglu et al., 2006; Aghion et al., 2009). Moreover, supply-
side effects may be larger, the greater the number of direct competitors
affected by the challenge. Hence, entry into a worldwide market may
induce considerably more pronounced supply-side effects than entry
into a market that is entirely local (for example, many kinds of con-
sumer services). The competitive effects of entry are not necessarily
limited to the output market but can also occur on the input market
and may be particularly relevant at the regional level.
In most cases, the incumbents’ reaction will not be immediate, but
after a considerable time lag — for two reasons. First, it may take some
time until the incumbents become aware of the challenge. Second, the
incumbents may need time to react, for example, because some R&D is
required for an innovative response. Hence, empirical research should
account for such time lags.
3.4.2.3 Industry Characteristics

There are a number of reasons for anticipating that there will be dif-
ferences in the effect start-ups have on regional growth based on the
industry to which the new business belongs. For example, the empirical
correlation between the level of new business formation and employ-
ment may be relatively pronounced in industries that are at the early
stage of their industry life cycle, because these industries benefit from
growing demand for their products or services. In mature industries
characterized by a routinized technological regime, the incumbents typ-
ically enjoy a strong competitive position so that an entrant’s prospects
for survival and growth are modest.
Another factor that may shape the level of entry as well as its effect
on growth is the market structure and the intensity of competition.
Although economic theory is as yet ambiguous as to the relationship
between market structure and the intensity of competition, it seems
reasonable to assume that easy entry and a high number of competitors
lead to rather strong competition that results in relatively large effects
of new business formation. To what extent certain barriers to entry such
as minimum efficient size and capital requirements influence the effects
of new business formation is a priori unclear. On the one hand, entry
rates will be relatively low in industries with a high minimum efficient
size (Fritsch and Falck, 2007), which should lead to lower intensity of
competition and a less pronounced role of new businesses in industry
development. On the other hand, a high minimum efficient size can
induce larger size entries, which will tend to have a more pronounced
effect than smaller start-ups (Acs and Mueller, 2008). A large minimum
efficient size may also constitute higher sunk costs of exit, which can
motivate incumbents to seek a productive response to the challenge
of entry instead of simply quitting the market. Hence, start-ups in
the manufacturing sector, which is characterized by a relatively large
minimum efficient size, should have a stronger effect on growth than
new businesses in small-scale industries with low barriers to entry and
exit, such as many types of consumer-oriented services.
3.4.2.4 The Regional Environment

There are several reasons why region-specific factors should play a pro-
nounced role in the emergence of new businesses and their effect on
economic development. Generally, entrepreneurship is a regional event
(Feldman, 2001; Malecki, 1994; Sternberg, 2009) in that new businesses
emerge from the regional context and are shaped by regional conditions.
Hence, governing formal and informal institutions, stage of economic
development, quality of the regional workforce and knowledge base,
presence of supportive infrastructure for start-ups, and intensity of local
competition, as well as agglomeration economies, such as availability of
necessary resources, may be important influences on the number and
quality of new businesses.
The regional knowledge base, which is partly embodied in the

regional workforce as well as in regional organizations for research and
education (for example, universities), should play a significant role not
only in the formation of new businesses, but also in the competitive
response of incumbent firms. On the one hand, the regional knowledge
base can be regarded as a main source of opportunities for innovative
entrepreneurship, possibly stimulating a large number of high-quality
start-ups to pose a strong challenge to incumbent firms. On the other
hand, the regional knowledge base may also enable local incumbents
to productively react to the challenges posed by new businesses. Thus,
a well-developed regional knowledge base may be conducive to pro-
ductive competition between newcomers and incumbent firms, leading
to pronounced supply-side effects. In particular, the type of regional
knowledge base can have a strong influence on the type and diversity
of industry that will be founded in the region (Boschma and Frenken,
2011; Helfat and Lieberman, 2002).
Another region-specific characteristic that should be important
for the effect of start-ups on development is the intensity of local
competition for the goods and services supplied by the newcomers,
that is, the presence of direct competitors. Spatial proximity to direct
competitors constitutes localization economies and diseconomies.
The number of regional competitors in the same industry or market
should be one of the main factors determining the magnitude of those
intraregional indirect effects of new business formation — displacement
and supply side — that stems from competition on the output market.
Hence, compared to new businesses that have very little spatially
proximate competition, these effects should be much more pronounced
for entries that emerge in regional clusters, that is, in regions with
many competitors supplying the same market.
A number of studies deal specifically with the relationship between
regional clustering and the level of new business formation. This work
finds that regional clusters are formed chiefly as a result of the tendency
of spin-offs from public research organizations and from private firms
to locate themselves near to their parents (Klepper, 2010; Buenstorf
and Klepper, 2009; Boschma and Frenken, 2011). Given the important
role of entrepreneurship for the emergence of spatial clusters, it is not
surprising that a number of studies find that the level of new business
formation tends to be higher in such clusters than in regions where firms
of the same industry are absent or relatively scarce (for an overview,
see Frenken et al., 2011). The available empirical evidence provides
only weak support for the hypothesis that new firms setup in clusters
of the same industry have higher survival rates and grow faster than
new businesses outside such clusters (Wennberg and Lindqvist, 2010;
Frenken et al., 2011). Although spatial proximity between firms of the
same industry may be conducive to the transfer of knowledge, clustered
firms are not found to be generally more innovative than firms located
outside of clusters (Martin and Sunley, 2003).
Relatively wide availability of resources on thick regional input
markets in cities can have two main advantages for new businesses
(Helsley and Strange, 2011). First, wide availability of inputs can lead
to faster project completion that may increase the success of new ven-
tures. Second, thick input markets may enable firms to successfully
manage rather complex projects such as innovations that would be
infeasible in regions with relatively thin markets. Generally, a richly
diverse supply of inputs can compensate for skill deficits in that it allows
entrepreneurs with a limited variety or “balance” of skills (Lazear,
2004, 2005) to hire local personnel with the appropriate qualifications,
thereby substituting market thickness for own skill imbalance. Due to
such agglomeration advantages, one may expect that larger cities have
a comparatively high share of entries that pose a significant challenge to
incumbent firms. However, large cities are also characterized by rather
intensive competition on input markets that — in contrast to com-
petition on output markets — is not necessarily limited to the same
industry. Since many input markets are much more local in character
than output markets, one may expect that the competition effects in
input markets will occur more often in the same region where a new
business is located than the competition effects in output markets.
In summary, there are many regional factors that can influence
the effect of new business formation on development. In particular,
there are a number of reasons why one may expect that the effects
of new business formation on regional development will be relatively
pronounced in large agglomerations characterized by high population
density. The main factors that should lead to more pronounced effects
of start-ups in larger cities are the following:
• Larger cities tend to have a greater knowledge base due

to their sheer size, the presence of public research facili-
ties (for example, universities), the relatively high share of
well-educated persons in the workforce, and because of their
ability to attract private and public R&D. Generally, the
greater knowledge base and the higher share of creative activ-
ity found in larger cities (Acs et al., 2011; Florida, 2004) can
be a source of innovative entrepreneurship.
• Agglomerations have relatively thick input markets that pro-
vide a rich variety of complementary skills and resources,
thereby enabling entrepreneurs to complete their projects
more quickly and to successfully engage in more complex
projects than would be feasible in smaller cities (Helsley and
Strange, 2011).
• Knowledge exchange between actors in large cities can be
more intense as a result of relatively rich opportunities for
communication and large, differentiated labor markets.
• A higher density of actors may lead to a correspondingly
high level of competition between newcomers and incumbents
for inputs, which stimulates market selection. For example,
intense competition for inputs could explain why survival
rates of new businesses are lower in regions with high pop-
ulation density (Fritsch et al., 2006; Renski, 2009). As a
result of the lower survival rates in agglomerations, the direct
effects of entry in such regional environments may be rela-
tively small.
• Competition between newcomers and incumbent firms in
agglomerations may also be relatively intense on the output
side, depending on the number and the quality of competitors
located in the same region.
All these points strongly suggest that the effects of new business for-
mation should be different across regions.
3.5 Summary and Conclusions

This review of the different approaches to defining entrepreneurship and
its effects on innovation and growth has shown that distinctions should
be made between different types of entrepreneurs and their businesses.
The spectrum ranges from the Schumpeterian entrepreneur, who suc-
cessfully introduces radically new products, to less revolutionary types,
such as the Kirznerian arbitrageur, and to routine entrepreneurship.
Although all these types of founders may have a positive effect on
economic performance, there is a strong reason to believe that it is
particularly the innovative new businesses that will have an effect on
economic development by spurring competition. Growth theory high-
lights the role of knowledge and innovation for economic development,
but it is completely silent as to how knowledge is transformed into
economic growth. Only recently, with the emergence of the knowledge
spillover theory of entrepreneurship, has it been conjectured that it is
innovative start-ups that transform the knowledge into commercialized
goods and services. These approaches are complemented by theories
of competition and market evolution. Competition theory and indus-
trial economics elucidate the role of industry-specific characteristics for
entry. Work in market evolution theory shows that entry is particu-
larly promising and relevant at particular stages of the industry life
cycle and is largely irrelevant at other stages.
The more eclectic approach to explaining the effects of new business
formation on regional development outlined here combines these theo-
ries with other considerations. The main focus of this approach is on the
competition between start-ups and incumbents. This competition can
have a number of consequences. One result of such competition can be
success and growth of the newcomers, that is, their direct contribution
to output and employment. However, there are also important indirect
effects, one of which is that successful new businesses can lead to a dis-
placement of established suppliers. If competition proceeds according
to survival of the fittest, such a displacement of incumbents should be
accompanied by increased productivity but also by less employment at
a given level of output. Positive consequences for employment can be
expected only from improved supply-side conditions that strengthen
regional competitiveness and attract further demand. Such supply-side

effects are also indirect in nature and can consist of — in addition
to the already mentioned productivity increase — accelerated struc-
tural change, amplified innovation, and a greater variety of products
and problem solutions. The overall effect of new business formation
results from the success and growth of the newcomers as well as from
a number of important indirect effects on regional development. These
developments are shaped by industry-specific conditions as well as by
the regional environment (Figure 3.4).
The recognition that the effects of new business formation emerge
from competition between newcomers and incumbent firms has a num-
ber of important implications. The magnitude of the effects will depend
on various factors, including:
Regional environment
Regional ‘culture’ of Location and accessibility Regional

entrepreneurship knowledge base
Supportive Qualification of
infrastructure the workforce
for start-ups
Industry-specific conditions
Quality of
Thickness Entry and other inputs
of local exit New
input barriers businesses
markets
Regional
Stage of growth
the industry
lifecycle Incumbent
firms
Size of the Market structure and Number

region and intensity of competition and size of
density of regional
actors competitors
Fig. 3.4 Factors that may determine the effect of new business formation on regional devel-
opment.
• The quality of the newcomers in terms of the competitive

pressure they exert on incumbents. A strongly challenging
entry such as a radical innovation introduced by a Schum-
peterian entrepreneur may revolutionize the market and cre-
ate a completely new industry; the effect of imitative new
businesses will be much smaller or even negligible.
• The way the incumbent firms react to the challenge of new
competition, for example, by product innovation, process
innovation, outsourcing to low-wage regions, and the like.
• The characteristics of the competitive process, which may
be considerably dependent on factors such as the number of
competitors, demand conditions, and technological develop-
ments, as well as by barriers to entry and exit.
Selection processes are at work in both output and input markets.

Given the interregional or even global scope of many output markets,
improvements by incumbents that were originally motivated by pres-
sure from local start-ups may not occur in the same region where the
local start-up is but elsewhere. Since the conditions for successful entry
and innovation, as well the characteristics of the competitive process,
can vary considerably across industries, there may be industry-specific
effects.
Aspects of the regional environment such as the regional “culture” of
entrepreneurship, the available supportive infrastructure for start-ups,
the location and accessibility of a region, the number and density of
actors, the thickness of input markets, the qualification of the regional
workforce, and the quality of other available inputs have a significant
influence on the number and quality of start-ups. A main determinant
of opportunity for innovative entrepreneurship is the regional knowl-
edge base, which is partly embodied in the regional workforce. The size
and quality of the regional knowledge base should have an important
impact on the emergence of challenging new businesses as well as on
the ability of incumbents to react to such challenge in an innovative
way.
The complex competitive process that is at the core of this explana-

tion of the effects of new business formation on regional development
may take a considerable amount of time to manifest. Scholars engaging
in empirical research on the topic need to be aware of these consider-
able time lags. Unfortunately, there are time lags in the manifestation
of indirect effects that new business formation has on growth. This
may increase the difficulties in identifying these effects. The previous
discussion of the different factors that influence the effect of new busi-
ness formation makes clear that it is not completely certain whether
and, if so, to what extent new business formation will lead to addi-
tional employment in the same region. The overview of the empirical
evidence in the next section shows that there are indeed several regions
in which the effect of new business formation on employment has been
insignificant or even negative during certain time periods. However, on
average and in most regions, start-ups do create more employment in
their region, particularly in the longer run.
4
Results of Empirical Research
Before presenting the results of empirical research on the effects of

new business formation on economic development, I first deal with a
number of methodological issues (Section 4.1). Section 4.2 reviews the
empirical evidence on how the development of new businesses directly
affects growth. Results of empirical studies that try to assess the over-
all effect, reviewed in Section 4.3, clearly suggest that there are rather
important indirect effects at work. Section 4.4 deals with different types
of indirect effects of new business formation, approaches for identify-
ing these indirect effects, and their magnitude compared to the direct
effects. Section 4.5 reports evidence for differences that have been found
between entries with different characteristics and in different industries
and Section 4.6 deals with differences across regions. The question of
whether new business formation is a cause or a symptom of growth is
the subject of Sections 4.7 and 4.8 summarizes the main results.
4.1 Methodological Issues

