Entrepreneurship and economic freedom: cross-country evidence from formal and informal sectors

Abstract

The paper empirically examines the effect of economic freedom on the average prevalence of formal and informal entrepreneurship. Whereas the formal entrepreneurship and economic freedom nexus has been studied, the influence of economic freedom on informal entrepreneurship is less forthcoming. The results, based on cross-country data and after accounting for possible reverse causality, show that economic freedom promotes formal entrepreneurship and inhibits informal entrepreneurship. Furthermore, the return from economic freedom is greatest in countries with a relatively higher prevalence of formal and informal entrepreneurship.

Keywords:

• Economic freedom
• entrepreneurship
• informal entrepreneurs
• formal entrepreneurs

Notes

1. For an excellent review of the consequences of the shadow economy consult Schneider and Enste (2000).

2. See Williams and Nadin (2011) for competing theories.

3. In fact, Buehn and Schneider (2012) find a complementary (positive) relationship between the size of the shadow economy and corruption.

4. It would be ideal to differentiate between individuals that are only partially underground and those that conduct all their work underground, but unfortunately, the data do not allow for this (see Williams (2008) and Williams, Shahid, and Martínez (2016)).

5. We chose real GDP over other common macroeconomic measures in order to circumvent problems with multicollinearity. For example, real GDP per capita, a common measure used, is highly correlated with economics freedom (correlation coefficient of 0.70).

6. Although primary and secondary education might also be important factors, we prefer tertiary education because it is more relevant for the development of technical and leadership skills necessary to start business ventures (see, e.g. Jiménez et al. (2015) and Levie and Autio (2008)).

7. Neighboring countries are defined using geographic distance such that countries that are closer in proximity receive a higher weight.

8. The 2SLS results are consistent with the OLS results, which are available upon request.

9. The curious reader might be interested in which of the sub-components of overall economic freedom have a statistically significant effect. Therefore, we replaced economic freedom with each of its sub-components in Model 3.2 with formal entrepreneurship as the dependent variable and estimated the model using OLS. The following subcomponents were positive and statistically significant: business freedom, freedom from corruption, investment freedom and property rights. Similarly, for Model 3.4 with informal entrepreneurship as the dependent variable the following sub-components were negative and statistically significant: monetary freedom, business, freedom, investment freedom, freedom from corruption, property rights. Curiously, fiscal freedom and government spending had a positive and statistically significant effect on informal entrepreneurship. The results for this analysis are not reported, but are available upon request.

10. We thank an anonymous referee for pointing this out.

11. We thank anonymous referees for these suggestions.

12. Our results are also not sensitive to alternate measures of the macro economy. In particular, unemployment and economic growth have been shown to influence entrepreneurship (see, Plehn-Dujowich 2012), therefore, we re-estimated Models 3.2 and 3.4 with, alternately, unemployment rates and real GDP per capita growth in place of Ln(GPD). The baseline results were robust to these changes, except that the coefficient on GDP growth was marginally insignificant (p-value = 0.11) when informal entrepreneurship was the dependent variable. These results are available upon request.