12 Unlocking the potential of innovation and entrepreneurship

The role of local policy in cities

Darrene Hackler

Abstract

As cities face increasing global competition and fiscal constraints in the post-recession economy, many city leaders wonder from what source future growth will emerge. One answer to this question is innovation, but the act of entrepreneurship assembles the components of knowledge and technology in the innovation process and amplifies the factors of economic growth. Cities that create and foster a culture of innovation and entrepreneurship will be better positioned for economic recovery, job creation, greater resiliency, and the potential for regional economic transformation. This chapter examines the concepts of innovation and entrepreneurship in relation to job creation from startups and young and second-stage small business, and reviews the barriers and policy options that local governments can use to address them. The chapter proposes a role for local government policy in cultivating and fostering an innovation and entrepreneurship ecosystem with strategies that research has shown help to remove barriers and support entrepreneurs' and small business development. Local actions and programmatic approaches can facilitate networks of public and private stakeholders that build trust and collaboration and leverage of local and regional assets. The chapter suggests possible problems that these approaches can encounter due to varied conceptions of entrepreneurship and innovation. The last section of the chapter considers the fiscal issues associated with development and support of an innovation and entrepreneurship ecosystem, as well as how a nuanced fiscal structure may capture the fiscal impacts.¹

Future of local economic growth

Today's cities face increasing global competition and are fiscally-constrained in the current post-recession economy. Additionally, the post-recession “way forward” is, in terms of national, state, and local policy, unsettled. The current environment leaves many city leaders seeking to determine their future sources of growth. The search becomes particularly relevant when there is uncertainty about the length of time before the economy goes back to “normal,” or if the sense of “normal” is no longer relevant for national, regional, and local economies because the economic and employment recovery from the great recession of 2008 will harbor long-term economic and social costs (Peck, 2010). In addition, the intra- and inter-regional variation will be large. One possible answer to all levels of government is innovation, a source of large technical change and growth in today's global economy.

Some have argued that innovation is a driving force and consequential to our future growth: “Long-term productivity growth will be more modest, and its rate will depend on investment, human capital and innovation” (The Economist, 2011). Although the traditional neoclassical economic approach relegates innovation to an at best secondary economic growth factor, a number of economists have acknowledged this logical inconsistency and in response developed a new theory and narrative of economic growth to explicitly address and model how innovation occurs. Often referred to as “innovation economics,” the theory recognizes knowledge, technology, entrepreneurship, and innovation as primary factors rather than as independent forces on economic growth (Atkinson and Hackler, 2010). Although each alone plays a role, the act of entrepreneurship assembles the components of knowledge and technology in the innovation process and amplifies the factors of economic growth.

Blank (2011) suggests entrepreneurship's importance, even in the throes of recession; he claims that this past decade has been the benefactor of great scientific discoveries and technological breakthroughs that “were integrated into the fabric of society faster than they had ever been before. When the speed of how businesses operated changed forever” (Blank, 2011). He believes that the reinvention of the American economy will be due to the democratization of entrepreneurship, where “the dawn of a new era for a new American economy [was] built on entrepreneur-ship and innovation” (Blank, 2011). Consequently, any look forward to ascertain the future engines or drivers of economic growth will necessarily recognize the mutually reinforcing relationship of innovation and entrepreneurship as well as how the strategically connected interaction of the two factors will generate greater returns.

Policy makers at all levels of government need to understand, now more than ever, how to create a culture of innovation and entrepreneurship – an “ecosystem” that will be better positioned for economic recovery and job creation, ensure greater resiliency in the future, and offer the potential for regional economic transformation. Unlocking what factors and tools best cultivate innovation and foster entrepreneurship begins with clearly distinguishing one from the other.

Defining the ecosystem

Although the relationship of innovation and entrepreneurship within an ecosystem may evoke the well-established concept of a regional innovation system (RIS), there are distinctions relevant to the discussion. First, Cooke's RIS concept evolved from his thinking about the relevance of systemic innovation, and developed out of regional science and economic geography (Cooke, 1992, 2001). In particular, the RIS research approach contained five key, linked concepts which he describes as region, innovation, network, learning, and interaction (Cooke, 2001: 953–4). However, some authors, including Cooke, have drawn attention to issues that make the RIS concept distinct from the innovation and entrepreneur-ship ecosystem. Cooke (2001) describes the “new economy innovation system” as similar to a RIS, but he notes that the RIS “really emerged in support of old economy regions” in economic crisis (Cooke, 2001: 969). More directly, Sternberg states that the RIS concept lacks an entrepreneurial dimension, even though studies have suggested its impact on regional growth (Feldman, 2001; Sternberg, 2007). Sternberg (2007) suggests the need to examine this dimension given that entrepreneurs and startups do benefit from the knowledge spillover, tacit knowledge, recruitment of specialized technical labor, and access to these through other institutions, such as higher education. In addition, the concept of entrepreneur-ship needs further exploration because regionally-integrated entrepreneurs and startups can help keep the region innovative, flexible, and resistant to lock-in. Consequently, the ecosystem described here recognizes the interconnection of innovation and entrepreneurship more directly than previous RIS research.