Micro-level analyses may be particularly suitable for identifying the
direct effects of new business formation, but they are of limited value
285
286 Results of Empirical Research
for assessing the indirect effects. To account for such indirect effects, the
relationship between level of new business formation and some aggre-
gate performance measure, such as change in employment, gross domes-
tic product, or productivity, in the country, region, or industry, has to
be analyzed. To date, work on the effects of new business formation
on economic development has mainly focused on employment creation,
possibly due to the importance policymakers place on job generation
and the prevention of unemployment. Another reason may be the bet-
ter availability of employment data compared to other performance
indicators.
A meaningful comparison of regions of different size or economic
potential should in one or another way account for this economic poten-
tial. An easy way to fulfill this requirement is to calculate a start-up rate
that relates the number of start-ups to a measure of regional size. Most
commonly, the number of employees, the regional workforce (including
the unemployed), or the regional population of working age is chosen
as the denominator of the start-up rate, what Audretsch and Fritsch
(1994) call the “labor market” approach. This kind of start-up rate is
based on the notion that each member of the workforce is faced with
the decision to either work as an employee in someone else’s business, to
be unemployed, or to start his or her own firm. According to the labor
market approach, the entry rate may be viewed as the propensity of a
member of the regional workforce to start an own business.1 Many of
the analyses of the effect of new business formation on regional devel-
opment use sector-adjusted start-up rates that account for the fact that
start-up rates differ systematically across industries.2 Sector-adjusted
1 Because start-ups are usually located close to the residence of the founder (Dahl and
Sorenson, 2009; Figueiredo et al., 2002; Stam, 2007), the regional workforce can be
regarded as an appropriate measure of the number of potential entrepreneurs.
2 For example, start-up rates are higher in the service sector than in manufacturing indus-
tries. This means that the relative importance of start-ups and incumbents in a region is
confounded by the composition of industries in that region. If this fact is not appropriately
taken into consideration, the result will be an overestimation of the level of entrepreneur-
ship in regions that are home to a large number of industries for which start-ups play an
important role, and an underestimation of the role of new business formation in regions
that are home to a high share of industries characterized by relatively low start-up rates.
To correct for the confounding effect of the regional composition of industries on the
number of start-ups, a shift–share procedure is employed to obtain a sector-adjusted mea-
sure of start-up activity (for details, see Audretsch and Fritsch, 2002, Appendix). This
start-up rates often lead to somewhat clearer results and higher lev-
els of determination than do estimates using the non-adjusted start-up
rate, but the basic relationships are usually left unchanged.
The results derived from an analysis of the relationship between
start-up rates and the development of employment or turnover at the
industry level can be very difficult to interpret. The problem is that if
industries follow a life cycle, then the number of entries and the start-up
rate will be relatively high in the early stages of the life cycle when the
industry is growing, and relatively low in later stages when the industry
is in decline (see Section 3.2 for a detailed exposition). Can the result-
ing positive correlation between the start-up rate and development of
the industry in subsequent periods be regarded as an effect of entry on
growth? Probably not—and, indeed, entirely different results are found
if, for example, the relationship between the level of start-ups and sub-
sequent employment change is analyzed at the regional or industry
level (see Fritsch, 1996; Bos and Stam, 2011). One may try to solve
this problem by controlling for industry-specific time trends (see, for
example, Falck, 2007, 2009), but such a control cannot completely rule
out the danger of a misspecification. Another problem when analyzing
the effects of new business formation on the development of industries
is that the impetus for new business formation in one industry may
also have effects on the development of other industries (Andersson
and Noseleit, 2011). These results and considerations strongly suggest
that geographical units of observation are much better suited for ana-
lyzing the effects of new business formation on economic development
than are industries.
Empirical studies analyzing the impact of new business formation
on the development of regions or countries usually employ a start-up
measure that is based on gross entry as indicator of the level of new
sector-adjusted number of start-ups is defined as the number of new businesses in a region

that could be expected if the composition of industries were identical across all regions.
Thus, the measure adjusts the raw data by imposing the same composition of industries
upon each region. This procedure leads to somewhat clearer results and higher levels of
determination than the estimates using the non-adjusted start-up rate, but the basic rela-
tionships are left unchanged. Including variables for the regional industry structure would
not provide the same type of control because the overall industry structure is dominated
by incumbents, not by start-ups.
business formation activity. Sometimes, net entry, calculated as the

change in the number of business owners, is used, mainly for reasons of
data availability (for example, Carree and Thurik, 2008; Piergiovanni
et al., 2012; Dejardin, 2011). Another variant is to analyze the effect of
turbulence, defined as the number of entries plus number of exits, on
economic development (for example, Bosma et al., 2011), which can be
regarded as an indicator of the level of creative destruction that takes
place in the industry or region. Most studies based on data from the
Global Entrepreneurship Monitor (GEM) (for example, Bosma, 2011)
use “total entrepreneurial activity” (TEA), which is the percentage of
the adult population between 18 and 64 years old that is either actively
involved in starting a new venture or is the owner/manager of a young
business (for details, see Reynolds et al., 2005). Some of the studies that
are based on GEM data analyze entries of subgroups, such as “oppor-
tunity,” “necessity,” or “high-growth expectation” entrepreneurship.
Most studies simply regress a performance measure on an indica-
tor of new business formation activity with some control variables.
A few studies apply an explicit production function framework that
also contains indicators for the contribution of other inputs to growth
(Audretsch et al., 2006; Mueller, 2006, 2007; Wong et al., 2005). In this
type of approach, entrepreneurship is regarded as a production factor
that introduces resources, such as initiative and opportunity recogni-
tion, as well as willingness and ability to take risk, into the model. The
advantage of analyzing the contribution of entrepreneurship within the
framework of a production function, compared to a simple regression
of measures of development on indicators for entrepreneurship, is that
doing so more systematically accounts for other determinants of growth,
and it has a foundation in production theory. However, entrepreneurs
do not accomplish success and growth by spirit and initiative alone;
they must hire labor and make capital investments. Hence, in a pro-
duction function framework that includes the inputs of labor and cap-
ital, parts of the impact of entrepreneurship on development may be
attributed to these other factors and not to the entrepreneur who made
the decisions regarding their use. Therefore, the effect of entrepreneur-
ship may well be underestimated in this sort of analysis. However, those
empirical studies that more or less solely relate the start-up rate to
growth are in danger of overestimating the effect of entrepreneurship

due to the neglect of other factors.
A serious problem with the production function approach involves
the data to be used. For example, data on capital stock must gener-
ally be regarded as of questionable reliability and, in many countries,
are rarely available at the regional level. Moreover, causal interpreta-
tion of these results can be problematic if the empirical analyses are
related to the level of gross domestic product (GDP) or productivity,
not to their development. To date, none of the available approaches
based on a production function framework have used longer time lags
of the entrepreneurship indicators, which turns out to be of crucial
importance, as will be shown in the next section.3
Neglect of longer time lags is also a critical issue in nearly all the
available job-turnover analyses that focus on employment gains and
employment losses in different categories of firms or establishments,
such as start-ups, incumbent firms of different size classes, exits of dif-
ferent size classes, and the like (for example, Davis et al., 1996; Spletzer,
2000; Neumark et al., 2006). The strength of this approach is to show
the anatomy of employment change, particularly the immense gross
changes that are often behind a relatively small net change, thereby
informing about the turbulence within economic aggregates such as
regional or industry employment. In principle, this type of approach
is well suited to investigate the intensity of competition caused by
new businesses, particularly the indirect effects of new businesses on
incumbents (see Section 4.4.1). However, without accounting for suffi-
ciently long time lags, nearly all these approaches neglect larger parts
of the indirect effects and, therefore, are more similar to a descriptive
job-growth accounting exercise than an assessment and analysis of the
effects of start-ups on economic development.4 The inclusion of longer
3 Moreover, most of the available approaches that analyze the effects of entrepreneurship in
a production function framework are based on cross-section estimates and therefore may
neglect the effect of region-specific factors on growth that are not explicitly accounted for.
Hence, a fixed-effects panel approach that controls for such unobserved regional effects
may lead to quite different estimates of the contribution of entrepreneurship to economic
development.
4 An exemption is Neumark et al. (2006), who account for time lags of up to 10 years.
time lags for new business formation makes it possible to identify indi-
rect effects of entry on incumbent employment (see Section 4.4.2). For a
more reliable identification of the relevant causalities, it would be desir-
able to include regional fixed effects and apply instrumental variable
approaches.
4.2 The Direct Contribution of New

Businesses to Employment
Birch’s (1979) empirical approach was to follow the development of
groups (cohorts) of businesses over time. His statements about the main
drivers of employment in the U.S. economy were based on comparisons
of the performance of business cohorts. A crucial issue in this type of
analysis is selection of the sample, which should be representative of the
entire population of firms. This requires datasets containing informa-
tion about the businesses at several points in time, that is, panel data.
Simple surveys that gather data on current and previous performance
at only one point in time are not sufficient for such an analysis. This
is because even if the information is representative for all businesses
during the period in which the survey is conducted, information for
businesses that existed in an earlier period but are no longer active will
nearly always be unavailable. Calculating average growth rates only for
firms that existed in both periods, the “survivors,” overestimates devel-
opment of the cohort as a whole and thus the analysis will suffer from
a “survivor bias.” Hence, cohort analyses of the development of new
businesses need information about businesses that exited the market
after some time.
The German Employment Statistics, a comprehensive database that
covers all businesses in the private sector (for details, see Spengler,
2008), provides information about representative cohorts of the vast
majority of new businesses in Germany over periods of up to 29 years.5
My discussion of the main findings about the development of start-up
cohorts is based on this database because of the exceptionally long time
period that is covered. The main results derived from these data are in
5 Thestatistic is limited to those businesses that have at least one employee, that is, start-
ups consisting only of owners are not included.
4.2 The Direct Contribution of New Businesses to Employment 291
Fig. 4.1 Evolution of employment and survival rates in entry cohorts

(Source: Schindele and Weyh, 2011).
Notes: Thin dotted lines: individual cohorts; dark thick line: average value over all cohorts
for which information in the respective year is available.
line with work using other kinds of data and for other countries.6 Ana-
lyzing the German Employment Statistics for West Germany, Fritsch
and Weyh (2006) and Schindele and Weyh (2011) show that overall
employment in entry cohorts first rises but then declines from the sec-
ond or third year on (Figure 4.1). After about eight years, it falls below
the initial level and after 20 years the overall number of employees in
a cohort is slightly less than 80 percent of that in the year the new
businesses were setup. After 29 years, the maximum length of the cur-
rently available time series, the overall number of employees is about 50
percent of the initial number of employees. Since most start-up activity
takes place in the service sector, employment development in services
is quite similar to the pattern observed in the private sector as a whole.
The results for manufacturing are somewhat different. The number of
6 See,
for example, Horrell and Litan (2010), Spletzer (2000), and Stangler and Kedrosky
(2010) for the United States, and the cross-country comparison in Bartelsman et al. (2009).
employees in the manufacturing start-up cohorts remains above the ini-

tial level for a longer period than it does in the services sector. From
year 18 onward, employment declines until it reaches 55 percent of the
initial level in year 29. During their first years, manufacturing start-ups
are also more successful than those in services, in that peak employ-
ment is about 160 percent of the initial level compared to 130 percent
for services.
In the service sector, the remaining 55 percent of initial employment
after 29 years is in just 15 percent of the initial cohort plants, that
is, only 15 percent of all newly founded businesses survive the entire
observation period. In manufacturing, nearly 20 percent of the start-
ups endure for the entire 29 years. At the end of the period of analysis,
in the year 2004, about 37 percent of all private-sector jobs are in
the start-ups of the previous 29 years. This share is higher in services
(47 percent) than in manufacturing (26 percent) (Schindele and Weyh,
2011).
A common finding from cohort studies is that only a small propor-
tion of the new businesses creates a considerable number of jobs; the
vast majority remains rather small.7 Accordingly, Schindele and Weyh
(2011) find that after 10 years, about 23 percent of the jobs are con-
centrated in the largest 1 percent of the initial start-ups, 45 percent of
employment is in the largest 5 percent, and more than 82 percent of the
employees work for the largest 25 percent of the initial start-ups. Over
time there is a continuously increasing employment concentration for
the largest 25 percent of surviving businesses. The relatively few high-
growth businesses, often termed “gazelles,” have attracted consider-
able interest (for a review, see Acs, 2011; Henrekson and Johansson,
2010). One important result of these studies is that there is a slight
tendency for gazelles to be relatively young, but also that quite a num-
ber of older firms can be found in this category. Moreover, gazelles
are not concentrated in innovative manufacturing industries but can
be found in all industries, particularly in the service sector (see also
Acs, 2011).
7 See,for example, Storey (1994, pp. 113–119) for a review of the cohort studies that were
available until the early 1990s.
4.2 The Direct Contribution of New Businesses to Employment 293
Fritsch and Schindele (2011) analyze the share that new businesses
contribute to regional employment in West Germany. Their measure
for the direct employment effect is the employment in regional start-up
cohorts two (short-term effect) and 10 years (long-term effect) after
entry divided by total regional employment in the year prior to the
start-up.8 On average, an entry cohort of a particular year adds 1.8
percent to overall employment after two years and 1.56 percent after
10 years. The difference between the long-term and the short-term
contribution reflects the declining employment in start-up cohorts
between the second year and the tenth year after entry. Both the
short-term and long-term contributions to employment are more
pronounced for start-ups in services than for those in manufacturing,
which is obviously a result of the higher level of new businesses
formation in the service sector.
Analyses of the direct contribution start-ups make to employment
clearly show that new businesses do create a considerable number
of jobs, but that the share of employment in new businesses in
overall employment is not overwhelming. Moreover, many new firms
exit the market soon after entry; only a small fraction of start-ups
exhibit considerable growth. Why these few gazelles succeed is still
unclear and deserves further investigation (Henrekson and Johansson,
2010). However, keeping in mind Schumpeter’s examples of innovative
entrepreneurs who initiate radical changes with important indirect
effects on other firms and other sectors of the economy (Schumpeter,
1911/1934, 1939), the development of start-ups tells only part of
the story. Hence, even if the number of jobs provided by gazelles or
the amount of value they add does make up a considerable part of
a region or sector, attempts to assess the impact of new business
formation on development should try to account for indirect effects
also. It is a severe disadvantage of cohort analyses that they do not
account for possible indirect effects of new business formation such as
the displacement of incumbent businesses or productivity enhancing
8 Employmentin the year prior to the start-up was used because this figure is not influenced
by employment in the newly created businesses.
effects of the innovative products they introduce. Such possible indirect

effects are reviewed in the next section.
4.3 The Overall Effect of New Business Formation on

