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Young Firms and Industry Dynamics in Belgium [Working Paper 06-16]

Recent studies reveal the importance of entrants and young firms for job creation, productivity and economic growth. Some scholars argue that the falling rate at which new firms are established, can explain, to a certain extent, the productivity slowdown witnessed in most OECD countries. Belgium appears to stand out unfavourably from other countries in its very low start-up rate. This paper reviews the empirical cross-country evidence, provides some additional analysis of the role of young firms in industry-level employment and productivity dynamics in Belgium and concludes with a discussion of the implications for economic policy.

Recent studies reveal the crucial role of young firms in job creation and industry-level productivity growth. There is growing concern that the declining entry of new firms could help explain, to a certain extent, the productivity slowdown witnessed in many OECD countries. The decrease in firm entry and productivity growth was apparent before the start of the ‘Great Recession’ following the 2007-2008 global financial crisis. The crisis may however have exacerbated this structural problem, as a ‘missing generation’ of entering firms can have a lasting negative impact on economic growth.

Firm-level data reveal substantial, persistent and even increasing heterogeneity in performance across firms. As the international competitiveness of economies appears to depend on a relatively small number of highly productive firms, analyses based on firm-level data can be useful to complement the traditional macro-economic perspective. Firm-level data clearly show the need to investigate the distribution of variables over the entire population of firms and indicate that conclusions based on the average ‘representative’ firm may be biased.

In this paper, we present the mounting evidence on the importance of young firms in employment and productivity dynamics. We point out the main results of recent analyses, coordinated by the OECD Directorate for Science, Technology and Innovation, which offer cross-country evidence on industry dynamics, based on national firm-level data. The common findings and differences of the results for Belgium, with respect to other participating countries, are discussed and complemented with additional analyses.

Early firm-level studies focus on the relationship between the size of firms and some indicator of growth (for example, job creation or sales growth). More recently, studies point out the important distinction between firm age and firm size. It appears that young – mostly small – firms account for a disproportionate share in job creation. On the contrary, old small firms, which make up the largest percentage of firms in all countries, tend to destroy more jobs than they create. Young firms also contribute substantially to industry-level productivity growth, although this occurs only some time after entry. Most entering firms have a productivity level below the industry average. Average productivity increases with age, because of organizational learning but also due to market selection, as many entrants that do not succeed in competing with established firms, are forced to exit within two to three years after entry. Learning and market selection are reflected in a positive contribution, of productivity growth of young firms, to industry-level productivity growth. The older firms become, the more market shares appear to shift away from less productive incumbents towards more productive incumbents.

As this paper shows, Belgium performed rather well in terms of net job creation over the period 2000-2014, in comparison with the three neighbouring countries France, Germany and the Netherlands. The jobs lost in most manufacturing industries were compensated for by strong employment growth in market services. The industry-specific pattern of employment growth hampered productivity growth in Belgium as it implies a shift of employment from industries with high productivity levels (mainly manufacturing industries) towards less productive service industries. However, our results underline the importance of the decrease in industry-level productivity growth as the main explanation of the aggregate productivity growth slowdown. The apparent trade-off between employment growth and productivity growth, which is most evident in market service industries, reveals the potential tension between different policies and suggests that in the introduction of labour market measures aimed at integrating more low-skilled persons in the economy – warranted because of the historically low employment rate in Belgium- a ‘productivity sacrifice’ needs to be accounted for.

Belgium stands out unfavourably from other OECD countries, in its low entry of new firms. The survival rate of young firms in Belgium does not differ much from other countries and post-entry growth of surviving start-ups actually appears to be relatively high. Over the period 2001-2011, the entry rate and the share of young firms decreased, which is a cause of concern as young firms are found to have a positive impact on industry-level productivity growth.

In view of the evidence that young firms – rather than small firms – are crucial for industry dynamics, the IMF and the OECD argue that economic growth would be achieved more efficiently by targeting tax support on young firms instead of favouring size-contingent tax benefits. The specific tax benefit for young innovative companies, introduced by the Belgian federal government in 2006, and the Start-up Plan that was initiated in 2015, seem to be good practice in targeting tax incentives on young firms as it minimises the budgetary cost and the tendency to favour less dynamic incumbents at the expense of dynamic young firms. Policy should however not be restricted to transactional support (grants, subsidies and tax benefits), but should also consider ‘relational support’ to the ‘entrepreneurial ecosystem’ of firms, universities, science parks, incubators and venture capitalists that are instrumental in generating knowledge spillovers, academic spinoffs and the formation of highly specialized human and social capital. Likewise, the focus on young firms does not imply that the key role of large incumbents in spawning entrepreneurial managers, who are capable of establishing and growing businesses, should not be acknowledged.

Considering the position of Belgium in rankings on factors that seem to explain cross-country differences in the entry of new firms, such as bankruptcy regulation, contract enforcement, access to finance and product market regulation, it seems that access to finance is the major barrier for entrants and young firms in Belgium. A recent survey indicates that start-ups in Belgium face vital problems in obtaining financing by banks. Banks motivate their rejection of demands for loans by the lack of collateral or equity of start-ups. Because of the financial crisis, venture capitalists have also become more averse to finance risky early-stage investment.

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