With regard to innovation, it is important to make a distinction between invention and innovation. “Invention is the first occurrence of an idea for a new product or process while innovation is the first attempt to carry it out into practice” (Fagerberg, 2003: 3). Thus, innovation is recognized as implemented change in products, services, and activities of business and their processes, and even within business owners and employees. An inventor's idea comes to fruition as an innovation through commercialization of an idea, market entry, monetization, and/or societal benefit, but each of these measures requires more action and resources from multiple actors. Joseph Schumpeter, an innovation theorist and economist, referred to the person responsible for translating the invention into an innovation as the “entrepreneur” (Schumpeter, 1934). The innovation that matters occurs at the intersection of one's “deep knowledge of a problem, intimate knowledge of market,” available technology, and capability (Kauffman Foundation, 2011a: 142).

Related, but distinct, the entrepreneur and the act of entrepreneurship rely on the inventor's ideas and makes innovation possible within an organizational context, or the “business.” Most research on entrepreneurship examines data on the population of such businesses, and their owners' demographics and characteristics, to understand their progression and economic contribution from the perspectives of innovation and employment. In general, the literature on entrepreneurship has not produced a universally accepted definition and varies according to interests and emphasis on aspects of entrepreneurship (Spencer et al., 2008). Often the focus is on the entrepreneur's recognition and creation of opportunities or “the role of new, independently owned, firms in the commercialization process” (Spencer et al., 2008: 11). The latter is more closely associated with the ideas of Schumpeter (1934) about firm formation leading to creative destruction because disruptive technologies and discontinuous innovations create new markets. Thus, this chapter classifies entrepreneurship with a Schumpeterian view but casts a broader definition as it is concerned with job creation potential. The discussion below will address entrepreneurship from the innovation perspective to include startups and young businesses. Startups are new firms, not yet a year in existence. Young businesses are new firms and those in existence at least one year and no more than five years.

In addition, the discussion of entrepreneurship will also address a segment of small businesses that have greater job creation potential. According to Stangler and Litan “firms responsible for net job creation are not only young but also small-and medium-sized” businesses (Stangler and Litan, 2009: 6). This classification of small business as a form of entrepreneurship deserves further explanation. Early work on entrepreneurship suggested several distinctions between the two – entrepreneurship was more innovative, profit and growth driven, and strategic in these efforts, while small business was less strategic and growth-oriented and more about personal goals or lifestyle (Carland et al., 1984: 358). Although these distinctions may be appropriate for some small business, it is not true for all. In fact, research has shown the pre-eminence of small firms in innovation and that small businesses are more likely to generate major innovations than large businesses (Small Business Administration, 1996: Baumol, 2005). Landström's recent work suggests that, from a policy standpoint, the inclusion of small business with entrepreneurship as a whole makes sense (Landström, 2005: 21), but more research is needed on entrepreneurial small firms and their strategy and characteristics.²

To focus in on this job creation subset of small business, the common definition for a small business is not appropriate. For example, the US Small Business Administration defines a small business as a firm with less than 500 employees, and those who use this definition remind policy makers that this is 97.7 percent of businesses in the United States, and they employ 50.2 percent of US workers. However, if non-employer firms are included, such small businesses account for 42 percent of the entire workforce (Stangler and Litan, 2009). For the purpose of this chapter, the 500 employee definition of small business does not capture the dynamic aspect of entrepreneurship as a source of job creation and growth. Consequently, references to small business in this chapter will include only those with fewer than 100 employees, accounting for 35.04 percent of the total workforce according to the 2009 US Census Bureau Statistics of US Business.³

Specifically, two segments of this definition are relevant to the chapter's focus on job creation. The first, with fewer than 10 employees, has some overlap with the startups and young businesses discussed above, and accounts for 10.95 percent of the total workforce in 2009. The second segment contains firms with 10–99 employees for 24.09 percent of the total workforce. The Edward Lowe Foundation identifies this segment as the “second stage of entrepreneurship” because the firm is not a startup, but also not mature; the idea is that these firms have a proven capacity to grow in employee size and are often considered to be “high growth” prospects with $750,000 to $50 million in revenues from a proven business model. “Between 1995 and 2009, second-stage companies only represented 10.9 percent of U.S. resident establishments, but represented 36.2 percent of jobs and 38.6 percent of sales” according to the National Establishment Time Series dataset (Edward Lowe Foundation, 2012: 1). The focus on increasing the capacity of these second-stage small business firms for job creation and growth is at the core of the idea of their inclusion in this chapter on the entrepreneurship and innovation ecosystem.

Factors limiting innovation and entrepreneurship

In distinguishing innovation from entrepreneurship, but recognizing their interactions, the potential of their separate and dual economic impacts are apparent. However, the existence of market failures dampens their potential and is the accepted reason for limited government intervention from a neoclassical economics point of view. Innovation economics suggests an even more compelling role for government because of the importance of both productive and adaptive efficiency⁴ and acceptance that market failures are the norm. Beyond the neoclassical impulse to remove market imperfections or distortions, innovation economics embraces many of those same imperfections and characterizes them as important sources of endogenous technological change and growth in a dynamic economy.

From the innovation economics perspective, government policy should support the process of innovation to correct for public-good market failures, to increase research and development, and create policies that nurture successful innovation systems which are composed of different actors, forms of organizations, and incentive structures necessary to seed innovation, as well as complex interdepen-dencies across the system. Innovation policy action would address the knowledge externalities an inventor faces when they cannot completely accrue the benefits of information and knowledge surrounding the innovation and invention because of “free riders” that can use the information, and benefit from utilizing it in their own offerings. It would also recognize the existence of information asymmetries, where information is usually incomplete, and although the response of innovators and entrepreneurs can be rational, they are bounded by what is known and how what they know is related to other pieces of information. Consequently, limited information and bounded rationality affect investment decisions because of the uncertainty of an innovation's future success – the impact may be too risky to garner anticipated returns.