Employment and GDP Growth
The first systematic analyses of the relationship between the level of
new business formation and regional employment change were con-
ducted by Reynolds (1994, 1999) for the United States. Reynolds finds a
pronounced positive effect. However, performing the analysis for differ-
ent time periods reveals considerable variation in the outcome. A posi-
tive relationship between the regional level of start-ups and employment
growth in subsequent years is confirmed, among others, by Ashcroft and
Love (1996) for the United Kingdom, by Acs and Armington (2002) for
the United States, by Brixy (1999) for East Germany, by Piergiovanni
et al. (2012) for Italy, and by Berkowitz and DeJong (2005) for Russia.
Audretsch et al. (2006) include the start-up rate into a Cobb–Douglas
production function and identify a positive effect on the level of GDP
in West German regions.9 However, a number of other studies do not
find a positive relationship between the level of start-ups and regional
employment growth (for example, Audretsch and Fritsch, 1996; Fritsch,
1996, 1997; EIM, 1994).
Results of international cross-section analyses at the country level
based on data of the Global Entrepreneurship Monitor (GEM) are
partly contradicting and do not reveal a clear picture. In an analy-
sis of 36 countries participating in the GEM project, van Stel et al.
(2005) found some evidence of a positive effect of “total entrepreneurial
activity” (TEA) on GDP growth in highly developed countries, but
not in the low-income countries included in the sample. In a follow-up
study that was based on GEM data for 30 countries, Stam et al. (2011)
found the opposite, that is, a significantly positive effect of TEA in
low-income countries but no significant effect in high-income countries.
9 Mueller (2007) uses a similar approach to assess the effects of the level of new business
formation on the GDP level in the regions of West Germany. She finds a weakly significant
positive coefficient for start-ups in technology- and knowledge-intensive industries, whereas
the coefficient for new business formation in the other industries is nonsignificant.
4.3 The Overall Effect of New Business Formation on Employment 295
“Ambitious” TEA10 had a significantly positive effect in both types of

countries and this effect was stronger in the poor countries. In the poor
countries, the coefficient for ambitious TEA was larger than the coeffi-
cient for the overall TEA. A study of 37 GEM countries by Wong et al.
(2005) confirms that it is more the growth-oriented entrepreneurs who
have an effect on development. These authors identify a significantly
positive impact on GDP growth for “high-growth potential” TEA,11
but not for overall TEA, necessity TEA, or opportunity TEA.12 A study
by Stam and van Stel (2009) based on a sample of 36 GEM countries
uses the information about the young business owners, which is that
subgroup of TEA that not only intends to start an own business but has
indeed set up an own business that is less than 42 months old (Reynolds
et al., 2005). The empirical analysis identifies no statistically significant
effect of young business ownership on economic growth in low-income
countries in contrast to transition and high-income countries, where
growth-oriented entrepreneurship seems to have an especially strong
effect. Gonzalez-Pernı́a and Peña-Legazkue (2011) find a positive effect
of the overall TEA on regional GDP growth in Spanish regions. Adding
an indicator for the export orientation of the founders, they identify
an additional positive effect for founders with a pronounced orientation
toward export.
One possible reason for the mixed results of studies analyzing the
impact of new business formation on employment change could be that
the entry and turnover of establishments (firms) may lead to a produc-
tivity increase (see Section 4.4.3) that compensates for the employment
effect. Another reason may be that not all the effects of new business
formation on employment emerge immediately upon the newcomers’
10 Respondents were classified as “ambitious” entrepreneurs if they stated that they expect
their firm to grow to at least six employees within five years.
11 A venture was classified as having a “high-growth potential” if it fulfilled four criteria:
(1) the venture plans to employ at least 20 employees in five years; (2) the venture
indicates at least some market creation impact; (3) at least 15 percent of the venture’s
customers normally live abroad; and (4) the technologies employed by the venture were
not widely available more than a year ago (Wong et al., 2005, p. 345).
12 Necessity entrepreneurship is understood as a start-up that is founded due to a lack
of alternatives (for example, the founder cannot find any other kind of job). A new
business setup to pursue an opportunity is classified as “opportunity” entrepreneurship.
See Reynolds et al. (2005) for details.
entry into the market. Due to data restrictions, the analyses mentioned
above do not include any or only rather short time lags between the
founding of the start-ups and the respective effect on output. However,
if longer time lags play a role, these studies may have assessed the
effects on regional development only incompletely. In an analysis for
West German regions, Audretsch and Fritsch (2002) do, indeed, find
evidence for positive long-term effects of new business formation. In
this study, new business formation activity in the early 1980s could not
explain regional employment change in the rest of the decade, but did
provide an explanation of employment change in the 1990s.
Van Stel and Storey (2004) analyze the relevance of such time lags
more systematically and estimate a time lag structure of the effects
of new business formation on regional employment growth with data
for Great Britain. They confirm that there are considerable time lags
between new business formation and its effect on regional development,
which they find to be positive. A severe problem in analyzing the time
lag structure of the effect of new business formation on growth emerges
from a high correlation between yearly start-up rates. Because of this
high correlation, the original estimates may not reflect the “true” lag
structure. In dealing with this problem, van Stel and Storey (2004)
apply the Almon polynomial lag procedure. This procedure attempts
to approximate the lag structure by means of a polynomial function
(for a detailed description of this method, see Greene, 2008). In this
type of analysis, an assumption must be made about the order of the
polynomial to be used for estimating the lag structure. Fritsch and
Mueller (2004) apply the Almon polynomial lag procedure in an anal-
ysis of the effect of new business formation on regional development in
West Germany. They find that a statistically significant effect of new
business formation on employment is restricted to a period of about
10 years. Van Stel and Storey (2004) assume a second-order polyno-
mial for estimating the lag structure of new business formation rates;
Fritsch (2004), however, also apply higher-order polynomials. With a
third- and higher-order polynomial, they find a “wave” pattern of the
effects (see Figure 4.2).
Figure 4.2 depicts the original regression coefficients that have been
found without application of the Almon lag procedure as well as the
4.3 The Overall Effect of New Business Formation on Employment 297
Fig. 4.2 Effects of new business formation on employment change over time in West Ger-
many — regression coefficients for start-up rates and the results of the Almon lag procedure
assuming a third-order polynomial
(Source: Fritsch, 2008).
coefficients that result from this procedure by assuming a third-order

polynomial. The resulting smoothened lag structure suggests that new
business formation during the current year has a positive impact on
employment change. For years t − 1 to t − 5, the effect is negative,
with a minimum in t − 3. For entries in years t − 6 to t − 9, a posi-
tive relationship is found, with a maximum between years t − 7 and
t − 8. The magnitude of the effect then decreases and becomes statisti-
cally insignificant for periods more distant than t − 10.13 This type of
wave pattern of the lag structure is confirmed for a number of countries,
including Belgium (Dejardin, 2011), the Netherlands (van Stel and Sud-
dle, 2008; Koster, 2011), Portugal (Baptista et al., 2008; Baptista and
Preto, 2011), Spain (Arauzo-Carod et al., 2008), Sweden (Andersson
and Noseleit, 2011), the United Kingdom (Mueller et al., 2008), and
13 The overall effect of new business formation on employment change can be measured by
the sum of the regression coefficients for the start-up rates of the different years (Gujarati,
2009), which are depicted by the three areas in Figure 4.2.
the United States (Acs and Mueller, 2008), as well as for a sample of
23 OECD countries (Carree and Thurik, 2008).14
Fritsch and Mueller (2004) suggest an interpretation of this wave
pattern that builds on the systematization of direct and indirect effects,
as discussed in Section 3.4.1. According to this interpretation, the posi-
tive employment impact for start-ups in the current year can be under-
stood as the additional jobs created by the newly founded businesses
at the time of inception. This direct employment effect is indicated
in Area I in Figure 4.2. It is well known from a number of analyses
that employment in entry cohorts tends to be stagnant or even decline
from the second or the third year onward (see Section 4.2). Therefore,
new firm formation in year t − 3 and more distant time periods should
not lead to any significant direct employment effect of the cohort as
a whole. As soon as a new business is set up, it is subject to market
selection and may gain market shares from incumbent suppliers. Thus,
the negative impact of the start-ups in years t − 1 to t − 5 (Area II in
Figure 4.2) is probably a result of market exit, that is, new businesses
that fail to be competitive and displacement of incumbents. The pos-
itive impact of new business formation on employment for years t − 6
to t − 10 (Area III in Figure 4.2) is probably due to a dominance of
indirect supply-side effects, that is, increased competitiveness of the
regional suppliers resulting from market selection. After about nine or
ten years, the impact of new business formation on regional employ-
ment fades away.
When they use a second-order polynomial for the Almon lag pro-
cedure, Fritsch and Mueller (2004) find the resulting lag structure to
be “u”-shaped. The interpretation of the “u”-shaped lag structure is
similar to that for the wave pattern that resulted from assuming a
higher-order polynomial. Fritsch and Mueller (2004) posit that the ini-
tial increase in employment is a result of the new businesses’ initial
14 Insome cases, the curve for the lag structure that is estimated by applying the Almond
polynomial lag procedure shows negative coefficients for the last one or two years of the
period under inspection. These negative coefficients in later periods should be regarded
as an artifact of the estimation procedure. It is difficult, if not impossible, to plausibly
argue for negative employment effects of new business formation after the supply-side
effects have phased out.
demand for resources, which is followed by a period during which the

crowding-out effects prevail, before the employment-increasing supply-
side effects finally start to dominate. What is different between the
two patterns is that these supply-side effects then become stronger and
stronger without decreasing again in the more distant years. However,
such an increase is highly implausible, given the statistical insignifi-
cance of start-up rates during these periods. The increase in the curve
for the latter periods is probably caused by the very nature of a second-
order polynomial, which by definition has only one inflection point. If
the interpretation of the lag structure proposed by Fritsch and Mueller
(2004) is correct, both patterns imply that the indirect employment
effects as indicated in Areas I and II of Figure 4.2 are more important
than the direct effect, that is, the initial employment created in the
newly founded businesses (Area I).
The wave pattern of the effects of new business formation that is
found in many of the empirical analyses makes very clear that the
largest part of the positive employment effects of new business forma-
tion occur only with a considerable time lag. Hence, it must be regarded
as a rather serious shortcoming if empirical analyses do not account for
sufficiently long time lags. Presently, most analyses of the lag structure
have been conducted for the employment effect of new business forma-
tion. Analyzing the effect of net entry on the change of GDP and pro-
ductivity for a sample of 23 OECD countries, Carree and Thurik (2008)
also identify a wave pattern with some negative coefficients for the first
years after net entry that are, however, not statistically significant.
4.4 Indirect Effects of New Business Formation

There are a number of approaches that aim at identifying indirect
effects of new business formation. In traditional industrial economic
literature, authors analyze the effect of entry on market mobility (Sec-
tion 4.4.1) and on productivity (Section 4.4.3). A main focus here is on
approaches for detecting indirect effects of entry on regional employ-
ment, which will be surveyed in Section 4.4.2. This section also provides
a comparison of the direct and the indirect employment effects of new
business formation.
Another type of indirect effect could be the influence of

entrepreneurial role models on a region’s “culture” of entrepreneur-
ship (Beugelsdijk, 2007; Chinitz, 1961; Etzioni, 1987; Fornahl, 2003;
Glaeser and Kerr, 2009; Glaeser et al., 2012; see Section 4.6.6 for a
more detailed treatment of this issue). Moreover, there may be “second-
round” indirect effects that result from the impetus given to regional
development from new business formation, such as increasing agglom-
eration economies and diseconomies, growth-induced start-ups, and the
like. Such second-round effects, however, are not discussed here.
4.4.1 The Challenge of Entry and Market Mobility

To identify indirect effects of new business formation on regional
growth, Koster et al. (2012) and Koster and van Stel (2011) use a
measure for regional market mobility that reflects the change in the
ranking of regional establishments with five or more employees in terms
of employment size. In a regression analysis, they find a pronounced
positive effect of the start-up rate on the measure of market mobility,
indicating significant effects of entry on the regional market structure
(Koster et al., 2012). The regression coefficient for the start-up rate is
considerably higher when the current value is replaced by the start-up
rate of about five years earlier, suggesting that the effect of entry
on market mobility comes with a substantial time lag. Including the
start-up rate and the market mobility measure in a model designed to
explain regional employment growth (Koster and van Stel, 2011) shows
a statistically significant effect of both indicators. This result seems
to be driven by development in the service sector. When running the
analysis for manufacturing only, the start-up rate as well as the market
mobility measure has no statistically significant effect on regional
employment growth.
This analysis clearly shows the competition-enhancing indirect
effect of new business formation on regional employment growth.
Accordingly, start-ups may have a direct employment effect and the
indirect effect of stimulating established firms to improve their perfor-
mance (Koster and van Stel, 2011).
4.4.2 Indirect Employment Effects of New

Business Formation
Fritsch and Noseleit (2012a) apply a decomposition procedure for iden-
tifying indirect effects of new business formation on regional employ-
ment. Using the information on total employment change (∆EMPtotal )
and on employment in new businesses15 (∆EMPnew ), they calculate
the employment change of incumbents as:
∆EMPinc = ∆EMPtotal − ∆EMPnew .
This employment change in incumbent businesses encompasses the

indirect effects of the new businesses — displacement and supply-side
effects — as well as other impacts that are not caused by the start-ups.
The authors then estimate the indirect effect of new business formation
by regressing the start-up rate of the preceding 10 years on the change
in incumbent employment.
Fritsch and Noseleit (2012a) calculate the direct contribution of new
businesses to overall employment as:
Emp cohort t=n − Emp cohort t=n−1
∆Emp direct t=n = ∗ 100
Emp total t=n−1
with ∆Emp cohort t , giving the number of employees in a certain cohort

in year t and where ∆Emp total t is the overall regional employment in
year t. Using data for West Germany, Fritsch and Noseleit (2012a)
find that the pattern of the direct employment effect identified that
this way is surprisingly similar for the different start-up cohorts in
the sample. In the year when the start-ups enter the market, they
account for an employment increase of about 1.5 to 1.8 percent. In
the first year after entry, this effect is also positive but much smaller.
Because the start-up cohorts tend to experience an employment decline
in later years, their direct contribution to employment change becomes
slightly negative. Hence, the largest direct contribution of start-ups to
employment change occurs in the year they are set up (see Figure 4.3).
15 Inthis analysis, new businesses are those that have been set up during the previous 10
years.
3.0
2.5
Employment change (in %) 2.0
1.5
1.0
0.5
0.0
-0.5 0 1 2 3 4 5 6 7 8 9 10
-1.0
-1.5
Years after start-up
Direct effect Indirect effect Overall effect
Fig. 4.3 Impact of start-ups on regional employment change — direct and indirect effects
(Source: Fritsch and Noseleit, 2012a).
Estimating the indirect effect of new business formation by regress-

ing the start-up rates of the preceding 10 years on the change in incum-
bent employment, Fritsch and Noseleit (2012a) find a wave pattern (see
Figure 4.3).16 After applying a weighing procedure that allows them to
express employment change in incumbents as a share of overall employ-
ment change, they compare the magnitude of the direct effect and the
indirect effects. The resulting curve for the overall effect (Figure 4.3)
corresponds well to the findings of earlier studies for West Germany
(Fritsch and Mueller, 2004, 2008). As Figure 4.3 clearly shows, the
largest part of the overall employment induced by new businesses is
due to indirect effects on incumbents. The main deviation between the
two curves is that the aggregate indirect effect is considerably lower
than the overall effect in the first two years, which is due to the direct
effect of new business formation on regional employment in this early
period.
According to the analysis of Fritsch and Noseleit (2012a) for West
Germany, the start-ups of a certain vintage have on average led to a
16 The period of 10 years was chosen here because the analyses by Fritsch and Mueller (2004,
2008) for Germany find significant effects of new business formation for this length of time
(see Section 4.2).
3.8 percent increase in regional employment over a period of 11 years.17

