The relationship between innovation and informal entrepreneurship: evidence from a developing country

Abstract

PurposeThis paper aims to evaluate whether entrepreneurs with an innovative product/service are more likely to formally register their businesses. Understanding the decision of business registration as a rational choice of the entrepreneurs, where she weighs the costs versus the benefits of such formalization, the study expands the literature on informal entrepreneurship by looking at the benefit-side rather than the typically evaluated cost-side of an individual cost-benefit evaluation.Design/methodology/approachThe authors relied on the Global Entrepreneurship Monitor (GEM) adult population survey to evaluate the hypothesis. Specifically, the authors used the GEM data of 2016 for Colombia, covering 2,069 observations (a representative sample at the country level), evaluating the relationship between innovativeness and business registration for the early stage of the entrepreneurial process. Given the nature of our dependent variable, the authors estimated a logistic regression model.FindingsDifferent from what the authors hypothesized, they did not find empirical evidence for a positive correlation between an innovative product or service and business registration. Instead, businesses that compete with many others offering the same product/service have a higher tendency to register at the Chamber of Commerce. Contrarily of what might be suspected, opportunity-based entrepreneurship – as opposed to necessity-based – is not a relevant variable when formalizing a business, providing evidence for our hypothesis that necessity-based entrepreneurship cannot be equalized with informal entrepreneurship. Additionally, the authors show that an entrepreneur with higher socioeconomic status is more likely to register his company.Research limitations/implicationsThe results provide first exploratory evidence that the benefit evaluation may play a role in formalizing a start-up, thus calling for future research that not only tackles the influence of registration costs and administrative burden but rather looks at the outcome of a cost-benefit analysis. The data imply several limitations which future research should address: variables measuring the innovativeness of the product/service are rather coarse measures and need to be expanded and detailed in future research. Additionally, the authors acknowledge that a relatively high number of missing values may generate a selection bias in our population sample. Finally, because of situating the research in a developing country, the research results may lack generalizability. Therefore, researchers are encouraged to test the proposed propositions further.Practical implicationsIn a country like Colombia with very high levels of informality, it is necessary that the government fully understands the role of innovation in the formalization process of start-ups. The results indicate that a differentiation of support mechanisms to increase the formalization of businesses according to the different stages of their development may be necessary and that aside from costs, benefits of formalization play a role. A higher level of formality is not only related to economic growth but also much better protection of workers, therefore going beyond the reduction of registration costs and the implied administrative burden should be an additional public policy target for decreasing informality. Finally, the correlation of socioeconomic stratum with the decision to register hints at a varying evaluation of formalization, a point that merits attention by government and academia.Originality/valueThe study shifts the focus from the evaluation of solely costs for business registering as a barrier to start-up formalization to the cost-benefit analysis. The authors propose – and show – that such an evaluation is not generalizable for all kinds of business. Specifically, the authors show that a start-up is more likely to register when it competes with a large number of competitors than when it competes with a smaller number of others offering the same. At the same time, the authors also show that the stage at which the start-up company is at influences the decision to formalize.