Innovation and entrepreneurship face these hurdles and further constraints in a post-recession economy. Incentives exist for policy makers to alter conditions to allow the greatest potential economic growth from an innovation and entrepreneur-ship ecosystem. Beyond national and state level policy, local policy makers have a share in facilitating the ecosystem, growing the national economy through the success of local economies. The remainder of this chapter examines the components and building of the local ecosystem. The next section reviews research on why our future economic growth is dependent on the innovation and entrepreneur-ship ecosystem. In following sections, the chapter discusses current local policy and programmatic approaches to building the ecosystem, offering critiques and proposing what is lacking in these approaches due to varied conceptions of entrepreneurship and the flow of innovations with respect to regional clusters. The last section of the chapter considers the fiscal issues associated with development and support of an innovation and entrepreneurship ecosystem, as well as how a nuanced local fiscal structure is essential to capture the positive fiscal impacts.

Economic benefits of innovation and entrepreneurship

The estimated contribution of innovation and entrepreneurship to economic growth is at best the result of indirect estimates. With innovation, the most consequential evolution in thinking has been to move from focusing on the invention itself to the actual impact of new inventions because only those successfully introduced into a market context are innovations (Acs and Audretsch, 2005: The Advisory Committee on Measuring Innovation in the 21st Century Economy, 2008: Fagerberg, 2009). With no single measure existing, two methods are common to measure innovation's impact and benefit to the economy. The first is the proxy method, which indirectly accounts for impact through patents and spending on research and development (R&D) and is more about the invention than the innovation. The second method “relies on the economic accounting of where economic growth is explained by factors that are measurable, such as the labor force and its quality” and capital (US Department of Commerce, 2012: 2–2). The method assesses innovation as technological change through measures of multi-factor productivity or total factor productivity and estimates that over one-third to a half of economic growth is attributed to innovation in the US. However, even this measure is not complex enough to directly account for innovation's impact, so most suggest the need for better data collection on the key factors for innovation with the intent to produce better measurement (The Advisory Committee on Measuring Innovation in the 21st Century Economy, 2008).

Of the key factors, human capital and its subsequent knowledge creation are components of innovation that provide a link to the relationship with entrepreneur-ship and the organizational context that knowledge creation occurs. The generation of new economic knowledge and subsequent knowledge spillovers are factors that contribute to innovation, entrepreneurship, and economic growth. A review of existing research by Acs and Audretsch suggests that the knowledge production model, with R&D investments as a proxy, links knowledge inputs to outputs and is the best predictor of aggregated levels of economic activity (Acs and Audretsch, 2005). That is, greater aggregate investments in knowledge generation are associated with more successful countries to industries; however, at the microeconomic level, higher levels of knowledge generation are from larger firms that have capacity and budgets for R&D. Yet, more recent research examining entrepreneurship, innovative output of these firms, and agglomeration in a regional context shows that knowledge spillovers have a positive economic growth effect (Acs and Armington, 2004; Acs and Storey, 2004; Acs and Audretsch, 2005; Acs and Varga, 2005; Carlsson et al., 2009).

As innovation theorists and economists suggest, entrepreneurship is essential to amplify innovation and create concrete economic impacts. Leading thinkers on entrepreneurship identify the process as a varied type of capitalism in the US. Baumol, Litan, and Schramm (Baumol et al., 2007) label it entrepreneurial capitalism with an economy dominated by new firms that have independence from large firm dynamics, referred to as big-firm capitalism. Although large firms benefit from economies of scale, financial and human resources for R&D, and great access to and deployment of capital, they have little incentive to invest in radical innovation. Because of the routinization of the innovation process, large firms invest in incremental innovation rather than invest in new products or services that may affect current profit centers.

In effect, entrepreneurial capitalism releases innovation from routine, incremental improvements inherent in big-firm capitalism. Entrepreneurial capitalism's new firms are more likely to commercialize radical, disruptive innovations or breakthroughs. Beyond the type of innovation productivity and advance from an economy strongly grounded in entrepreneurship, the employment and job creation outcomes of entrepreneurship also provide large economic effects. Various studies indicate that the entrepreneurial economy generates significant churn – the combination of job destruction and job creation – for economic success. The churn of startups and young business bring a dynamic from which even small business can benefit, particularly the second-stage small business. Consequently, entrepreneurial capitalism provides a construct to examine the dynamic and its economic benefits within the US capitalist system. The following examines the recent contribution of entrepreneurship as defined in this chapter to the economy and job creation.

Isolating the effect of startups alone, their job creation impact added an average of 3 million new jobs a year in 1992–2005, which was four times higher than any other yearly age firm group during that time period (Kane, 2010). A main concern about startups is that, while they may create churn, the likelihood of their existence beyond a few years and their contribution to long-term growth is questionable. However, research indicates that new companies were a primary source of net job creation in the US from 1977–2005, and 50 percent of them survived until age five (Stangler and Litan, 2009). Another study found that startups retain 80 percent of initial total employment until five years (Horrell and Litan, 2010). In fact, since 1980 nearly all net job creation in the US is in firms less than five years old. Startups with three years in business are providing opportunities in the economy (Haltiwanger et al., 2009). Headd and Kirchoff point to the fact that these findings have held across different time periods and datasets that researchers have examined (Headd and Kirchhoff, 2007).⁵

Young firms (startups that last for five years) also provide job creation. They accounted for not only roughly two-thirds of job creation in the US in 2007, approximately 8 million jobs, but also created the highest average number of jobs (Stangler and Litan, 2009). The churn that young firms provide also has an impact on employment and innovation as they are sources of growth for large and older firms, acquired for their innovations and revenues (Stangler and Litan, 2009). Barkley and Dudensing (2011) found that young businesses as well as churn increased employment growth in metropolitan areas (Barkley and Dudensing, 2011).