About 40 percent of this increase is attributable to employment in new
businesses; the other 60 percent is due to indirect effects. Hence, nearly
two-thirds of the employment change generated by new business forma-
tion arises from the interaction between newcomers and incumbents in
the region. The authors conclude that employment in the start-ups —
the direct effect of new business formation on regional employment —
is clearly the smaller part of the overall effect.
This result is confirmed by regression analyses that relate the
average start-up rate of the previous 10 years to overall regional
employment change, employment change in young new businesses, and
employment change in incumbents (Fritsch and Noseleit, 2012b; Fritsch
et al., 2010). Since employment change as well as start-up rates are
included with their logarithmic values, the coefficients can be inter-
preted as quasi-elasticities and thus allow easy comparison between
the different models. These coefficients represent the relative employ-
ment change in incumbent and new/young businesses that can be
explained by the start-up activity. Incumbent employment encompasses
all employees in businesses that are more than 10 years old. Young
businesses are those that have been set up in the preceding 10 years.
The models control for the effect of regional human capital, popula-
tion density, spatial proximity to other regions (“market potential”),
and regional industry structure. Since fixed effects panel regression is
applied, the model also accounts for unobserved time-invariant region-
specific characteristics.
Fritsch and Noseleit (2012b) find a significant positive relationship
between the long-run start-up rate and overall employment change
(Model I in Table 4.1). Such a positive relationship is also present
for the effect of start-ups on employment change in the new/young
and incumbent businesses (Models II and III in Table 4.1). The posi-
tive coefficient for employment change in the incumbents suggests that
17 This result corresponds quite well with the estimates of Fritsch and Mueller (2008).
According to Fritsch and Mueller (2008), one additional start-up per 1,000 employees
leads to an overall employment increase of about 0.46 percent in the average region.
Given an average start-up rate of about nine new businesses per 1,000 employees, an
employment increase of 4.14 percent can be attributed to new business formation.
Table 4.1. The impact of new business formation on total employment change, employment
change in incumbent businesses, and employment change in new and young businesses.
Employment change Total Incumbents New businesses

Independent variables (I) (II) (III)
Average sector-adjusted start-up 0.191∗∗∗ 0.160∗∗∗ 0.0340∗
rate (log), t − 1 (0.029) (0.025) (0.017)
Share of highly qualified 0.0704∗∗ 0.0528∗ 0.0177∗∗
employees (log), t − 1 (0.035) (0.031) (0.0083)
Population density (log), t − 1 0.0259∗ 0.0291∗∗ −0.00324
(0.015) (0.032) (0.0075)
Market potential (log), t − 1 0.638∗∗∗ 0.244 0.394∗∗∗
(0.18) (0.18) (0.12)
Constant −7.380∗∗∗ −2.694 −4.686∗∗∗
(2.31) (2.27) (1.54)
Year dummies Yesa Yesa Yesa
Number of observations 1,184 1,184 1,184
Control for industry structure Yesa Yesa Yesa
Log-likelihood 3447 3441 4006
R-squared (within) 0.75 0.65 0.60
Notes: Fixed effects regressions. Robust standard errors in parentheses.

∗∗∗ Statistically significant at the 1 percent level;
∗∗ statistically significant at the 5 percent level; and
∗ statistically significant at the 10 percent level.
a Jointly significant at the 5 percent level.
positive supply-side effects of new business formation outweigh their

displacement effects. The estimated coefficient for the link between
new business formation and employment change in the young busi-
nesses (Model III) is considerably smaller than the coefficient for the
effect of the start-up rate in the model for employment change in incum-
bents (Model II). This suggests that the indirect employment effects of
new business formation on incumbents are more pronounced than the
relationship between start-up activity and employment created in the
new and young entities. A simple explanation for the larger indirect
employment effects may be found in the greater number of incumbents
compared to entries. If many more incumbents react to the challenge
posed by a much fewer number of newcomers, it could produce more
employment.
Another way of identifying indirect employment effects of new busi-
ness formation is to regress employment change in a certain sector on
new business formation in other sectors of the economy. This method is
employed by Andersson and Noseleit (2011) in an analysis of Swedish
regions. The study reveals that there are indeed pronounced indirect
effects that were the strongest for start-ups in manufacturing, followed
by start-ups in low-end services, with high-end service industries bring-
ing up the rear.
4.4.3 Effects of Entry on Productivity

Productivity is a measure for the competitiveness of a firm, industry, or
region. A productivity increase particularly indicates that some inno-
vation has become effective.18 I argue above (Section 3.4.1) that if the
competition between entries and incumbents is based on survival of the
fittest, new business formation should lead to an increased productivity
even if employment declines. This productivity enhancing effect of new
business formation should become evident rather soon after entry when
the employment effect is dominated by a displacement of incumbents
(Area II of the “wave” shown in Figure 4.2).
The first empirical study to relate new business formation to
the change of regional productivity was an analysis by Callejon and
Segarra (1999) for Spain. The authors show that regional gross entry,
gross exit, and turbulence (number of entries plus number of exits) of
manufacturing establishment firms made a significant contribution to
the growth of total factor productivity in the respective year. However,
when including entry, exit, and turbulence rates for the two previous
years, the authors find a number of negative coefficients for these lagged
effects. Studies by Audretsch and Keilbach (2004) and Audretsch
et al. (2006) for regions of West Germany show a positive effect of new
business formation on the regional level of labor productivity. When
including the three-year average start-up rate in a production function
framework, they identify a significant positive relationship between
the start-up rate and the growth of labor productivity.19
Carree and Thurik (2008) analyze the effect of net entry on the
change in labor productivity in 23 OECD countries using longer time
18 I am not aware of any study that relates regional new business formation to other indi-
cators of innovation output.
19 Mueller (2006) identifies a highly significant positive effect of the start-up rate on the
level of regional labor productivity.

lags. They identify a wave pattern as has been found in many anal-
yses of the effect of entry on employment change (see Section 4.3).
There are some negative coefficients for first years after net entry but
these coefficients are not statistically significant. The overall effect of
net entry on productivity growth measured over a period of ten years
is clearly positive. Andersson et al. (2012), investigate the effect of
new business formation and turbulence (entry plus exit) on the pro-
ductivity of incumbent firms in Swedish regions accounting for time
lags of up to four years. In the various estimations they frequently find
significantly negative effects of entry and turbulence on incumbent’s
productivity for the current year and for the first two years after entry.
After these first years the effect becomes strongly positive in most cases.
Andersson et al. (2012) suggest that the negative effect of entry and
turbulence in the first years may be due to the effort of “adjusting rou-
tines and strategies etc. to respond to the newcomers on the regional
market.”
Bosma (2011), using GEM data for European regions, finds a
positive relationship between the level of early-stage entrepreneurial
activity and labor productivity. It is remarkable that this relation-
ship is weaker for early-stage entrepreneurial activity with low-growth
ambitions than for other types of entrepreneurship. The relationship is
particularly strong for early entrepreneurial activity with high-growth
ambitions and for those entrepreneurs with innovative ambition. Bosma
et al. (2011) analyze the effect of entry and turbulence (defined as the
number of entry plus the number of exits) on the change of total factor
productivity in the 40 NUTS III regions of the Netherlands. Turbu-
lence is defined as the number of entries plus the number of exits and
is intended to measure the level of business dynamics understood as
“creative destruction.” The number of entries was lagged by two years;
the number of exits was taken from the current year. They find a posi-
tive effect for both indicators in the service sector but not for start-ups
and turbulence in manufacturing. According to their estimates, the
marginal effect of entry and turbulence in the service sector on the
growth of total factor productivity decreases with a rising level of busi-
ness dynamics. They identify a certain rate of turbulence at which the
effect on productivity growth is at a maximum.
4.4.4 Entry and the Evolution of Industry Structure

Entry of new businesses accompanied by the exit of incumbents can
be an important means by which regional economies adjust to perma-
nent changes in their framework conditions, as is been illustrated by
Marshall’s (1920) famous analogy of a forest in which the old trees
must fall to give way to the new ones, or what Schumpeter (1911/1934,
1942) calls “creative destruction.” Structural adjustment by turnover
of economic units is especially prone to occur when incumbents do
not make necessary internal changes. In the long run, new and differ-
ent businesses can be a vital antidote to “lock-in” situations in which
incumbent firms are unable to make necessary changes (Fagerberg,
2003; Grabher, 1993). However, entry of new businesses can involve
more than just an adjustment to the economic environment. As is high-
lighted by Schumpeter (1911/1934, 1939), innovative start-ups can ini-
tiate the emergence of new markets and industries that may be drivers
of regional growth processes (Klepper, 2010). Neffke et al. (2011) show
for Swedish regions that processes of entry and exit can particularly
lead to the emergence and growth of industries that are technologically
related and require similar capabilities.
A study by Noseleit (2012) for the regions of West Germany strongly
indicates that a change in industry structure induced by entry and exit
may have positive effects on employment growth. Noseleit (2012) uses
two types of indicators, the similarity of industry affiliation between
entries and incumbents and the similarity of industry affiliation between
entries and exits. Including these indicators in a multivariate regression
for regional employment change results in a significantly negative coef-
ficient for both similarity indicators. This suggests that regions experi-
ence higher growth rates when entries induce more pronounced changes
in the local industry structure.
4.5 The Quality of Entry

The explanatory approach outlined in Section 3.4 assumes that the
magnitude of the effect that new business formation has on regional
development depends on the intensity of the challenge that the new-
comers pose to incumbents. Hence, the quality of the start-ups in terms
of the founder’s entrepreneurial skill and the firm’s knowledge base and
innovativeness should be important for its effect. One fact that may
indicate certain aspects of the quality of a new business is its industry
affiliation. There are many classifications, including “high-tech man-
ufacturing,” “technologically advanced manufacturing,” “knowledge-
intensive services,” and “non-technical consulting,” that can be used
to distinguish the quality of start-ups. Other ways of distinguishing
between the quality of start-ups is to use information about their orga-
nizational status (headquarter vs. subsidiary location), the qualification
of the entrepreneur, and the personnel or characteristics based on self-
estimations that are available in the GEM data, such as “necessity,”
“opportunity,” or “ambitious” entrepreneurship.
Section 4.5.1 provides an overview of the results of analyses of start-
ups in different industries. Section 4.5.2 reports results for other types
of classifications.
4.5.1 Differences Between Industries

Like Birch (1979), many scholars find that start-up development is
highly industry dependent. For example, in general, new businesses in
the manufacturing sector have better prospects for survival and growth
than do those in services (for example, Engel and Metzger, 2006, and
Schindele and Weyh, 2011). The higher survival rates of entries in
manufacturing may be explained by greater barriers to entry in this
industry, which lead to larger average size of entrants. Higher growth
prospects of manufacturing firms are probably due to geographically
larger markets. Engel and Metzger (2006) find no significant difference
in the development of employment between high-technology and low-
technology manufacturing, but do find a higher direct employment con-
tribution for technology- and knowledge-intensive services compared to
other parts of the service sector.
Empirical results on the survival of innovative firms are mixed. Stud-
ies by Audretsch (1995) for the United States and by Audretsch et al.
(2000) for the Netherlands indicate a relatively greater risk of failure
for start-ups in industries with high R&D levels. In contrast, Cefis
and Marsili (2005), for the Netherlands, and Metzger and Rammer
(2009) as well as Fritsch et al. (2013), for Germany, present evidence

for higher survival rates for new ventures in innovative industries.
Metzger and Rammer (2009) also show that new businesses in innova-
tive manufacturing industries and knowledge-intensive services created,
on average, more jobs per start-up than entries in non-innovative and
non-knowledge-intensive industries.
Analyses of the overall effect of new business formation on regional
employment growth find much stronger effects for start-ups in manu-
facturing than for start-ups in the service sector (Andersson and Nose-
leit, 2011; Fritsch and Mueller, 2004; Fritsch and Schroeter, 2011b; van
Stel and Suddle, 2008). Distinguishing between several segments of the
service sector in the Netherlands, van Stel and Suddle (2008) iden-
tify the lowest effect for new business formation in trades. However,
other studies using performance indicators based on GDP figures find
a stronger effect for start-ups in services. Dejardin (2011), in an analysis
of Belgium, identifies a positive effect of net entry on GDP growth only
for services, while the effect of net entry in manufacturing industries is
nonsignificant. Bosma et al. (2011), in their analysis for regions of the
Netherlands, also find a positive effect of entry and turbulence on the
growth of total factor productivity only for services, not for manufac-
turing. Quite in line with these results, Andersson et al. (2012) in their
analysis for Sweden identify a more pronounced productivity response
for incumbent firms in the service sector compared to manufacturing
firms.
Analyzing the effect of new business formation on regional employ-
ment in Portugal, Baptista and Preto (2011) find that the overall effect
on regional employment was substantially larger for new businesses in
knowledge-based industries than for start-ups in other sectors. In their
study, “knowledge-based” industries include innovative manufacturing
and knowledge-intensive services. Specifically, the study shows that
displacement effects as well as the supply-side effects of new businesses
in knowledge-based industries were much more pronounced than
in non-knowledge-intensive industries. Audretsch et al. (2006) in
their analysis of West German regions confirm that new business
formation in high-tech manufacturing industries and in information
and communication technology had a considerably stronger positive
impact on regional GDP and on the growth of labor productivity

than did the overall start-up rate or the level of start-ups in low-tech
industries. However, Fritsch and Schroeter (2011b) in their study
for West Germany find that new businesses in knowledge-intensive
services and in non-innovative or knowledge-intensive industries have
the strongest impact on overall employment growth, whereas the effect
of new businesses in innovative manufacturing remains statistically
insignificant.
The wave pattern observed for the effects of new businesses on
employment implies that start-ups may induce a considerable real-
location of resources in the respective regional economy. Andersson
and Noseleit (2011), in an analysis for Sweden, focus on such inter-
sectoral effects. In a first step, they confirm the well-known wave pat-
tern for the Swedish economy as a whole. In a second step, the model
is run for three sectors: manufacturing, low-end services, and high-
end services. Andersson and Noseleit find that in all three sectors new
business formation resulted in an employment increase. Analyzing the
effect on overall employment change, start-ups in manufacturing had
the strongest impact, followed by new business formation in low-end
services. The effect of start-ups in high-end services, defined to include
knowledge-intensive services, on overall employment change, however,
was barely statistically significant. Andersson and Noseleit clearly show
the presence of indirect effects by regressing new business formation in a
certain sector on employment change in other sectors of the economy.
These indirect effects were strongest for start-ups in manufacturing,
again followed by start-ups in low-end services, with high-end service
industries again bringing up the rear.
In short, the results of empirical studies on how new business
formation in different industries affects growth are far from being
monolithic. The only point of agreement among these studies is
that start-ups in manufacturing tend to have a stronger impact on
employment than do new businesses in the service sector, which may
be explained by the larger average size of manufacturing start-ups.
However, in analyses with GDP or productivity as the dependent
variable, only entry into the service sector has a statistically significant
effect. With regard to entries in innovative industries, some analyses
find lower probabilities of survival, whereas studies for other countries

show relatively high survival rates. The results on the overall impact
of start-ups in innovative or knowledge-intensive industries on regional
employment are also inconclusive. In some studies, start-ups in these
industries had a pronounced impact, while in others, this effect was
statistically insignificant.
There are a number of possible explanations for these diverse empir-
ical results. One reason may be that industry classifications are not well
suited for distinguishing between entries that have different impacts on
regional development. A second reason could be that there are con-
siderable differences between certain industries in specific countries or
types of regions that have implications for the effects of entry on devel-
opment. Differences in the results between countries or regions may
have to do with how close the firms under study are to their technolog-
ical frontiers (Aghion et al., 2009). Also unclear is how the method of
analysis and the choice of the dependent variable shape the results. For
example, that Audretsch et al. (2006), applying a production function
approach, identify a strong positive effect of new business formation in
the German high-tech manufacturing industries on the development of
labor productivity, while, for the same country and sector, Fritsch and
Schroeter (2011b) find no significant effect on employment needs expla-
nation. Obviously, considerable further research is needed for a better
understanding of how economic development is affected by start-ups in
different industries.
4.5.2 Other Quality-related Characteristics of

