This paper considers the impact of institutions on new firm entry in emerging markets. In particular, it surveys the findings of a 2-year research project on the sources of success in terms of entry rates and conditions (including gross entry rates, exit rates and therefore net entry rates) across the BRIC countries (Brazil, Russia, India, China). These emerging market economies display widely varying entry and exit rates and a framework is developed to capture the interaction between key aspects of formal institutions, how those institutions play out in practice, and their impact on entry and exit rates. The country case studies reveal that, whilst different contingencies affect the relationships between institutions and entry in each country, there are some empirical regularities in the determinants of successful entry and conversely in its constraints. One such regularity is the critical interaction between formal rules and informal mechanisms. There is also variation in whether these works so as to compensate for deficiencies in formal institutions, as in China and India, or whether deficiencies in formal mechanisms are compounded by poor informal mechanisms, as is sometimes true in Brazil. Indeed, relatively good formal rules and structures can be undermined by informal mechanisms deterring or blocking entry, as is largely the case in Russia.
Entrepreneurship and the process of new firm entry is recognized as an important element in economic development (Baumol, 1990 and Wennekers and Turik, 1999). Mechanisms whereby the entry of new firms might contribute to economic growth and development include the generation, dissemination and application of innovative ideas enhancing efficiency and productivity (Nickell, 1996), increasing competition and providing diversity among firms (Cohen and Klepper, 1992). However, as Baumol (1990) shows, the various rules of the game through the system of respective rewards may divert entrepreneurial effort either to productive uses or to unproductive uses, which may even be destructive. De Soto (1990) has also highlighted the critical role of institutions – both formal and informal in the sense of North (1990) – in the process of entry in developing economies. In this paper, we survey the literature about the relevance of institutions for the entry of new firms in emerging markets. We draw in particular on the findings from a cross-country study in four major emerging markets – Brazil, Russia, India and China, the so-called BRIC economies.
The entry of new firms is an important aspect of the development process, influencing both the pace and character of economic growth. The literature has recognized that in emerging markets, institutions and regulations are a particularly significant factor determining both the entry rate and the prospects of new firm survival and growth. This has motivated important new work seeking to quantify the quality of institutions and their impact on entry. However, this method of necessity loses some fineness of classification and interpretation to gain cross-country comparability. In this paper, we have sought to supplement the approach by using a comparative case study method. Our findings considerably enrich the literature on the impact of institutions on entry. We confirm the importance of institutions for entry, but in contrast to the view that different aspects of institutional quality tend to be highly correlated (see Aidis et al., 2008, for a survey), we find different institutions to have significant impacts in different contexts. Moreover, we identify that informal institutions can work either to undermine or substitute formal ones. Thus, in China and India, we observe a significant degree of substitution, while in Russia, and to a lesser extent Brazil, informal processes lead to outcomes that conflict with the objectives of the formal arrangements. This suggests that researchers should be cautious in the interpretation of studies that rely only on formal measures.
Our work also casts some light on the interpretation of corrupt practices and informal sector development in emerging markets. It is too simplistic to argue that either are inherently damaging to new firms’ entry; the impact depends on the nature of the interaction between formal and informal institutions, notably with respect to property rights, regulation and finance. In China, high levels of corruption act to some extent as a counter to inefficiencies in formal structures, while in Russia, corruption acts instead to debilitate those structures. In the former case, policies to eradicate corruption could in fact be damaging; instead, the institutional weaknesses underlying the corruption should be eradicated. In Russia, however, the effectiveness of the formal structures has to be strengthened at the expense of informal ones. Similarly, one suspects that part of the informal sector in Brazil might shrink on its own as formal institutional arrangements improve. In Russia, however, the large size of the informal sector is related to failures to enforce the existing regulations as intended, and it is necessary to bring informal structures in line with the formal ones.