Stangler and Litan (2009) supplied greater context to the size of entrepreneur-ship's job impact when they found that “firms responsible for net job creation are not only young but also small- and medium-sized” businesses (Stangler and Litan, 2009: 6). With regard to small businesses, approximately 63 percent of net job creation in 2007 occurred for those firms with less than 100 employees. Breaking this down further shows that firms with 1–9 employees accounted for approximately 24 percent of job creation, and those with 10–99 employees accounted for the remaining 39 percent, indicating the relevance of both segments to the economy.

Another segment of entrepreneurship relevant to capturing its contribution to employment is high-growth firms, or gazelles, which account for a “disproportionate share of job creation” (Stangler, 2010: 5). Stangler's (2010) research showed that of the 5.5 million firms in the US in 2007, the top one percent of fastest growing companies generated approximately 40 percent of new jobs, while the top five percent of gazelles generated 66 percent of new jobs. Relevant to this chapter is that most gazelles are young (age three to five years), and although they account for less than one percent of all firms, young gazelles generate 10 percent of new jobs (Stangler, 2010).

Overall, the weight of these statistics on startups, young firms, and gazelles suggest entrepreneurship's potentially sizable effect that is viable to both job and economic growth. As mentioned above, second-stage entrepreneurship represents only about a tenth of the economy, but over one-third of the jobs and sales (Edward Lowe Foundation, 2012). Austin, Texas, offers an example of the importance of such small business and churn at the local level. Capturing the first position in the small business rankings of cities, Austin experienced 1.5 percent small business growth between 2007 and 2008, and no other market fared better than 0.6 percent (Thomas, 2011).⁶ The growth in the number of small businesses contributed to Austin's job base expanding 9.3 percent between 2005 and 2010 and helped create jobs for 20.2 percent growth in Austin's population between 2004 and 2009.

The above research on entrepreneurship indicates that the policy discussion about supporting entrepreneurship should not focus merely on their share of the economy's jobs, but on the job creation potential of startups and young and small businesses. In addition, assisting them to become established firms also has employment benefits since surviving firms continue to grow and create employment churn as firms mature past the average of five years (Horrell and Litan, 2010). The development of the ecosystem should recognize how to foster startups and support their growth and longevity. Phasing of entrepreneur-ship support policies recognizes the different stages of entrepreneurial ventures and is consistent with Schumpeter's long ago advice about the benefits of creative destruction.

A second policy implication of the job creation impact of startups and young and small businesses implies a need to alter the profile of the traditional economic development business target. The preponderance of economic development policy at state and local levels should recognize that incentives for large firm relocation ignore these statistics. Also, those policies are based on unrealistic models of employment growth since “job growth is driven, essentially entirely, by startup firms that develop organically” (Kane, 2010: 6). From the perspective of entrepreneurial capitalism, policy should not focus on “too big to fail” firms, diverting limited capital and resources to automobile plants and big box stores.

“Over the long-run, a vibrant, growing economy must maximize opportunity for new firms at the margin” (Litan, 2010: 4). Feldman identified that entrepreneur-ship is a regional event and thus not only contributes to national but also regional growth (Feldman, 2001), and Acs and Armington find evidence in US labor markets that the level of entrepreneurial activity has a positive effect on the employment growth rate. Even in rural areas, Stephens and Partridge find contradictory evidence to the common thinking “that remote rural regions may lack the agglomeration economies to benefit greatly from entrepreneurship” (Stephens and Partridge, 2011: 431). They suggest that entrepreneurship increases employment and income growth, “and that efforts to promote entrepreneurial capacity may be among the few economic development strategies with positive payoffs in remote regions” (Stephens and Partridge, 2011: 431).

Thus, the protection and seeking of large firms is both destructive to entrepreneurship and ignores this long recession's effect on job creation on account of its effect on entrepreneurship and small business. Headd and Kirchhoff (2007) highlighted a sobering fact. In the 2001 downturn, “firms with fewer than 20 employees accounted for 7 percent” of the employment loss while the firms with 20–499 accounted for 43 percent (Headd and Kirchhoff, 2007: 15). However, in the past recession, two noteworthy facts changed. First, “firms with fewer than 20 employees were hit hard early, as their string of employment losses dates back to the second quarter of 2007,” but “firms with 20 to 499 employees have taken their beating more recently” (Headd and Kirchhoff, 2007: 14). The length of the recession has deepened its effects on even the more established businesses. Second, in the great recession, small firms with fewer than 20 employees had a greater loss of employees than 2001, losing 24 percent from 2008 to the second quarter of 2009; however, firms with 20–499 employees suffered fewer losses than in the 2001 downturn, accounting for 36 percent. Although the breakdown clumps second-stage small business between the categories, the effect is not trivial. Research on startups shows a similar problem. Although startups continue to grow during recession periods, they create fewer jobs in prolonged recessions (Horrell and Litan, 2010). Horrell and Litan (2010) stress that a prolonged recession of three years results in roughly 10 percent less employment, presenting a considerable problem to job creation dynamics in the economy. On the bright side, startups surviving recessions catch up with normal job creation trends at the age of five years. Consequently, policy makers seeking long-term job growth should refocus on the job-creating firms and provide conditions during and following recessions to allow the quick return of normalcy in these firms' job creation dynamic.