New Businesses
The currently available datasets that allow assessing the regional level
of new business formation provide only modest information about the
characteristics of start-ups that may be indicative of quality. Infor-
mation about new businesses that is available in some data includes
their size at the time of entry, the qualification of the entrepreneur, or
their organizational status, for example, whether the start-up is part
of a larger firm or whether it can be viewed as independent. Other
information available in the GEM data is based on self-estimations by
founders as to their growth prospects and the innovativeness of their

venture. Studies that employ only very short time lags demonstrate
that it is particularly “ambitious” and growth- and export-oriented
entrepreneurship that has pronounced effects on regional growth (see
Section 4.3).
One important aspect of the quality of an entry is the qualifica-
tion of the entrepreneur. However, surprisingly little is known about
the effect of an entrepreneur’s qualifications on the success and impact
that a start-up has (for a meta-analysis of the available empirical stud-
ies, see Unger et al., 2011). While a number of studies show that the
founder’s qualifications have a positive effect on the survival of a start-
up (Brüderl et al., 1992; Parker, 2009, p. 392), nearly nothing is known
about how qualifications impact employment growth and the indirect
effects. One piece of evidence in this respect is a cohort analysis by
Engel and Metzger (2006) showing that new businesses that are set up
by a person with an academic degree have a larger direct employment
effect than start-ups founded by persons without an academic degree.
Koster (2011) investigated whether independent new firms in
the Netherlands have different effects than establishments started
by existing firms (organizational foundings) on regional employment
change. Such different effects might very well be expected since new
establishments set up by existing firms can rely on the resource base
of the parent firm, which makes them less vulnerable and can result
in relatively high survival and growth rates (Tübke, 2004; Brüderl
et al., 1992).20 Koster finds that the lag structure for the effects of
organizational foundings on regional employment indicates a positive
direct effect on regional employment, but that this positive impact
rapidly tapers off until it is close to zero and nonsignificant; specifically,
he does not find the positive third part of the typical wave pattern that
Fritsch and Mueller (2004, 2008) view as an indication of supply-side
effects (see Section 4.3). However, a statistically significant third part
of the wave was found for independent start-ups. This supports the
20 The number of organizational foundings in Koster’s data is about half the number of
independent start-ups (Koster, 2011).
idea that the organizational status of entries influences their potential

effect on regional development.
In an analysis employing data on Portugal, Baptista and Preto
(2010) study the time lag structure of different types of new busi-
nesses. They find that start-ups involving foreign capital, which are
a very small share of the total number of new businesses, have a strong
displacement effect on employment as well as pronounced supply-side
effects, whereas the impact of start-ups without foreign capital is very
weak, resulting in only a low amplitude of the wave. According to the
results of Baptista and Preto (2010), the overall employment effect of
start-ups with foreign capital is clearly positive. Distinguishing between
new businesses that enter with an above-average size and smaller start-
ups leads to similar results: the larger entries have a pronounced effect
and show the usual wave pattern of the time lag structure with a
rather high amplitude, whereas the impact of smaller start-ups is minor.
It remains unclear, however, whether the larger start-ups lead to an
increase or a decrease in regional employment over the observation
period.
In comparable research, Acs and Mueller (2008) investigate the
effect of different kinds of start-ups on employment in U.S. Metropoli-
tan Statistical Areas. According to their estimates, the start-up of
firms having less than 20 employees, of which the vast majority can be
assumed to be independent new businesses, has a positive initial, but
quickly disappearing, effect on regional employment; no positive third
part of the wave pattern indicating dominant supply-side effects could
be found for these small start-ups. However, Acs and Mueller (2008)
do find a pronounced third part of the wave for entry firms having
between 20 and 499 employees. New businesses setup with 500 or more
employees, the majority of which are plausibly assumed to be subsidiary
establishments, have a pronounced negative employment effect that
probably indicates considerable displacement of incumbents.21 This
negative effect is the largest about three years after start-up and then
becomes weaker. Unfortunately, the time series available to Acs and
21 More than 10 percent of the entries were firms with less than 20 employees, about 8 per-
cent were firms with between 20 and 499 employees, and the larger firms made up a little
more than 10 percent of all new establishments.
Mueller (2008) allow them to estimate a lag structure of the effects of

new business formation on regional employment for a period of only
six years, so they cannot say if the effect of the start-up of large firms
becomes positive in later years. The authors speculate that the entry
of larger firms induces massive restructuring of the regional economy,
leading to a pronounced reduction of labor inputs during the first years
after start-up.22
Another indication that not all entries are equally important to
economic development but that the quality of the newcomers may play
a decisive role is provided by empirical work that distinguishes between
new businesses according to how long they remain in the market. In an
empirical analysis at the level of German industries, Falck (2007, 2009)
finds that new businesses that survived for at least five years (“long-
distance runners”) had a significantly positive impact on GDP growth,
whereas the effect of entries that stayed in the market for only one
year (“mayflies”) was statistically insignificant or significantly negative.
Fritsch and Noseleit (2012b) arrive at a similar result in an analysis at
the level of West German regions. They find that the positive effect
of new business formation on incumbent employment is nearly entirely
caused by start-ups that are able to survive for at least four years. The
employment effect of new businesses that exit the market within the
first four years is much weaker or statistically insignificant.
The available evidence on the effect of entries with different char-
acteristics clearly suggests that not all start-ups are equally important
to economic development but that the quality of the newcomers does
play a decisive role. However, the results are by no means uniform.
For example, while Acs and Mueller (2008) as well as Baptista and
Preto (2010) find relatively pronounced effects on regional employment
from larger start-ups, many of which are probably subsidiaries of larger
companies, Koster (2011) identifies a slightly lower impact from organi-
zational foundings (that is, new subsidiaries of already existing firms).
22 Such a development is well illustrated by Neumark et al. (2008), who analyze the ini-
tial effect of new stores set up by a large supermarket chain (Wal-Mart) on local retail
employment in the United States. According to their estimates, the new competition has
on average led to a 2.7 percent reduction of average retail employment and a decline of
retail earnings of 1.5 percent in the short run.
4.6 The Effects of New Business Formation on Economic Development 315
According to Acs and Mueller (2008) as well as Baptista and Preto

(2010), large start-ups induce strong displacement effects, but it is
unclear whether they lead to an increase or a decrease in overall employ-
ment in the long run. Moreover, it is not entirely clear what impact
setting up subsidiary establishments of large firms has on incumbents
in the region. On the one hand, it could lead to increased competition
for scarce resources on the local input market; on the other hand, it
could be an important source of regional growth (Baptista and Preto,
2010). Presumably, much depends on the type of activity conducted
by the new establishment and on the regional economic environment
(for example, the intensity of competition for local inputs). However,
despite some ambiguity in the results, it is fairly clear from the avail-
able evidence that small and short-lived new businesses have very little
effect on regional development, probably because they do not constitute
a strong enough challenge to incumbents. The intensity of the challenge
may also explain why entry by ambitious entrepreneurs who expect to
grow has a stronger impact than that of start-ups with low-growth
expectations.
Clearly, it would be helpful to have data that allow for a much more
differentiated characterization of entry in attempting to discover more
about how the quality of a new business affects the direct and indirect
contributions it will make to economic development.
4.6 Regional Differences in the Effects of New Business

Formation on Economic Development
Empirical analyses find remarkable variation in the contribution of new
businesses to employment across regions. In the following, I first report
regional differences in the overall employment effects of start-ups (Sec-
tion 4.6.1). Section 4.6.2 reviews the evidence concerning the direct
employment effect and Section 4.6.3 deals with results of those studies
that analyze regional differences in indirect effects. Section 4.6.4 dis-
cusses possible reasons for the result that the indirect effect of new
business formation on employment growth is much stronger in regions
with a high population density. Sections 4.6.5 and 4.6.6 review evidence
on the role of regional growth regimes and regional entrepreneurial
culture that may lead to long-term effects of new business formation

on development.
4.6.1 Differences in the Overall Effect Across Regions

Regions may differ considerably with regard to the number and the
characteristics of start-ups, the characteristics of their incumbent busi-
nesses, and with regard to their ability to absorb the positive effects
of new business formation. Fritsch and Mueller (2004, 2008) analyze
three types of West German planning regions: highly agglomerated
areas, moderately congested regions, and rural regions. The analysis
shows that new business formation in agglomerations not only cre-
ates relatively pronounced positive short-term (direct) effects, but also
leads to comparatively high positive long-term (supply-side) effects
(Figure 4.4). Also, the negative medium-term (displacement) effects
are slightly stronger in agglomerations. Generally, the effects of new
0.40
Agglomerated
regions
Moderately
Impact of new business formation
0.20 congested regions

on employment change
0.00
Rural
regions
-0.20
-0.40
0 1 2 3 4 5 6 7 8 9 10
Lag (year)
Fig. 4.4 Impact of new business formation on regional employment change in agglomera-
tions, moderately congested regions, and rural regions (Fritsch and Mueller, 2008).
business formation on employment change are much more pronounced

in agglomerations than in the other two types of regions.23 A simi-
lar result is found by van Stel and Suddle (2008) for urban and rural
regions of the Netherlands, and by Baptista and Preto (2011) for highly
and moderately agglomerated regions of Portugal. Mueller et al. (2008)
show that the effects of new business formation on regional employment
are much more pronounced in England compared to either Wales or,
particularly, Scotland.
Fritsch and Schroeter (2011a) use a multivariate approach to sys-
tematically analyze the influence of region-specific factors on the overall
effect of start-up activity on employment change. The regression model
contains the average regional start-up rate of the previous 10 years
together with its squared value in order to account for a nonlinear rela-
tionship with employment change. Fritsch and Schroeter (2011a) find
a positive coefficient for the average start-up rate, but a significantly
negative coefficient for its squared value, indicating that the marginal
effect of new business formation on regional employment declines with
the number of start-ups. This suggests that regions with a relatively
low level of start-ups may benefit more from an increase in the start-up
rate than will regions in which the start-up rate is already high. This
result is confirmed by Fritsch and Noseleit (2012a), who compare West
German regions with above and below median levels of new business
formation. They find positive employment effects of new businesses,
particularly in the regions with a below median level of start-ups; this
effect was almost zero for regions with relatively high start-up rates.
This larger employment effect in regions with lower levels of start-up
activity was particularly due to a stronger direct effect and a less pro-
nounced displacement of incumbents.
Other regional characteristics included in the regression were also
interacted with the start-up rate in order to assess their moderat-
ing effect on the relationship between new business formation and
23 However, the results for rural regions should be viewed with caution because only two of
the 11 coefficients for start-up rates in the unrestricted model proved to be statistically
significant and the coefficients for the Almon lags remained insignificant.
growth.24 The estimated coefficients for the regional characteristics

indicate their direct influence on employment change. The coefficients
of the interaction terms can be regarded as a measure of the impact
the respective variable has on the employment effect of the new busi-
nesses. This makes it possible to distinguish between the direct effects
of several regional characteristics and the impact that these potential
determinants of regional growth may have through new business for-
mation activity. For example, because employment in West German
agglomerations grew less than it did in other types of regions during
the period of analysis, Fritsch and Schroeter (2011a) find a negative
coefficient for the effect of population density on employment change.
However, interaction of the start-up rate with population density shows
a strongly positive relationship, indicating that new business formation
has a much larger effect in high-density areas than in rural regions.25
According to Fritsch and Schroeter (2011a), the effect of popula-
tion density is dominant. Other region-specific factors that lead to a
relatively pronounced effect of new business formation on employment
growth are a large share of medium-skilled workers and a high level
of innovative activity. Although the total unemployment rate appears
to be unimportant, a high share of short-time unemployed had a neg-
ative influence on the employment effect of start-ups. Moreover, the
growth impact of new businesses turned out to be negatively related
to the employment share in small establishments. The regional share
of highly skilled employees, labor productivity, and the entrepreneurial
character of the technological regime were insignificant factors in the
employment growth effects of new business formation.
24 Fritsch and Schroeter (2011a) estimate the regression:

Average employment changer,t+2−to = a + b1 ∗ average start-up rater,t−1 to t−10 +
b2 ∗ average start-up rate2r,t−1 to t−10 + b3 ∗ variable Ir,t−1 + b4 ∗ variable Ir,t−1 ∗
average start-up rater,t−1 to t−10 + b5 ∗ variable II r,t−1 + b6 ∗ variable II r,t−1 ∗
average start-up rater,t−1 to t−10 + industry sharesr,t−1 + time dummies + ur,t
where r indicates the regions and t the time.
25 A problem with this approach is that including a variable in its pure form and as part of
an interaction term may lead to pronounced multicollinearity. This pertains particularly
to the start-up rate when it is interacted with several other variables in the same model.
In principle, one could test and control for spatial autocorrelation in such an approach
by including variables, particularly start-up rates, for adjacent regions.
In their analysis of the effect of entry and turbulence on the total

factor productivity in a region, Bosma et al. (2011) identify a signifi-
cantly higher effect in regions with high population density, particularly
those regions in which the industry structure is characterized by a high
level of related variety (for more on this concept, see Frenken et al.,
2007). “Related variety” of regional industry structure means that the
region’s industries are diverse but technologically related, so that they
share at least some portion of the same knowledge base. For example,
technological relatedness of industries can be assumed if one firm pro-
duces goods normally produced by several different industries (Neffke
and Svensson, 2008). Such technological relatedness may be conducive
to the emergence of new ideas among different industries, which could
be viewed as a special case of Jacobs externalities (Jacobs, 1969).
4.6.2 Regional Differences in the Direct Contribution of

