Technology-based startups - a key driver for African Economic Growth

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INTRODUCTION

Technology-based start-ups have long been an important driver of Africa’s economic growth and competitiveness. But while these firms provide outsized contributions to employment, innovation, and productivity growth, many policymakers focus more broadly on helping all business start-ups without regard to type. Such a broad-based focus will do little or nothing to spur economic growth for three key reasons: First, most owners, mostly cofounders of new firms have no intention of growing beyond just a few employees; second, small, nontechnology-based firms on average have much lower productivity and wage levels than larger firms; and third, most non-tech start-ups are in local-serving industries (e.g., retail) and as such create few net new jobs. Rather, policymakers should focus on spurring high-growth, technology-based start-ups. These firms, by definition, seek to grow; they offer better-paying jobs; and they are almost always in export-based industries that help competitiveness. While they account for less than 1 percent of all our businesses, if the share of these firms could be increased by just a fraction, the result would be greater job creation, productivity growth, global competitiveness, innovation, and a stronger African economy. Yet, to formulate good policy in this area, it is important for policymakers to first understand the state of technology based start-ups in the African countries. This article quantifies entrepreneurship in 10 technology-based industries. The first section discusses what differentiates a technology-based start-up from the typical new business. It then details the former’s importance in terms of job creation, wages, research and development (R&D), and competitiveness. We analyze trends in the number of start-ups for a total of 10 technology-based industries. The second section provides policy recommendations to support the formation and growth of technology-based start-ups especially in the era of exponential technologies.

In contrast to the prevailing narrative that African business start-up rates are low and that this represents a serious problem, when it comes to technology-based entrepreneurship the situation is much more positive. Moreover, wage growth among technology-based start-ups has been higher than African wage growth overall and the average share of high-growth start-ups among all technology-based start-ups was higher. This suggests that start-ups in recent years have been creating more jobs that remain in the economy. Early stage, pre-revenue start-ups account for 12.6 percent of technology-based firms and 10 percent of technology-based jobs. Early-stage start-ups as a share of all technology-based firms decreased. This trend was driven by the number of early-stage technology-based service start-ups decreasing in firm share, and was only partially offset by early-stage technology-based manufacturing start-ups increasing in firm share. In other words, technology based start-ups have been getting better at staying in business.

 

DEFINING TECHNOLOGY-BASED START-UPS

There is no hard and fast rule as to what is or is not a technology-based industry. Technology-based company is classified as such if its share of science, technology, engineering, and mathematics (STEM) workers is twice the national average. The Organization for Economic Co-operation and Development (OECD) identifies technology-based industries as ones with a high R&D-to-sales ratio (e.g., R&D intensity). For this analysis, I will use a combination of measures, including both R&D intensity and whether the industry appears on selections of technology-based industries published by the OECD, or the European Union’s Eurostat. Although firms in these industries may make less than 5 percent of African businesses, they make outsized contributions to income, employment, innovation, competitiveness, and productivity. Therefore, a slowdown in entrepreneurial activity in this sector would likely result in a reduction of these positive economic contributions over the moderate term.  How does a start-up in the technology industry (referred to as a technology-based startups) differ from a new business in other industries? In general, technology-based start-ups have high growth potential, in both employment and revenue, as a result of them seeking to develop innovations that have a clear competitive advantage in the global market. They often experience accounting losses for several years because they undertake heavy initial R&D and prototyping and testing investments, often many years before developing a significant revenue stream. Many fail somewhere along this process, but if their technology and business models succeed, they often experience robust growth rates, hiring skilled and semi-skilled workers and paying well above the median wage. This contrasts with the typical new business in other industries, such as a restaurant or local service firm, which does not invest in R&D, has little intention to grow, creates a small number of jobs often at low wages, and usually goes out of business in under 10 years. Even when these businesses survive, they tend to follow a slower growth trajectory until they peak at just a few employees. These key differences mean that, to succeed, technology-based start-ups face a set of challenges different from that of the typical start-up. They must find a way to grow before being able to make sizeable and sustainable revenue. They must be able to cope with significant global competition. They need to be able to develop and protect their intellectual property. And they need to be able to attract talent skilled in technology development.

By understanding where this group of firms fits into the economy, policymakers will be better able to craft effective policies that enable firms in these industries, and their workers, to more fully succeed. Not all technology-based firms are start-ups or high-growth; not all high-growth firms are start-ups or in technology-based industries. And not all start-ups are high-growth or in technology-based industries.