Figure 12.1 Product innovation lifecycle.

Source: Cogan Owens Cogan (Wise et al., 2007: 31).

How to foster and support an innovation and entrepreneurship ecosystem

The development of the innovation and entrepreneurship ecosystem must reflect the current economic effects, the basic actions and needs of the innovation process, its lifecycle, and the entrepreneurs that enter along this lifecycle. Figure 12.1 captures some of this dynamic. From an innovation perspective, the product innovation lifecycle includes a number of stages that enjoy the participation of a variety of stakeholders. The figure illustrates an integrated and circular view of the product development and production process over time, from conception or invention to maturity. Determining the stages at which entrepreneurs encounter the largest hurdles and what, if anything, local policy and support can accomplish, is the policy makers' struggle. Often, existing programs are not as nuanced as this figure would suggest they need to be. In addition, a rising number of serial entrepreneurs, thinkers, and academics are suggesting that the programs, not to mention business schools, may be offering guidance and assistance that are more appropriate to large firm business processes and models and thus miss the distinctive needs of startups and young and second-stage small businesses.

In stepping back to account for what entrepreneurs need, the type of entrepreneurship desired often affects the design of policy and development of programs. Baumol (2011) makes a useful distinction between replicative entrepreneurship and innovation entrepreneurship. The former are entrepreneurs that open businesses of the standard variety, such as retail shops, and are small businesses without the nuance used for this chapter. The latter are innovation entrepreneurs that take promising inventions and put them into effective use. They are commonly what one associates with entrepreneurial ventures, and Baumol believes that their characteristics are part of what make innovation entrepreneurs the key to long-term economic growth. Yet, the interactive nature of innovative entrepreneurs make them more dependent on others “who play complementary roles in furthering their efforts” (Baumol, 2011: 82). Government plays such a complementary role to the production lifecycle depicted in Figure 12.1, and while Baumol suggests the construction and maintenance of infrastructure and educational institutions that produce skilled employees, his emphasis is mainly on national level policies, such as trade.

In overlooking the local level of government that can potentially have the most contact with entrepreneurs creating the startups and leading the dynamic young and second-stage small businesses, he ignores how much local policy makers can facilitate innovative actions and support complex innovation systems with variety of policy tools, and grow the economy in a strategic direction. As discussed above, the past recession and the current recovery hinder entrepreneurship's startups and young businesses as they are likely to adopt more conservative behavior in hiring and encounter an environment with more market failures that further limit their innovation success and growth. Thus, the “complementary role” that government can play has grown in the post-recession environment, which is reminiscent of Cooke's (2001) suggestion that the rise of RIS was to address economic crisis in declining regions.

Karlsson also sees a strategic role that policy makers can play “in fostering entrepreneurship by functioning as catalysts by on the one hand pulling together resources, factors of production, such as human capital and financial means and on the other hand facilitating institutional change in such a direction that entrepreneurship becomes a more interesting alternative for individuals as well as groups of individuals” (Karlsson, 2012: 6). The recognition of entrepreneurship's relationship with innovation and resulting economic growth suggests that more may be done than the US norm where public sector investment occurs in basic research funding and the rest is left to the private sector. Herrera and Sánchez-González suggest “that regardless of firm size, public funding stimulates investment within the firm's technological domain (applied research and technological development)” and small firm investment expanded their sale of new products in the market (Herrera and Sánchez-González, 2012: 1). However, more than direct investment is important to the ecosystem, and the following section examines how local governments can foster and support an innovation and entrepreneurship ecosystem.

Prior to detailing the local policy and actions in the ecosystem, many suggest that such activities – “picking a winner” – should be beyond the scope of local government and desire facts and figures on returns from any support the local government provides in regard to the success and failure of the actual businesses. As with the lack of data on direct measures of innovation, there is a lack of data on local government expenditures because of the complexity of these activities that fall across multiple local budget lines and organizations.

It is also important to note the nuance involved with using the measure of firm survival as success. In Stangler and Kedrosky's examination of firm survival trends by firm characteristics, they suggest that the longevity of survival is not necessarily the equivalent of increased productivity (Stangler and Kedrosky, 2010). The idea of investing in entrepreneurship should not be about survival but greater economic growth because the investment lowers the cost of barriers to entry and increases the churn (higher failure, greater turnover). The idea that the fostering of the ecosystem picks winners is also problematic since governments already are active in traditional economic development, recruiting large firms that may never have the size of operation or hire the number of employees originally promised. Reprioritizing some of those funds to the ecosystem could result in more job creation because of the economic benefits that startups and young and small businesses deliver. In addition, as the remainder of the chapter discusses, a local government's role is about connecting relevant actors and facilitating networks and collaboration, which does not suggest a primary role of an investor in the private sense.