New Businesses to Regional Employment
The results of investigations into regional differences in the direct effects
of new business formation on employment do not reach a clear consen-
sus. These varied results could be the product of peculiarities in the
database employed or have to do with the country and time period
under investigation. Since the studies I survey here were performed
for the same country (West Germany) for comparable time periods,
the differences in results may be most likely due to differences in the
applied methodology. Hence, caution is needed in interpreting these
results, particularly with respect to the definitions and methods used.
A main difference in empirical attempts at comparing the direct
employment effects of new business formation across regions con-
cerns measurement. One way of measuring the performance of start-up
cohorts is to use an index for the number of employees that has the
value of 100 at the time of start-up and to compare the development
of cohorts that have been set up in different regions over time. It is
known that employment in start-up cohorts tends to increase in the
first few years and, after having reached a maximum, decreases again
and falls below the initial level, that is, assuming values of the employ-
ment index of below 100 (Section 4.2). This measure mainly expresses
the employment development of start-ups and not their contribution

to regional employment. Based on this measure, Engel and Metzger
(2006) find considerably less employment generation for start-ups in
West German agglomerations compared to regions with a lower degree
of population density. Using a different database, Weyh (2006), in an
analysis of West German regions, confirms this result for start-ups in
manufacturing. For start-ups in the service sector, she finds the most
positive employment development in the agglomerations. A relatively
weak employment performance of start-up cohorts in agglomerations
is probably chiefly the result of the lower survival rate in these areas
(Fritsch et al., 2006; Renski, 2009). Weyh (2006) finds that surviving
start-ups in high-density areas reach a significantly larger average size
after five years but that this higher growth rate of survivors cannot
compensate for the higher shares of start-ups in agglomerations that
do not succeed in the market.
Fritsch and Noseleit (2012a) take the percent employment change
in a region that was due to start-ups as a measure of the direct employ-
ment effect (for a more detailed description, see Section 4.5.5). They
find only minor differences in the average direct employment effects
between agglomerations, moderately congested areas, and rural regions.
However, they do not analyze the pronounced variation in this indicator
within these three broad spatial categories.
Fritsch and Schindele (2011) make a more detailed analysis of
regional differences in direct employment effects of new businesses in
West Germany. Their measure is the employment in a particular start-
up cohort after two and 10 years over total regional employment in the
year prior to the start-up. Fritsch and Schindele (2011) find notewor-
thy variation in the employment contribution of new businesses across
regions. The minimum value for the long-term employment contribu-
tion for all private industries is 0.84 percent; the maximum value is
about eight times as high (6.56 percent). For short-term employment
contributions of new businesses, the maximum value (4.71 percent)
is more than four times larger than the minimum value of 0.95 per-
cent. A multivariate analysis of the factors that may be regarded as
responsible for the direct employment contribution of new businesses
reveals that — in addition to high start-up rates, high survival rates,
and high growth among the newcomers — the growth of incumbent

businesses also has a positive effect, indicating that employment cre-
ated by newcomers is not necessarily at the expense of incumbents,
but that employment in both new and incumbent businesses may be
positively interlinked (Fritsch and Schindele, 2011). Positive effects on
the direct employment contribution of start-ups are also found for the
share of regional workforce with a tertiary degree and for the short-
term unemployment rate. This indicates that new businesses benefit
from the regional availability of high-qualified employees. Moreover,
the direct employment contribution is significantly higher in regions
where a high share of innovation activity is conducted by small busi-
nesses. This result may be regarded as an indication that start-ups have
a particularly pronounced effect in a regional environment character-
ized by an “entrepreneurial regime” (see Section 4.6.5) that provides
better opportunities for regional start-ups to compete successfully and
seriously challenge incumbent firms.
4.6.3 Regional Differences in the Indirect Effects

Fritsch and Noseleit (2012a) use their decomposition procedure
for identifying the indirect effects of new business formation on
employment (see Section 4.4.2) to analyze differences in these indirect
effects between types of regions in West Germany. In looking at
agglomerations, moderately congested areas, and rural areas they
find pronounced differences that are well suited for explaining the
patterns detected by Fritsch and Mueller (2008). Figure 4.5 displays
the results of their analysis. The basic shape of the curve for the
aggregate indirect effect in agglomerations is similar to the shape of
the curve for moderately congested regions, the main difference being
that the amplitude of the wave is more pronounced in agglomerations,
indicating a higher intensity of indirect effects. This higher intensity of
indirect effects of new business formation on incumbents in agglomer-
ations suggests a higher level of economic interaction in these regions,
which may directly result from higher density, particularly the spatial
proximity of relatively many actors. The pronounced negative indirect
effect in agglomerations between year 1 and year 6 after start-up
4.0
3.0
Employment change (in %)
2.0
1.0
0.0
-1.0 0 1 2 3 4 5 6 7 8 9 10
-2.0
-3.0
-4.0
Years after start -up
Agglomerations Moderatly congested areas Rural regions
Fig. 4.5 Average effects of new business formation on incumbent employment in different
types of regions
(Source: Fritsch and Noseleit, 2012a).
suggests higher displacement effects, which may be due to more intense

competition in these regions. In turn, this relatively intense competi-
tion and selection in agglomerations may explain the more pronounced
supply-side effects that dominate the third phase of the wave.
Another main difference between agglomerations and moderately
congested areas, on the one hand, and rural regions on the other, is the
direction of the aggregate indirect effects in the first years. In agglomer-
ations and moderately congested areas, the early indirect effect is posi-
tive, suggesting that demand-side effects of the resources purchased by
the newly founded businesses are much stronger than the displacement
effects. In rural regions, the early indirect effects are significantly neg-
ative, a possible explanation for which could be that because of poor
local supply, an increased demand for resources by the rural start-ups
is chiefly met by suppliers in other areas. That the values for the coef-
ficients of the aggregate indirect effect in rural areas do not decrease
in the last periods as is the case for agglomerations and moderately
congested areas should be interpreted with great caution because the
unrestricted regressions coefficients for the start-up rate in later peri-
ods almost never prove to be statistically significant if included in the
model.
Another way of identifying indirect employment effects of new busi-

ness formation is to regress the 10-year average change of incumbent
employment on the regional start-up rate over the same 10-year period
(Fritsch and Noseleit, 2012b, 2013) (see Section 4.4.2). Running sepa-
rate analyses for West German regions with below and above median
population density Fritsch and Noseleit (2013) find that the value for
the coefficient that represents the effects of start-ups on incumbent
employment is more than twice as high for regions with above median
population density. Separate regressions for regions with above and
below median shares of employment in businesses with less than 200
employees result in much higher coefficients for the effect on incumbent
employment in regions with a relatively high share of employment in
smaller units. This result may be regarded as an indication that the
competitive challenge of start-ups within the region is more pronounced
for small incumbent firms than for larger ones because large firms
tend to have geographically more widespread output markets and are
much more involved in interregional competition than are smaller firms
(Bernard and Wagner, 1997; Bernard and Jensen, 1999). In another
approach, Fritsch and Noseleit (2013) subdivide the regions accord-
ing to the similarity of the industry structure between start-ups and
incumbents. The idea behind this categorization is that the competition
between new businesses and incumbents should be more intense if they
are both active in the same or at least related markets. As expected, the
induced employment effect on incumbents is much stronger in regions
that are characterized by high similarity of the industry structure.
Having found that new business formation has a relatively strong
indirect effect in regions with a high share of employment in small
establishments and in regions with relatively high similarity between
the industry structure of start-ups and incumbents, Fritsch and Nose-
leit (2013) finally combine these two regional characteristics, running
separate regressions for small business regions only, divided into regions
with low similarity of industry structure between newcomers and
incumbents, and regions with high similarity of industry structure
between entries and incumbents. The estimated coefficient for the rela-
tionship between new business formation and incumbent employment
is significantly positive for both types of regions but stronger in small
business regions with a relatively high level of correspondence between

the industry structure of the start-ups and that of incumbents. In par-
ticular, this coefficient is larger than all other coefficients for the indirect
effects they find in this type of analysis.
These results clearly demonstrate the importance of the regional
environment for the magnitude of the indirect effects of new business
formation. They are in accordance with the hypothesis that the effect of
new business formation on incumbent employment is larger, the more
intense the competition between the two types of firms.
4.6.4 What Explains the Greater Effects in

High-density Regions?
Many of the empirical analyses reviewed above find that the effect of
new business formation on growth is considerably more pronounced in
high-density areas compared to rural regions. There are at least three
explanations for this phenomenon:
• First, high-density areas tend to be breeding grounds for

relatively high-quality start-ups, such as innovative new busi-
nesses, chiefly because larger cities have a larger knowledge
base, manifested by the presence of universities and other
research institutes. This explanation is supported by empir-
ical evidence showing that innovative new businesses are
particularly likely to be set up near such research institu-
tions (Bade and Nerlinger, 2000; Baptista and Mendonça,
2010). Moreover, agglomerations tend to have thick input
markets that can be especially conducive to the emer-
gence and development of ambitious, innovative start-ups
(Helsley and Strange, 2011). Especially important in this
regard are the abundant high-skilled workforces found in
agglomerations, which can be viewed as a reservoir of high-
quality entrepreneurs. Other factors that may stimulate the
emergence and success of high-quality start-ups in high-
density areas include spatial proximity to other actors and
the resulting knowledge spillovers, as well as diversity of eco-
nomic activity (Jacobs externalities).
• Second, the high intensity of local competition, particu-

larly on input markets, may lead to relatively strong selec-
tion effects that spur regional productivity. That such areas
are indeed subject to a high intensity of selection effects
finds support in the observation that survival rates of new
businesses are significantly lower in these regions compared
to other areas (Fritsch et al., 2013; Renski, 2009). The
argument is also consistent with the results of Fritsch and
Mueller (2004, 2008) as well as those of Fritsch and Noseleit
(2012a), who show that displacement effects tend to be more
severe in agglomerations, but that positive supply-side effects
are also considerably more pronounced (see Figures 4.4
and 4.5).
• Third, the higher intensity of nonmarket-based interaction
(“local buzz”) in agglomerations may not only be conducive
to the emergence of high-quality start-ups, but may also
facilitate knowledge flows between entries and incumbent
competitors. This closely proximate competitive interaction
between newcomers and incumbents could result in quicker
and better responses to the challenges each party poses the
other, leading to productivity gains.
Thus, there are some plausible explanations for the relatively

pronounced effect of new business formation on regional development
in high-density areas, but the reasons behind this phenomenon are
not yet well understood. In particular, we do not know whether these
differences are due to different qualities of regional entries, or what role
local competition plays. If intensity of local competition contributes to
explaining the regional effects, which is more important — competition
on the output market or competition for local inputs? Moreover, the
density effect holds for a sample of regions on average; there are also
high-density areas where new business formation has no such strong
effect.26
26 This holds, for example, for large sections of the old industrialized Ruhr area in Germany.
4.6.5 Regional Growth Regimes

Audretsch and Fritsch (2002) suggest that there may be considerable
differences between regions with regard to the role that new firms
and entrepreneurship play in development. In introducing the concept
of regional growth regimes, they extend the idea of the technologi-
cal regime (Audretsch, 1995, pp. 39–64; Marsili, 2002; Winter, 1984)
from the unit of observation being the industry to a geographic unit of
observation (see also Fritsch, 2004). By analogy to the common con-
cept of a technological regime, the growth regime in a region is called
entrepreneurial if growth results from a high level of new firm start-
ups and a turbulent enterprise structure. In contrast, regions in which
above-average growth is accompanied by relatively stable large incum-
bent enterprises are regarded as having a routinized growth regime
(Figure 4.6). In the routinized regime, new businesses do not play an
important role, and their chances for survival and growth are much
lower than in an entrepreneurial regime.
Audretsch and Fritsch (2002) characterize regions with relatively
low-growth rates but above-average start-up rates as revolving-door
growth regimes (see also Fritsch and Mueller, 2006). They conjecture
that under such a regime, entries will tend to be non-innovative, supply-
ing basically the same products and using nearly the same technology
Employment
change
Growth is result of
Growth is result of
stable enterprise
start-ups and highly
structure and
turbulent enterprise
development of
structure
incumbents
Routinized Entrepreneurial Start-up
rate
Downsizing Revolving door
Effects of low level of
High start-up rates but
new business format-
entries tend to be of
ion do not compensate
low quality and hardly
for losses of
induce any growth
incumbents
Fig. 4.6 Regional growth regime types and their characteristics.

as the incumbent firms. Finally, relatively low growth regions, which

are characterized by a below-average level of start-up activity, are clas-
sified as downsizing growth regimes. In such regions, the number and
quality of start-ups are not sufficient to provide enough new jobs or
income to substitute for the losses in incumbent firms.
In analyzing transitions between the different growth regimes,
Fritsch and Mueller (2006) identify several patterns. They find that
while downsizing as well as entrepreneurial growth regimes tend to be
stable over time, the other two types of regime appear to be more tem-
porary. Moreover, if a region with a downsizing regime experiences an
increase in new business formation, it will most probably become a
revolving-door regime before it eventually reaches the stage of being
an entrepreneurial growth regime. Correspondingly, if regions with an
entrepreneurial growth regime experience a decline in start-ups, they
will first assume the character of a routinized growth regime before
they eventually turn into a downsizing regime. These findings suggest
that the effect of new business formation on growth occurs with a time
lag that may be considerably longer than the lag suggested by the wave
pattern (Section 4.3). It may take a long time before the growth effects
of an increased level of entrepreneurship become evident and even if the
start-up rate begins to decrease, the growth benefits of higher start-up
rates in a region will continue for some time.
In comparing entrepreneurship and growth in former socialist East
Germany with the long-established market economy of West Germany,
Fritsch (2004) concludes that the two parts of the country experienced
different growth regimes during the period under inspection, the 1990s
and the early 2000s. Despite quite similar formal institutions in both
parts of the country, differences with regard to entrepreneurship cul-
ture, level of economic development, and policy, to name just a few,
seem to have had a relatively strong effect on how the two regions
developed.
4.6.6 Regional Entrepreneurship Culture and Growth