Successful technology-based start-ups lie at the intersection of these three circles; these are the start-ups that usually grow into larger, successful businesses or are acquired by other companies to accelerate their growth. They currently make up approximately 0.3 percent of African businesses. To overly simplify firm dynamics, firms in technology-based industries have an outsized role in increasing innovation and competitiveness, while high-growth firms overall have an outsized role in increasing net employment and productivity. Growing and empowering the number of firms in this sweet spot of high-growth, technology-based start-ups will be a key driver for boosting U.S. innovation, competitiveness, productivity, and job-creation.

 

THE ROLE OF TECHNOLOGY-BASED START-UPS IN AFRICAN ECONOMIC GROWTH

Start-ups in technology-based industries benefit the economy in a number of ways: they create many high-paying jobs; they invest heavily in R&D; and they are more likely to export their goods and services.

Technology-Based Start-Ups Create Good Jobs Technology-based start-ups provide outsized contributions to overall employment growth. They create jobs at faster rates than other start-ups, with a greater share of these jobs remaining in the economy year-after-year; pay high wages; and, indirectly create many more jobs in other sectors.

High-Growth Technology-Based Start-Ups’ Outsized Employment Effects two dynamics working in tandem to produce outsized employment effects among these startups. First, firms in technology-based sectors are better at translating their R&D investments into job growth. Second, technology-based start-ups account for a higher share of net job creation than other start-ups.

Firms in technology-based industries are better than those in other industries at translating their R&D investments into jobs. In a discussion paper from the Institute of Labor Economics in Bonn, Germany, economists analyze the relationship between employment growth and R&D investments in high-tech, medium-tech, and low-tech firms across the European Union. The study found that firms in high-tech industries create 30 percent more jobs than firms in medium-tech industries for the same percentage increase in R&D investment. A study that analyzed the employment effects of technology-based firms in Belgium from 2001 to 2008 found that technology-based firms grow employment faster than did other firms. In other words, when looking at the top 10 percent of technology based firms in terms of employment growth and comparing that to the equivalent top 10 percent of other firms in the economy, technology-based firms have higher employment growth rates (approximately 10 percentage points higher). This trend remains consistent across the rest of the employment growth range, with the slowest-growing 10 percent of technology-based firms growing employment 7 percentage points higher than the slowest growing 10 percent of all other firms. An analysis of Spanish firms that invested in R&D between 2004 to 2010 returned similar findings: R&D intensity has an effect on employment growth, but only for high-growth and start-up firms.  On average, technology-based start-ups increase their employment much faster than do start-ups generally. Examining technology-based firms aged from six to ten, this magnitude increased to a factor of three, in part because so many start-ups in non-technology-based sectors don’t survive to year ten. Strong job creation by technology-based start-ups is likely to continue due to the fact that technology-based industries have increased their share of the economy’s output year-after-year.

Technology-based start-ups’ greater-than-average employment growth is not just a U.S. phenomenon. An analysis of firms in Portugal from 1983 to 2000 finds that technology based start-ups created more employment in the long run than typical new businesses. In a more recent study, economists Dirk Czarnitzki and Julie Delanote analyze the performance of 3,500 Belgian firms from 2001 to 2008. They find that technology-based start-ups increase their employment faster than other new businesses by 5 percentage points.

High-Growth Technology-Based Start-Ups Pay Higher Wages While the number of jobs that businesses create matter, the number of “good” jobs (jobs that pay higher-than-average wages) matters even more. An independent personal or business-services company may employ a few workers at relatively low wages, but firms in technology-based industries on average pay much higher wages. Although not sub-analyzing technology-based start-ups, economists Diane Burton, Michael Dahl, and Olav Sorenson in analyzing Danish firm data from 1991 to 2006 found that as start-ups grew rapidly, they passed that success on as higher wages for their workers. They estimate that one-quarter of these high-growth start-ups pay a wage premium over older firms. And, as we find in our analysis, technology-based start-ups do pay a higher wage than other start-ups and the economy average.

Technology-Based Start-Ups Create Jobs in Other Economic Sectors Alongside outsized contributions to direct employment growth, firms, including start-ups, in technology-based industries enable high levels of indirect job creation. These are jobs created in other firms that technology-based firms conduct business with—for example, manufacturing jobs in production supply chains, laboratory technicians in third-party laboratories, hospital workers where biotech firms conduct trails, and lawyers and accountants that help firms. They are also responsible for induced job creation—the jobs created by the spending of their employees on everything from groceries and financial services to entertainment.