Local development of the innovation and entrepreneurship ecosystem

Over the past decade most local governments have recognized the value of a robust and growing entrepreneurial and small business community to local economic competitiveness. The role of local governments in this chapter is not one that actively creates new businesses, but assists instead through its policies. These include those general policies that enhance quality of life and ensure appropriate physical and digital infrastructure (Florida, 2004; Hackler, 2006, 2009), as well as the ability to network relevant actors. Local government has the ability to influence the environment and enhance the probability of innovation that engenders entrepreneurship and its business development. The innovation lifecycle (see Figure 12.1) has many stages, but how it is expressed inside a city's entrepreneurial base can drive opportunities and propel the local economy past challenges. Local governments are playing a complementary role as well as addressing market failures to seed innovation and promote its development, commercialization, and integration into existing clusters and networks of the local and regional market. A host of collective actors are necessary to build, foster, and secure the ecosystem in which innovation and entrepreneurship thrive: government, economic developers, private industry educational institutions, nonprofits, and foundations. Understanding how local policy and programs can facilitate this nexus and interaction will unlock the potential for growth of these economic drivers.

Focus on the ecosystem

Embarking on the creation and development of a strategy should consider further what types of entrepreneurs and small business will yield the most job creation and long-term growth. Cities must focus on cultivating the innovation entrepreneurs and “pull entrepreneurs,” those whose multiple motivations pull or lure them into entrepreneurship in order to realize a venture idea and are not pushed on account of the recession. Post-recession statistics suggest the importance of this distinction. In 2010, self-employment and non-employer firms showed a four percent increase over 2008, and the highest in 15 years (Fairlie, 2011). However, these are startups with the least likely job creation and survival because the characteristics of the newly self-employed are people without high school diplomas and workers in the construction industry. These were the most likely people to enter self-employment because of necessity – push entrepreneurs.

Cities with existing entrepreneurship support strategies and programs may need to rethink and refocus on which type of entrepreneurship and small business it wants to invest. Many of the programs that foster the innovation and entrepreneurship ecosystem may benefit the replicative entrepreneurs as well as those who are pushed into entrepreneurship. The spillover benefit from a focused strategy, while important, should not allow local government to lose focus on assisting the desired type of entrepreneur that fits their local economic profile and growth capacity – a second-stage business or specific industry. Each locality will “need to tailor the policy initiatives to fit the specific circumstances of each individual region” and local economy (Karlsson, 2012: 6). Long-term commitment builds consistency and certainty that can yield the greatest potential because innovation and resulting entrepreneurship can thrive. In addition, for localities that may not deem such a strategy appropriate at the current time, their understanding of the difference and what types of policies and programs are more likely to develop the ecosystem can be a goal for future development of the entrepreneurial base.

Actions to foster the ecosystem

Developing a culture supportive of innovation and entrepreneurship involves the design of strategies that remove barriers and is supportive of entrepreneurs' development, allowing them to thrive. Once policy makers determine the types of entrepreneurship and small business that are essential to their long-term economic growth and resiliency, they must focus on where the key points of entry to entrepreneurship exist in the community. Subsequently, locals must convene stakeholders and nurture these relationships into networks that encourage innovation and risk taking around these entry points as well as create stronger ties and trust, often referred to as social capital. The degree of trust among firms, organizations, and individuals can possibly “reduce transaction costs both in market exchanges and in regional development projects” (Karlsson, 2012: 9). Research suggests that the development of a stronger entrepreneurial culture, which is conducive to the ecosystem, encourages “nascent and existing entrepreneurs to exploit their formal and informal network relationships, seeking the development of organisations and institutions that will assist in building social capital” (Ferri et al., 2009: 138).

Local governments will need to enlist a diverse set of actors and facilitate interactions, including dialogues that allow private industry to share what their needs are and educational institutions and residents to fuel ideas that could find commercialization support of those ideas. Facilitation of global and inter-regional networks is also important. These steps are consequential to increasing innovation absorption in the local economy. The networks enable connections and guide the entrepreneur's knowledge creation through the innovation lifecycle to technology transfer and commercialization. The environment may also lead to the cultivation of further business development in the local cluster of businesses, although the trend of open innovation enhances inventors and entrepreneurs to transcend geographical boundaries.

Cultivation of innovation and entrepreneurship ecosystems continues to rely on educational stakeholders for the preparation and skill development of the local workforce, but local strategies should persuade these institutions to go beyond this mission, and their myopic focus on technology transfer, to engender stronger ties and collaboration in the ecosystem. Universities and colleges need to work beyond efforts to commercialize inventions and intellectual property derived from federally-funded research, dictated by the legal framework set out in the 1980 Bayh-Dole Act (University and Small Business Patent Procedures Act). The Act effectively increased university activity in the technology transfer process because universities financially benefit from the ownership of the patents from the funded research. However, a current Supreme Court case, Stanford v. Roche, may greatly affect contract negotiations that would alter issues of ownership and downstream benefits to the university (Gernstein, 2011). In addition, technology transfer programs are already under scrutiny for not generating more commercialization. The case outcome, as well as other policy recommendations that would directly incentivize commercialization of technologies from any federallyfunded research grant, may cause universities to redouble their technology transfer efforts. This climate would present an opportunity for local governments to play a strategic role in these efforts as part of supporting the ecosystem. Local policy makers should push for broader technology transfer than just that for federallyfunded research, and leverage university expertise to assist other inventors and entrepreneurs in the community. The university can leverage space for proof of concept centers that do not just provide university faculty access to expertise and scrutiny. The university may also be the institution to seed and partner, assisting with small scale demonstrations of new business models for community entrepreneurs.