A number of authors argue that there is something such as an
entrepreneurial culture that may have a significant effect on the
level and quality of regional start-ups, as well as on how they affect

regional development.27 Empirical research has produced considerable
evidence in support of this view. For example, scholarly work shows
that acceptance of entrepreneurial values (Beugelsdijk, 2007; Beugels-
dijk and Noorderhaven, 2004), ability to bear risk, and exposure to
entrepreneurial role models (Sternberg, 2009; Wagner and Sternberg,
2004) vary considerably across regions. Accordingly, studies of estab-
lished market economies such as Germany (Fritsch and Mueller, 2007;
Fritsch and Wyrwich, 2012), the Netherlands (van Stel and Suddle,
2008), Sweden (Andersson and Koster, 2011), the United Kingdom
(Mueller et al., 2008), and the United States (Acs and Mueller, 2008)
find that regional start-up rates tend to be relatively persistent over
periods of one or two decades. Fritsch and Wyrwich (2012) and Wyr-
wich (2012) show for Germany that relatively high regional levels of
self-employment can survive even abrupt and harsh changes in environ-
mental conditions. Thus, it appears that regional norms and values, as
well as peer effects of entrepreneurial role models (Bosma et al., 2012),
can create a positive “mental software” or “aggregate psychological
trait” (Freytag and Thurik, 2007, p. 123) in the regional population
that is not forgotten even when the economic environment turns hos-
tile. Such an entrepreneurial culture may induce high levels of regional
start-ups and self-employment but can also manifest in pronounced
intrapreneurship.28
Although high levels of entrepreneurship can persist over time, the
relationship between entrepreneurial culture and growth is less clear.
Take the case of East Germany where, after World War II, a socialist
regime seriously tried to extinguish private enterprise for a period of
about 40 years. Nevertheless, regions of East Germany that had had
27 See, for example, Audretsch and Keilbach (2004), Beugelsdijk (2007), Beugelsdijk and
Noorderhaven (2004), Beugelsdijk and Maseland (2011), Chinitz (1961), Davidsson
(1995), Etzioni (1987), Freytag and Thurik (2007), Glaeser and Kerr (2009), Glaeser
et al. (2012), and Malecki (1994).
28 Beugelsdijk (2007) and Beugelsdijk and Noorderhaven (2004) have constructed an indica-
tor for regional entrepreneurial culture based on data from the European Values Survey
(EVS) and relate this indicator to measures for regional patenting activity. Comparing
the regional values of the indicator for an entrepreneurial culture with measures for the
level of regional patenting activity shows a pronounced positive relationship.
4.7 New Business Formation a Cause or a Symptom of Regional Development? 329
high levels of self-employment before the war successfully maintained

relatively high levels of self-employment until the end of the social-
ist period. After the breakdown of the socialist regime in the years
1989/1990, these regions experienced a particular boom of start-ups
(Wyrwich, 2012). There are indications that these more entrepreneurial
regions managed the transformation to a capitalist market economy rel-
atively well; the exact causal links, however, remain unclear.29
Thus, there appear to be long-term benefits from establishing an
entrepreneurial culture. However, creating such a culture is a long-
term process itself, and may require considerable political effort. Hence,
trying to build a regional entrepreneurial culture can be regarded as an
investment in a kind of entrepreneurial capital stock (Audretsch and
Keilbach, 2004) that may take a long time to show “a return,” but once
it does, will continue to generate good payoffs long into the future.
4.7 Is New Business Formation a Cause or a Symptom

of Regional Development?
This review of research on the effect of entry on regional develop-
ment shows that there is compelling empirical evidence in favor of
a positive relationship. However, given that economic growth creates
entrepreneurial opportunities, which, in turn, are accompanied by an
increasing number of firms, entry may also be viewed as a symptom
of development. If growth stimulates the emergence of new businesses,
ignoring this relationship may lead to overestimating the effect that
start-ups have on economic development.30 In an extreme case, new
business formation would simply be a byproduct of growth processes
that take place independently of new business formation. One exam-
ple of such a relationship is the ”second-round” indirect effects of new
business formation discussed in Section 3.4.1.
29 Long-term positive effects of historical levels of entrepreneurship on regional growth have

also been identified in a recent study by Glaeser et al. (2012) for the USA.
30 Economic growth can stimulate new business formation in at least in three ways. First,
previous growth may generate a relatively large number of new entrepreneurial oppor-
tunities. Second, positive expectations about future growth can encourage individuals to
start an own business. Third, overall growth makes it easier for start-ups to survive their
first critical years and to establish themselves in the market.
However, viewing new business formation as only a byprod-

uct of economic development is implausible, as it would necessitate
ignoring numerous examples of the pioneering role some exceptional
entrepreneurial personalities have played in economic development.
Even if one made the rather strong assumption that historical devel-
opments obviously largely initiated by new ventures — for example,
the Industrial Revolution of the eighteenth and nineteenth century or
development of the micro computer and emergence of the Internet econ-
omy — would have occurred anyway, such a stance cannot explain the
geography of these developments. Without an adequate empirical anal-
ysis of the relationships, the bias that may result from the ambiguous
link between economic development and new business formation cannot
be ignored. Therefore, the question is: Does economic growth truly have
such a significant impact on new business formation and, if so, does this
situation lead to overestimating the effect of entry on development in
subsequent periods?
A first indication of the extent to which the emergence of new busi-
nesses is a result of growth processes can be drawn from studies that
analyze the determinants of entry. Many of these studies find such a
positive effect of growth, particularly population growth, on entry, but
in most cases the relationship is not very strong.31 Audretsch et al.
(2006) simultaneously estimate the effect of regional performance on
the level of new business formation and the effect of new business for-
mation on the growth of regional labor productivity using a production
function framework. They find that the growth of GDP per head has
a statistically significant positive impact on new business formation
in subsequent periods, but that the effect of start-ups on the increase
in labor productivity remains statistically significant. This clearly sug-
gests that new business formation has a distinct positive effect on devel-
opment that is independent of an overall growth trend.
In a recent paper, Anyadike-Danes et al. (2011) analyze this rela-
tionship for Irish regions between 1988 and 2004, a time span that
includes the period of rapid economic growth Ireland enjoyed between
31 See, for example, Audretsch and Keilbach (2007), Fritsch and Falck (2007), Reynolds
et al. (1994), and Sutaria and Hicks (2004).
4.7 New Business Formation a Cause or a Symptom of Regional Development? 331
1994 and 2000. The authors find that during the period of analysis,
the number of businesses in Ireland has almost tripled. However, the
number of start-ups in relation to the number of incumbent businesses
remained fairly constant in the longer run. The same holds for the num-
ber of new businesses in relation to the number of employees. Relat-
ing the time series of new business formation and employment showed
no statistically significant effect of employment growth on the level of
start-ups, but did show a weak effect of gross entry on employment.
These statistical tests, however, were restricted by the limited length
of the two time series. Anyadike-Danes et al. (2011) find that the stock
of businesses per regional population is fairly constant across regions,
supporting the idea of an equilibrium number of businesses per popu-
lation at a certain point in time (see Section 3.2). The authors suggest
that relatively high start-up rates in a region might be regarded as a
process of catching-up to this equilibrium rate.
Hartog et al. (2010) investigates the possible two-way relationship
between changes in the business ownership rate (= net entry) and
growth for 21 OECD countries for the period 1981–2006, employing a
simultaneous empirical approach. The authors identify a link between
the national welfare level and the business ownership rate, but find that
development during the previous periods has no statistically significant
effect. Analyzing the effect of changes in the business ownership rate on
GDP growth, Hartog et al. (2010) conclude that there are decreasing
marginal returns in terms of growth effects to entrepreneurship, which
confirms results of Fritsch and Schroeter (2011a) for German regions.
Hartog et al. (2010) explain this result with the notion of an equilib-
rium business ownership rate: an increasing level of entrepreneurship
will have relatively pronounced effects on growth if the initial business
ownership rate is below the equilibrium rate; the effects will be consid-
erably smaller if the initial rate is above the equilibrium rate. A main
limitation of Hartog et al.’s (2010) study is that it contains no informa-
tion on gross entry and thus nothing can be learned about the effects
of the number of entries on turbulence in the stock of businesses and
its effects on economic development.
In summary, work to date has not identified any, or only a rela-
tively weak, effect of growth in previous periods on the level of new
business formation; the effect of new business formation on economic

development, however, is found to be considerably pronounced. Based
on this evidence, we can conclude that start-ups do have a distinct
impact on growth independent of any long-term growth trajectory that
might exist. New business formation is more a cause than a symptom
of growth. However, assessing the effect of new business formation on
economic development without simultaneously accounting for a possi-
ble effect of growth on the level of start-ups may lead to some overes-
timation of the effects of start-ups.
4.8 Summary of the Empirical Evidence

The main results of the empirical research on the effects of new business
formation on regional development can be summarized as follows:
• New businesses do create employment, but their direct con-

tribution to overall employment is relatively small.
• New business formation can have pronounced indirect effects
that tend to emerge with a considerable time lag. The effects
may take as long as 10 years to manifest, and there is indica-
tion that other effects could occur even farther in the future.
• The indirect employment effects tend to be of a much larger
magnitude than the direct effect. The indirect net effect on
employment is in most cases positive. This indicates that the
supply-side effects of new business formation on employment
are larger than the displacement of incumbent employment.
In some cases, however, the overall effect on employment has
been found to be negative.
• There is a typical time sequence of the different effects. In a
first phase, at the time around entry, the resources needed by
the new businesses lead to a slight employment increase. In
a second phase, which often begins in the second or the third
year after entry, the displacement of incumbent employment
dominates the overall employment effect. In many cases, the
overall employment effect in this second phase has been found
to be negative. In a third phase, there can be pronounced
4.8 Summary of the Empirical Evidence 333
positive supply-side effects. Most of the empirical analyses

find a “wave” pattern of the effects.
• The regional environment has an important influence not
only on the number and quality of emerging new businesses,
but also on the impact these new businesses have on regional
development. There is a strong tendency for the overall effect
of new business to be larger, the higher the regional popu-
lation density. This result is particularly remarkable because
diverse empirical studies find that new businesses setup in
high-density areas have lower prospects of survival. The rea-
sons for the stronger positive effect of new business formation
in agglomerations remain unclear.
• The effect of new business formation on regional employment
increases with the start-up rate but at a decreasing rate.
• Regional levels of new business formation and self-
employment tend to be persistent over time and can survive
even abrupt and harsh changes in environmental conditions.
This indicates the existence of a long-lasting and robust
entrepreneurship culture in some regions.
These results are in accordance with the eclectic explanatory approach

outlined in Section 3.4. In particular, the empirical evidence clearly
shows that start-ups must be viewed as an integral part of the market
process. Accordingly, the effects of new business formation on economic
development emerge from the competition between the newcomers and
the incumbent firms. The results of this process can be seen in the
development of the start-ups and of the incumbents.
5
Implications for Entrepreneurship Policy
Although our understanding of the effects of new business formation on

regional development is still incomplete, the current state of knowledge
suggests a number of important implications for an entrepreneurship
policy aimed at stimulating regional growth.
There is considerable evidence that new business formation may
produce a number of important indirect effects that have a strong
impact on regional competitiveness and growth. These competitiveness-
enhancing supply-side effects of new business formation are dependent
on markets operating according to survival of the fittest basis. If the
market does not operate according to these principles, which when
functioning properly force less productive firms to exit, entry may not
stimulate growth. Therefore, a growth-oriented entrepreneurship policy
needs to be accompanied by an appropriate competition policy ensur-
ing that the market is truly determined by survival of the fittest. Such
a competition policy should be particularly alert to the possibility of
“unfair” attempts at entry deterrence by incumbents. In a sufficiently
well-operating market, policymakers should avoid any action that will
disturb market selection. Hence, direct support of new businesses by
means of special subsidies that are not available to incumbents must
be regarded as of questionable utility.
334
335
A number of analyses clearly suggest that it is not so much the

sheer number of start-ups, but their ability to compete successfully with
incumbents and to survive that is important for their effect on regional
development. Hence, just increasing the overall number of start-ups
may not be an appropriate strategy for stimulating growth; rather,
such a policy should focus on improving the quality of start-ups and
on increasing the number of high-quality new businesses. Hence, to be
truly effective, the policy must concern itself with the quality of the
start-ups it encourages. This implies that start-up rates or business
ownership rates that include all types of businesses are of only limited
relevance for assessing the level of growth-relevant entrepreneurship in
a region.
Policy intended to stimulate high-quality start-ups should be firmly
based on the preconditions necessary to successful entrepreneurship,
such as general as well as entrepreneurship education, and provide
qualified advice to potential founders. Entrepreneurship education, in
particular, could be very useful in helping people make a more real-
istic assessment of their ability to run a business and, in the best
case, convince those ill-suited to such a venture from embarking on it
(von Graevenitz et al., 2010). In particular, the empirical results indi-
cate that a highly educated regional workforce and good availabil-
ity of labor are generally conducive to the employment contribution
of new businesses. Moreover, policy should be especially designed to
include measures aimed at the regional knowledge base, which is an
important source of spatially bounded knowledge externalities that
may enhance the recognition of promising entrepreneurial opportunities
and the emergence of high-quality start-ups. For innovative start-ups,
this includes building a high-quality university system that provides
cutting-edge scientific knowledge and technology, facilitates access to
higher education by talented people, and effective technology transfer.
There is considerable indication that trying to increase the number of
high-quality start-ups means actively creating an entrepreneurial cul-
ture (Astebro and Bazzazian, 2011).
The results of recent research clearly show that region-specific
factors play an important role in the development of new businesses
and their contribution to employment. Growth conditions for new
336 Implications for Entrepreneurship Policy
businesses and their impact on regional development will vary accord-

ing to the regional environment, and thus different regions may have
quite different types of growth regimes (Audretsch and Fritsch, 2002;
Fritsch, 2004; Fritsch and Mueller, 2006). This suggests that policy
measures aimed at creating an environment for successful entrepreneur-
ship should be region specific and take into consideration both the
advantages and disadvantages of a region’s economic structure. The
pronounced persistence of the regional level of entrepreneurial activity
that has been found (see Section 4.6.6) clearly suggests that an impor-
tant part of the regional conditions for entrepreneurship has a long-
lasting effect. As far as changes in the level of regional start-up activity
do occur, they emerge over a long time period, and they are in most
cases rather small. This high degree of persistence suggests that there
are only weak prospects for rapid change with regard to regional new
business formation activity. Therefore, a policy that is aiming at stim-
ulating the regional level of entrepreneurship and to build up a regional
entrepreneurship culture needs patience and a long-term orientation.
All these issues point to the important role of institutions for new
business formation and its impact on economic development. Institu-
tions, both formal and informal, not only shape the incentives for dif-
ferent types of entrepreneurship but particularly govern the interaction
between newcomers and incumbent firms, which is the mechanism by
which new business formation transforms into growth. However, our
knowledge about the appropriate institutional framework for produc-
tive entrepreneurship is still incomplete (Boettke and Coyne, 2009).
6
Avenues for Further Research
Recent empirical analyses of the effects of new businesses on economic

development have produced a number of interesting results. This work
makes it very clear that start-ups need to be understood as an integral
part of the market process. According to this view, new businesses
are a challenge to incumbents and may induce improvement of overall
economic performance, given that market selection is operating on a
survival of the fittest basis. The recent research substantially improves
our understanding of the underlying forces, but there is considerable
room for further investigation. In what follows, I sketch some important
avenues for further research in the field.
• The effect of new business formation on output and produc-