Technology-Based Start-Ups Invest in R&D  Technology-based start-ups invest in R&D to create new products and implement better production processes.26 In contrast, fewer than 5 percent of U.S. businesses invest in R&D, with this figure differing by less than half a percentage point when looking only at businesses under two years of age. Jorge Guzman and Scott Stern find a similar figure: from 1988 to 2014 just 5 percent of U.S. start-ups were technology-based and had high growth potential. Other advanced economies are similar. Erik Stam and Karl Wennberg studied 12,000 Dutch start-ups from 1994 to 2000. They found that only 9 percent of these start-ups engaged in R&D activities. Furthermore, start-ups in technology-based sectors tend to be more R&D-intensive (R&D spending as a share of sales) than older firms in their industries. For example, in the biotech industry, the average R&D intensity is around 20 percent, but a survey of bio-tech start-ups found that the average R&D intensity was 62 percent, while over one-third of surveyed start-ups had R&D intensities higher than 75 percent. In part, this is because at this stage in their life cycle they are investing to create and perfect products and have fewer sales than more mature firms. Nonetheless, not investing heavily enough into R&D is likely a liability for start-ups in technology-based sectors. David Deeds, in an analysis of technology-based start-ups, concludes, “Our findings are that R&D intensity restricts the growth of technology-based SMEs at lower levels of R&D intensity and stimulates their growth at higher levels. “But investing heavily into R&D in itself isn’t a guarantee of success; too often start-ups that invest in R&D fail. Because innovation is inherently risky, not all R&D investments result in either technical innovations or market success, and thus there is a huge dispersion in the economic outcomes for the same level of R&D intensity.33 Dirk Czarnitzki and Julie Delanote analyze the performance of 3,500 Belgium firms from 2001 to 2008. They find that after controlling for R&D intensity, the fastest growing 10 percent of technology based start-ups grew their revenues 30 percent more than the fastest growing 10 percent of all other firms in the economy; the slowest growing 10 percent of technology-based startups grew their revenues 10 percent less than the slowest growing 10 percent of all other firms in the economy. But, on average, they find that technology-based start-ups increase their revenues 10 percentage points greater than all other firms in the economy.

 

TECHNOLOGY-BASED START-UPS SUPPORT COMPETITIVENESS

A strong African competitive position internationally will depend in large part on African firms introducing and exporting a steady stream of high-value-added technological innovations. Technology-based start-ups do just that, investing in R&D to develop technologically advanced goods and services, usually for global markets.  Indeed, a study reviewing 38 economic analyses of international-orientated start-ups found that investment in R&D is a key determinant of success in international markets. Firms that compete in international markets invest more in R&D than firms with only domestic ambitions. Investment in R&D is a strong indicator that a start-up will compete in international markets. A study of Danish firms, “Do R&D Investments Affect Export Performance,” finds that as start-ups that invest in R&D grow, they are likely to export more. The authors conclude that “the answer to the question asked in the title of the paper is yes. Export is affected positively if the firm has decided to engage in R&D activities.”38 Similarly, in a survey of 75 Canadian technology-based start-ups, the larger they grew, the greater their export intensity and export diversity. This means that as these firms grew, exports became a larger share of their sales revenue and the number of countries they exported to increased. In a British economic analysis that merged 2004 trade data with an innovation survey, the authors found that technology-based start-ups were up to 40 percent more likely to be an exporter than start-ups not engaged in innovation.40 One reason technology-based firms in general and technology-based start-ups in particular export more is because of the unique economics they confront, namely the high up-front fixed costs associated with developing innovative products and services followed by marginal incremental production costs. For instance, there is high fixed cost associated with developing a new software program, but once developed, creating an additional copy of that software costs virtually zero dollars. Similarly, developing the first new biologic or pharmaceutical drug can cost billions in upfront research, development, and clinical trials, but incremental copies can be produced at the marginal production cost. This means that the larger markets that international trade affords become critical for the success of technology-driven firms since they enable those high fixed costs to be recouped over many more sales in the global marketplace.

 

THE STATE OF TECHNOLOGY-BASED START-UPS IN AFRICA

A critical question for the future of the African economy is the current state of technology based start-ups.

It’s increasingly difficult to think of a position or career that is untouched by technology. Today, nearly half of jobs require some technology skills. In a decade, that percentage will rise even more.

In fact, labor economists predict that in less than 10 years, 77% of jobs will require deep and specific technical skills. And a staggering 65% of today’s primary school students will perform jobs that haven’t been invented yet.

Preparing students for future success isn’t simply about developing particular skill sets, or understanding specific technology.

The goal is to spark early learning and inspire students with technology, while establishing the key non-technical skills that employers seek Creativity, Critical Thinking, Computational Thinking, Communication and Collaboration Often referred to as the 5Cs, these represent key non-technical skills students must develop in order to achieve 3Es Employability, Entrepreneurship and Economic development.

In addition to developing the non-technical skills required in the workforce today, the aim would be to prepare students for the technological demands of tomorrow.

 

Article by Derek kweku Degbedzui

Cofounder, Plug-x

 

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