As community stakeholders, universities and colleges should delve into local economic development with the establishment of high-level administrative positions that are specifically tasked with making universities and colleges into more effective engines of economic development, and providing a clear entry point for private industry and entrepreneurs. A possible avenue includes tailoring research, teaching portfolios, and provision of technical assistance to meet the economic needs of their regions (McHugh, 2010).

Internally, governments also must evaluate any regulations that may be creating red tape and limiting entrepreneurship.

Governments can, given their powers, have considerable influence over the entrepreneurial process by stifling the efforts of those attempting to start a new business. This may be done through onerous bureaucratic requirements, complex regulations, or merely slow reaction to requests for decisions required to form a new business.

(Reynolds et al., 1994: 452)

Local governments should examine where they could reduce delays, streamline processes, and offer assistance for businesses to navigate the regulatory process (Morris and Brennan, 2003). Research examining county small business growth from 2007 to 2008 indicates that, in a recession, government regulations, such as offering permitting and zoning assistance, can make a difference (McFarland et al., 2010). Consequently, when a business needs to find space for expansion, local governments can ease the process, and such a finding would be expected for startups and/or young businesses making a similar step.

The long-term outcome of the innovation and entrepreneurship ecosystem is the spawning of further job and wealth creation. The leveraging of existing and future assets and provision of programs and tools are interdependent decisions. In selecting the appropriate level of government involvement for programmatic delivery, a strong network of qualified stakeholders can reinforce and assist with the delivery. Local governments can assist with leveraging space in support of private and other network stakeholder initiatives and provide public in-kind contribution to the effort as long as it is structured to meet the long-term strategy's goals. Recent actions by the cities of Minneapolis and St Paul, Minnesota, serve as one example of the role that local government and surrounding actors can play fostering and supporting the innovation and entrepreneurship ecosystem (see Figure 12.2).

Missing in action: nuances of the innovation and entrepreneurship ecosystems?

The regional collaborative approach described above, with the suggestions for the roles of various stakeholders and coordinated institutional policy support, can lay a foundation for the innovation and entrepreneurship ecosystem. As discussed earlier, traditional economic development policy fails to recognize that large firms are not the primary generators of job creation. But even for policy makers who recognize the consequence of supporting internal sources of growth, entrepreneurship strategies and support programs are often designed around flawed assumptions about entrepreneurial behavior and needs.

The overriding issue is that these approaches are based on business techniques and models derived from the theory of large firms in the industrial revolution. Local policy makers responsible for program design and implementation must recognize that,

business schools borrowed ideas from the management of large firms and applied them in a startup setting to fill the teaching and theoretical gap. Strategic planning in large firms was transposed into business plans in startups, corporate marketing was transformed into entrepreneurial marketing, and product development model subtly became the process for launching a business.

(Furr, 2010a)

Figure 12.2 A case of a regional approach.

Steve Blank, a serial entrepreneur that turned academic, and is now a consulting professor in the Graduate School of Engineering Stanford Technology Ventures Program, goes as far to say that the stress on the business plan for entrepreneurs is no more than a creative writing assignment (Blank, 2011). He stresses that the business model is key and focuses on the hypothesis concerning nine basic characteristics.⁷ Yet, many entrepreneurship programs teach business plan writing and have competitions for them, and even funders rely on them.

Applying large firm techniques and models assumes that entrepreneurs face similar decision points, market forces, and access to capital. Yet, a “startup, because it is dealing with high risk, high uncertainty, high change, low knowledge and low resources… requires different techniques, practices, and theory than what is appropriate for a large firm” (Furr, 2010b). Entrepreneurs face additional market failures, information asymmetries, and uncertainties such that any assistance must embed these differences into the design of the approach.

The flawed equivalence of startups and young and second-stage small business to large firms also has a consequence on approaches to integrate entrepreneurs into existing markets. The prevailing economic competition model of regional economic clusters provides a limited view of the spread of ideas such that the flow of innovation is not always maximized within regional borders. The concept of open innovation (Chesbrough, 2003) suggests that the firm incorporates innovation from a variety of sources.

From a new firm's perspective, licensing out can enable the firm to maintain a focus on further innovation or free the firm from the investment required to commercialize the idea, while licensing in allows a new business to take advantage of an innovation to improve the firm's own good or service production.

(Hackler, 2011)

The geography of open innovation and licensing activities are not restricted to the region of the entrepreneur's venture.

A recent study (Fitjar and Rodriguez-Pose, 2011) inferred that clusters are not as important to the innovative capacity of firms as “global pipelines” or open innovation outside of the local region, and even internationally. The findings, and open innovation concept, suggest support for a nuanced strategy to integrate entrepreneurs into a regional cluster fully and capture their potential where appropriate. From an innovation product life cycle viewpoint, global pipelines to innovation and licenses may be more important for innovation in terms of product development. However, clusters are also important as they facilitate later stages of the innovation lifecycle: proof of concept, demonstrations projects, small scale manufacturing and production, and, finally, full commercialization. Clusters can enable exchanges that lower the transactions costs of supporting and facilitating the entire process and innovation lifecycle. The exchanges within clusters can also engender further product development for each component of a product's production or its business process. These developments may come from global pipelines because it would be a stagnant, closed innovation world if ideas only could be used where they were invented. However, the distinction is essential to maximize the innovation growth effect that entrepreneurship can have on economic growth. Entrepreneurship support programs need to encourage flexibility and assist with access to global pipelines while creating solid networks to those in the region.