tivity. Most analyses of the effect of new business formation
on regional development use employment change as a
measure of performance for reasons of data availability. Only
very few studies use GDP-based indicators such as GDP
growth or productivity, sometimes with considerably differ-
ent results than analyses using employment growth figures.
Such divergent results deserve further investigation. Since
337
338 Avenues for Further Research
productivity can be regarded a catch-all variable that should

particularly reflect improvements of performance that do not
result in more employment (for example, labor-saving pro-
cess innovations), a positive effect of new business formation
on productivity should be more pronounced than the effect
on employment. Moreover, since the wave pattern found for
the effect of new business formation on employment change
suggests that market selection begins to work rather soon
after entry, the positive effect of entry on GDP and pro-
ductivity should occur considerably earlier than the positive
supply-side effect on employment. To date, hardly any work
(exemption are Carree and Thurik, 2008; Andersson et al.,
2012) attempts to analyze the lag structure of the effects that
new business formation has on GDP growth or productivity.
• Quality of entry. The quality of a new business may be indi-
cated by factors such as the innovativeness of the supplied
goods and services, the entrepreneur’s qualifications, her
or his motivations (for example, opportunity vs. necessity
start-ups) and growth ambitions, the marketing strategy
pursued, the amount and quality of resources mobilized for
the new business, its productivity, survival over a certain
period of time, and the like. Since high-quality start-ups put
greater competitive pressure on incumbents, the market-
process-oriented view expressed above implies that they
should have a stronger effect on overall development than
start-ups of a lower quality. However, nearly nothing is
known about those characteristics of new businesses that
make them particularly challenging to incumbents. Only
few studies analyze the factors that are conducive to the
emergence of high-quality entry such as innovative start-ups
or new businesses with high-growth expectations. To derive
policy recommendations for increasing the number of high-
quality start-ups, much more needs to be known about the
determinants of this type of entry.
• The role of new businesses for the generation and dissem-
ination of innovation and knowledge. The spillover theory
339
of entrepreneurship (see Section 3.3) regards new business

formation, particularly spin-offs from incumbent firms and
from research institutions, as a main vehicle by which knowl-
edge and inventions are transformed into marketable goods.
However, our knowledge about the emergence of innovative
and knowledge-intensive start-ups is still incomplete. What
circumstances are conducive for the emergence of these
firms? How can the emergence of these firms be stimulated?
• Universities and other research institutions as incubators.
Although our knowledge about the characteristics of those
new businesses that are of particular importance for regional
growth processes is incomplete, there is good evidence
that the regional knowledge base, particularly universities
and other research institutions, plays an important role in
this respect. Hence the role of these knowledge sources as
incubators of new businesses should be further investigated
(for a review of this field, see Astebro and Bazzazian, 2011).
A more comprehensive understanding of the role played by
these institutions could be particularly helpful in designing
effective policy.
• The role of non-innovative entry. Although there is strong
reason to believe that innovative entry is of key importance
for economic development, non-innovative new businesses
may also play a role (Minniti and Lévesque, 2010). The
indirect effects of non-innovative new businesses in com-
parison to innovative start-ups should be further explored.
An important contribution of purely imitative entry and
self-employment could be that these entrepreneurs provide
role models conducive to the emergence of new businesses
that may be more innovative (Bosma et al., 2012).
• Gazelles. Fast-growing new businesses (gazelles) are a special
case of high-quality start-ups. Although these firms have
attracted a fair amount of attention and research in recent
years (Acs, 2011; Henrekson and Johansson, 2010), not
much is known about them. This is particularly true with
regard to their effect on the respective industry and region.
What regional conditions are conducive to the emergence of

gazelles? What impact do these fast-growing new businesses
have on overall regional development? Does the emergence
of gazelles lead to a particularly pronounced response by
incumbents?
• Indicators for growth-relevant new businesses. All the studies
on how new business formation affects regional development
are based on start-up rates for the entire regional economy
or for different sectors. If it is correct that only a small
portion of new businesses has a significant effect on regional
development, then start-up rates that include all new
businesses produce a too-diffuse picture and are not well
suited to assess the level of growth-relevant entrepreneurship
in a region. More informative indicators for this type of
entrepreneurship should be developed.
• Effects of entry on competition in input markets and output
markets. The available evidence as to the competitive pro-
cesses induced by newcomers is incomplete and somewhat
speculative. For example, it is still a largely open question as
to why we can observe such pronounced supply-side effects
of new business formation in many regions when output
markets are interregional or even global. Is the effect of
start-ups on such interregional markets concentrated in the
respective region? Moreover, what is the relative importance
of competition on output markets compared to competition
for local inputs such as floor space and labor? To what
degree do the indirect effects of new business formation that
occur in the region rely on input market competition?
• Characteristics of output markets. Entry conditions and the
competitive process vary considerably with the characteris-
tics of the industry, such as the stage of the industry life cycle
(Audretsch, 1995; Klepper, 1997). Such characteristics of out-
put markets should have consequences for the performance of
newcomers as well as for the effect of new business formation
on overall development. They may also have some influence
on the quality of entry. Empirical evidence as to the impact
341
of start-ups in different industries on overall economic per-

formance, however, is less than clear and contradictory. And
nothing is known about the influence that the intensity of
competition and the importance of particular parameters in
the competitive process of a certain market, such as price and
quality, have on the direct and the indirect effects of entry.
• Institutional environment. Generally, the role the institu-
tional environment plays in entrepreneurship is a research
“blind spot.” This is particularly true for the effects of
new business formation on development. Formal as well
as informal institutions may be important at all stages of
the entrepreneurial process and can affect the number and
quality of start-ups as well as their impact on input and
output markets (for a more detailed treatment of this topic,
see Boettke and Coyne, 2009; Henrekson, 2007; Henrekson
and Johansson, 2011).
• Regional characteristics. A number of studies clearly show
that regional characteristics can play a considerable role
in the employment effects of new business formation. For
example, population density seems to have a particularly
dominant effect. These regional differences are not yet well
understood and should be further investigated.
• The role of the level of new business formation. Several
studies show that the effect of start-ups is higher in regions
with a relatively low level of new business formation and con-
siderably less pronounced in high start-up regions (Bosma
et al., 2011; Fritsch and Schroeter, 2011a,b; Fritsch and
Noseleit, 2012a). According to these studies, the marginal
effect of new business formation declines with a growing
number of regional start-ups, suggesting that there is an
“optimum” level of new business formation at which the
effect of start-ups on development attains a maximum. The
reasons behind this phenomenon are largely unknown and
should be further investigated.
• The role of the economic development level. Most of the
empirical research on the effect of new business formation
on regional development involves well-developed countries

of Western Europe or the United States. Empirical evidence
for other countries, particularly for less-developed countries,
is more or less entirely based on GEM data and does not
include sufficiently long time lags. The available empirical
evidence suggests that developing countries are indeed a
rather special case in that high levels of entrepreneurship
and new business formation are not positively linked to
economic growth (Acs and Virgill, 2010; Vivarelli, 2012;
Naudé, 2011). One possible explanation for the rather
weak or nonexistent link between new business formation
and economic growth in developing countries could be
deficiencies in the institutional framework and a less than
optimum level of division of labor (Sautet, 2011). More
needs to be learned about such peculiarities of new business
formation and its effects in developing countries.
• Entry as a cause or as a symptom of growth? Research in
this important field is particularly hampered by the lack
of appropriate data. Time series are often too short for
adequately investigating this important issue. Although
the few available studies clearly indicate that start-ups can
have an effect on subsequent growth that is independent
from long-term development trajectories, more such studies
for countries of different wealth levels would be desirable.
It would be particularly interesting to know whether it is
possible to identify types of new businesses that are mainly
induced by increasing domestic demand and have no signif-
icant effect on future development (start-ups as a symptom
of growth). Accordingly, it would be desirable to know what
types of new ventures are growth initiators and to what
extent their emergence is a result of development processes.
• Longer-run effects of new business formation on regional
development. Research on regional growth regimes and
regional entrepreneurship culture has produced evidence of
rather long-run positive effects of new business formation for
development. For example, research shows that high regional
343
levels of new business formation and self-employment can be

persistent and survive dramatic changes in the framework
conditions. This evidence raises at least three questions.
First, how does a regional entrepreneurship culture emerge?
Second, what are the factors that make such a regional
entrepreneurship culture so persistent? Third, to what
extent is a regional culture of entrepreneurship conducive
to coping with necessary structural change? That is, are
regions with a well-developed culture of entrepreneurship
more resilient than other regions? There are some indications
that entrepreneurship culture does indeed have such effects
(see Section 4.6.6) but much more needs to be learned about
this issue.
• Entrepreneurship policy. Finally, all the research directions
proposed above should lead to the design of an appropriate
growth-oriented entrepreneurship policy. A great deal of the
entrepreneurship policy currently in place in many countries
and regions is motivated by stimulating regional growth.
However, these policy instruments have been designed more
or less ad hoc, without a sufficient understanding of the
underlying processes. The effects of the current strategies
should be analyzed and considerable effort should be devoted
to translating research results into appropriate and effective
policy strategies.
This catalog of open questions makes clear that much more needs to
be learned about how different types of new businesses impact economic
development in different regional environments.
7
Final Remarks
The relationship between new business formation and regional develop-

ment is still a largely underresearched field. This is remarkable, given
the importance of the issue, particularly since regional development is
often the stated justification for policy measures intended to promote
the emergence of new ventures. Recent research shows that new busi-
ness formation can indeed benefit regional development, but it would
be naı̈ve to expect that all or even most of these new businesses create
a substantial number of jobs. Many and probably the most impor-
tant effects of new business formation on growth are indirect in nature
and depend much on factors such as the quality of the start-ups and
the regional environment. Our knowledge about these influences has
increased considerably in recent years, but still a great deal of research
is necessary before we will arrive at an appropriate understanding of
the effects.
The empirical evidence clearly shows that the main effect of new
business formation on economic development comes from spurring the
competitive process. Much of this process’s outcome in terms of the
economic performance of regions, nations, or industries is indirect in
nature. This implies that the strong focus often put on the performance
344
345
of the newly founded firms — their direct effect — is misguided because

it neglects the often more important indirect effects. The results of
empirical research suggest that successful new businesses that pose a
strong challenge to incumbent firms are likely to also induce strong
indirect effects, but that such indirect effects can also occur even if
many of the newcomers fail and exit the market after a short time.
Against the background of current theory and empirical evidence,
it is obvious that highly challenging new businesses have a relatively
strong stimulating effect on economic growth. They can be assumed to
be much more important for economic development than, for example,
purely imitative start-ups that practice a routine for entrepreneurship
and serve only small local markets. This result has some important
implications for policy as well as for empirical descriptions and analy-
ses of new business formation. The main implication for policy intended
to stimulate economic development is that such policy should partic-
ularly focus on challenging entrepreneurship, for example, by trying
to improve the entrepreneurial qualifications of founders and stimulat-
ing the emergence of innovative start-ups (for a discussion of possible
policy measures, see Stam et al., 2012). An important implication for
the description and analysis of new business formation processes is
that measures for the numbers of challenging or high-quality new busi-
nesses are needed. This is particularly relevant because the shares of
highly innovative start-ups (Fritsch, 2011), of fast growing “gazelles”
(Acs, 2011; Henrekson and Johansson, 2010), or of “ambitious” start-
ups (Stam et al., 2012), in all new businesses tend to be small so that
measures for the overall level of new business formation in a country
or region may be an only vague and imprecise representation of those
start-ups that have a particular impact on growth.
This survey of research on the effect of new business formation on
economic development has highlighted a number of open questions that
deserve further research. I very much hope that further explorations of
the field will lead to answers (and, of course, more questions) that will
aid in the design of appropriate and effective policies.
Acknowledgments
I am indebted to Ronney Aamoucke, Florian Noseleit, Erik Stam, and

Michael Wyrwich for their helpful comments on an earlier version.
346
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New Business Formation and Regional

1 The Link Between New Business

2 Emergence of the Research Field 253

3 Theory: The Role of Entrepreneurship in Economic

3.1 The Nature of Entrepreneurship 256

4 Results of Empirical Research 285

5 Implications for Entrepreneurship Policy 334

6 Avenues for Further Research 337

7 Final Remarks 344

New Business Formation and Regional

Friedrich Schiller University Jena, School of Economics and Business

Keywords: Entrepreneurship, new business formation, employment,

JEL Codes: L26, M13, O1, O18, R11

The belief that new business formation is a source of economic

This monograph provides an overview on the current state of

Theoretical attempts to explain why and how entrepreneurship and

and, thereby, with entrepreneurship (McCraw, 2007). However, in the

rarely available at the time,6 and considerable eﬀort was expended on

et al. (2010), and Stangler and Kedrosky (2010).

The following overview of theoretical approaches that may contribute

3.1 The Nature of Entrepreneurship

business formation for economic development. According to Schum-

imperfections and ineﬃciencies. Obviously, these more ordinary types

1 The productive entrepreneurs comprise the innovative entrepreneurs that Schumpeter

aims at stimulating the productive type of entrepreneurship (Boettke

3.2 The Industry Perspective: New Firms and

distinguished: an early exploratory stage, an intermediate stage, and a

‘Entrepreneurial’ regime ‘Routinized’ regime

the approach may also be regarded as of limited relevance for explaining

ownership rates that exceed the equilibrium are expected to be unsta-

Acemoglu et al. (2006) and Aghion et al. (2009) put forward a

on the operating mode of the market. In this competitive process, the

3.3 Growth Theory

Hence, a key assumption of this approach is that radical innovation

“creative construction,” as opposed to Schumpeter’s notion of “creative

where Y represents output, K is physical capital input, L is labor

contribution of entrepreneurship capital to the growth of regions in

3.4 Entry, Competition, and Growth:

3.4.1 The Basic Relationships

Fig. 3.2 Direct and indirect eﬀects of new businesses on growth.

incumbents tend to be considerably larger than the direct eﬀects.

Start-ups or market entries Supply-side effects

Fig. 3.3 New business formation and the market process.

However, a well-functioning market process is not a zero-sum game

• Securing eﬃciency and stimulating productivity by contesting

are substituted for by newcomers.10 This type of process is

may make regions more resilient to external shocks (Boschma

Like the displacement eﬀects, the supply-side eﬀects are indirect

is only a portion of their total eﬀect on development. Many important

3.4.2 Factors Determining the Eﬀects of New Business

• the type of new business and the intensity of the challenge it

All these factors, particularly the emergence of challenging new

3.4.2.1 The type of new business, its quality, and the

• The amount and quality of the employed resources (for

Since competition can be multifaceted, new businesses may challenge

3.4.2.2 The Incumbents’ Reaction

3.4.2.3 Industry Characteristics