Readying cities to profit from the innovation and entrepreneurship ecosystem

A strategy to develop and foster an innovation and entrepreneurship ecosystem will necessarily need to provide the services that will pull in entrepreneurs and provide a foundation of support for them as they progress through the product innovation lifecycle. Although cities should question to what degree they are fiscally able to promote, seed, and leverage these activities, they should also consider if they are fiscally structured to capture resulting growth. The chapter concludes with a discussion of these issues.

In the short term, not much can be gained from cities restructuring fiscal systems to capture revenue from innovation and entrepreneurship. At the most practical level, the primary sources of local tax revenue do not directly target the types of growth affiliated with today's innovation and entrepreneurship. In terms of innovation, the taxing of ideas would be the opposite of what economic theory would suggest because innovation, research, and development are already characterized as market failures given that each are public goods and, while they generate positive externalities, much less is produced than is socially efficient.

In addition, the majority of cities primarily rely on property tax revenues or a combination of property and sales taxes. Both of these traditional streams will fail to capture much of the personal income or capital gains of the owner and any employees of small entrepreneurial ventures. Also the locations of many of these startup ventures are located in personal home offices, for which property taxes cannot account. Wealth- and income-related taxes would better capture some of what the other tools are missing, but research has found that wealth taxes are “likely to influence entrepreneurship negatively by affecting the pool of capital available for start-up businesses as well as reducing the net return to successful entrepreneurs” (Hansson, 2008: 1). Fiscal restructuring focused on single and small entrepreneurial ventures is unlikely to yield significant revenue gains and likely to be counter-productive in pushing entrepreneurs out of the community.

Instead, cities should focus on reducing barriers and improving economic integration of entrepreneurs and small businesses in the local economy. The Kauffman Foundation and Lowe Foundation, two entrepreneurship-focused research and educational organizations, stress that the policy of localities should be more about lowering the barriers to entrepreneurship and encouraging their seamless inclusion in the local economy. In fact, it would be better for local efforts to seek to push these ventures into the second stage of entrepreneurship. Local policy should focus on supportive programs that can fuel their growth in employees and income resulting in expanded investment in business property, which traditional fiscal structures can capture. It would be more advantageous for cities to focus on foregoing burdensome fiscal and regulatory structures on startups and entrepreneurial ventures and instead restructure to realize these later stage gains.

In the medium to longer term, the question for cities is how to restructure their fiscal systems to capture future growth and better reflect longer-term economic shifts. Currently, city fiscal systems reflect the nineteenth and twentieth century economic systems, focused on land and physical assets. The sources of growth in the twenty-first century economy are knowledge, technology, innovation, and entrepreneurship. Cities must restructure fiscal systems to fit this reality. The Kauffman Foundation believes that taxes on income penalize risk taking, innovation, and employment, and that a more consumption-based tax system would encourage saving that funds investment (Kauffman Foundation, 2011b). Although a redesign of the national tax system is unlikely, there may be a role for city action.

The combination of innovation and entrepreneurship is mutually reinforcing and will generate greater returns if both are connected strategically. Each has implications on local service provision and tax base. To be most successful in fostering the ecosystem, cities must cultivate the innovative and pull entrepreneurs as well as second-stage small business that complement their economy, and focus on the key points of entry for these into the community. They need to create and incentivize a culture of risk taking. Local governments are tactically positioned to enlist a diverse set of actors that can help fuel ideas and build the workforce that can support the commercialization of those ideas. Diversifying services on the basis of startups' unique needs, reducing the red tape, leveraging space, unifying public and private funding initiatives are all concretes steps that can increase innovation absorption capacity of the local economy and build long-term economic growth and resiliency.

Notes

1 The author thanks the gracious review and comments from Kim Rueben, Christopher Hoene, and three anonymous reviewers.

2 See the call for papers for the International Small Business Journal special issue by Landström and Welter to address entrepreneurial small firms' contemporary issues and perspectives: htt­p:/­/ww­w.e­csb­.or­g/d­ocu­men­t.p­hp?­DOC­_ID­=55­2&S­EC=­0f6­8b4­97d­1f5­12b­cdf­7cd­72d­5d9­3b6­9f&S­ID=­1#i­sbj­_re­nt_­spe­cia­l_i­ssu­e-­ent­rep­ren­eur­ial­_sm­all­_fi­rms­.pdf.

3 See US Census Bureau, Statistics of US Business, at http://www.census.gov/econ/susb/, and particularly http://www2.census.gov/econ/susb/data/2009/us_state_totals_2009.xls to make these calculations.

4 Productive efficiency is the ability of organizations to reorganize production in ways that lead to the greatest output with the fewest inputs, including labor inputs, while adaptive efficiency refers to the ability of economies and institutions to change over time in response to new situations, in part by developing and adopting technological innovations.

5 See Headd and Kirchhoff (2007) for discussion: “Following Birch (1987), Kirchhoff (1994), also found that small startup firms created the majority of net new jobs in the US. Birch's job generation findings have largely been corroborated using the more widely accepted SUSB (Acs, Armington, and Robb, 1999) and Bureau of Labor Statistics data (U.S. Bureau of Labor Statistics, 2005 and Okolie, 2004)” (Headd and Kirchhoff, 2007: 3).

6 The rankings defined a small business as any private-sector employer with 99 or fewer employees.

7 The nine characteristics are part of Osterwalder's and Pigneur's business model generation “building blocks,” which include attention to key partners, key activities, key resources, value propositions, customer relationships, customer segments, distribution channels, cost structures, and revenue streams (Osterwalder and Pigneur, 2009).

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