Tackling risk aversion to encourage new businesses 1

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1 Tackling risk aversion to encourage new businesses 1 Valerie Habbel, Adnan Abdulaziz & Alfred Gjeloshi The percentage of adults founding new businesses in the European Union (EU) is one of the lowest in the world at 8.1% i, threatening future productivity and innovation. A major factor that discourages people from starting a business is risk aversion ii. Some of the factors that influence risk aversion are gender, family structure, perceived and actual level of skills and knowledge, and the desire to minimise losses. Reversing the low and falling rate of entrepreneurship requires training programmes that draw on evidence on risk aversion, promotional programmes that emphasise the opportunities for low-risk start ups and targeted research that looks at ways of tackling risk aversion to encourage the individuals decision to become an entrepreneur. What is the issue? The EU is currently experiencing an economic upswing after a long recession, having grown by 2.4% in 2017 and boasting the lowest unemployment rate since iii A by-product of the fallen, though still comparatively high unemployment rate is that people now have a broader range of attractive employment options to choose from. Faced with the choice between starting a business, financial risks included, and a socially secured traditional job, more individuals are choosing the latter. In 23 out of 27 EU Member States, the share of people preferring self-employment to being an employee has dropped since iv One indicator to measure actual entrepreneurial activity is the total early-stage entrepreneurial activity (TEA) rate, or the percentage of adults who are either about to start an entrepreneurial activity, have just started one or have been running a business for up to 3.5 years. Europe is the region with the lowest TEA in the world at 8.1%, half of the TEA rate in North America (16.2%). i Within Europe, Estonia is an outlier with 19.4%, while France (3.9%), Germany (5.3%) and Greece (4.8%) have some of the lowest rates worldwide. The level of TEA in several EU Member States, the USA and Japan over the last five years is depicted in Graph 1. 1 This policy brief is part of the project The Future of Work and Opportunities Arising from Non-traditional Working Arrangements. For more information, please read page 5. 1

2 Graph 1. Total early-stage entrepreneurial activity (TEA) indicator Source: own elaboration based on Global Entrepreneurship Monitor (2017) i One demographic group with a large potential for increasing entrepreneurship are females, who currently constitute only 14.8% of European founders. v Greece has one of the highest percentages of female founders with 28.4%, while Germany lags behind with 13.9%. One factor that might explain the demographic make-up of entrepreneurs and how to encourage the groups that are underrepresented is risk aversion, or the preference for a sure outcome over a gamble with higher or equal expected value. vi Empirical evidence has revealed several factors that have an impact on risk aversion: Demographics. Risk aversion is lower among entrepreneurs than non-entrepreneurs vii and among males compared to females. viii On the other hand, being married or having children increases the level of risk aversion. ix Actual and perceived self-efficacy. A higher level of skills and expertise in a particular field generally increases risk taking behaviour for relevant choices, x as does leading subjects to believe that they are very competent at decision-making. xi Loss aversion. Loss aversion is the tendency to prefer avoiding losses to acquiring equivalent gains. Some studies have suggested that losses are twice as powerful, psychologically, as gains. xii Making choices involving gains and losses also depends on the way the choice is presented. People have been found to be risk-taking if problems are presented as potential losses and risk-averse if problems are presented as potential gains. xiii While the available psychological evidence offers an understanding of the influences on risk aversion, most of the research analyses preferences in the laboratory using hypothetical choices and include mainly university students as participants. xiv To better understand the factors that affect actual risk behaviour, such as founding a business, more research involving real gains and losses as well as a wider demographic variety in participants are needed. 2

3 Why is this important? Diversity and competitiveness: There is a large body of evidence confirming that entrepreneurship is a major source of long-run growth in high-income countries. xv New businesses are not only key to sustaining innovation and productivity, thereby contributing to the diversity and competitiveness of EU businesses, but also create a significant share of new jobs. xvi This applies not only at country-level, but also at the regional level. xvii Impact on worker satisfaction: In addition to the economic benefits for the society at large, the individual stands to benefit from starting a business; most studies find that self-employed workers enjoy higher job satisfaction than employed workers. xviii They also rate many factors such as autonomy, level of empowerment, creativity and flexibility higher than traditional employees. xix However, this might depend on whether self-employment is one s most favoured work status. Self-employed people who are self-employed out of necessity (e.g. because they could not find a traditional job) report lower job satisfaction in many aspects than those who chose this type of work. What should policymakers do? 1. The EU should encourage Member States to introduce and expand training schemes in schools and universities that draw on psychological evidence on risk aversion. 2. The EU should start promotional campaigns specifically aimed at risk averse people, highlighting that businesses can be founded without assuming large risks. 3. The EU should target some of their funding to research that looks at the interaction between risk aversion and the decision to start a business. How should they do it? 1. The training schemes should aim not only at improving the skills, knowledge and expertise that future entrepreneurs need, but also at increasing their level of confidence to improve their perceived and actual selfefficacy. Training schemes should focus on conveying a positive image of entrepreneurship by emphasising potential gains, both personal, social and financial gains, rather than losses. In addition, more effort should be put into monitoring and evaluating the effectiveness of these programmes to see what works and what does not. To aid the latter, the EU should incorporate the evidence on risk aversion in existing guidance frameworks that can be used by universities and schools throughout the EU. 2. The promotional campaign should highlight the various programmes that already exist to minimise potential losses and reduce risks for nascent entrepreneurs. For example, in Germany the loss in salary to be expected for entrepreneurs in the beginning of their career can be offset by a grant that pays a salary for the first six months of the business. xx The promotional campaign could include a website, social media, advertising and press events, and they should feature well-known entrepreneurs as role models who come from underrepresented demographic groups, including those who have children. 3

4 3. Targeted research funding would make it possible to conduct socio-economic analyses of the determinants of early-stage entrepreneurial activities in EU Member States. This would increase the awareness of underlying problems, thereby advancing the understanding of how risk aversion for decisions in real life rather than the laboratory can be tackled. These studies should include Member States tax systems, labour market regulations and the role of existing public-sector institutions and businesses in their effects on individuals decision to become an entrepreneur. 4

5 Information about the project Project Supervisor Institutions Focus This policy brief is part of the project The Future of Work and Opportunities Arising from Nontraditional Working Arrangements. Dr. Edgar Aragón The project is carried on by students of the, in partnership with the European Centre for International Political Economy (ECIPE). The project is focused on the European Union (with emphasis on the specific situation of Germany, France, Greece, Poland and Sweden), the United States and Japan. Date The project was executed between October 2017 and February To contact the authors of this brief, use the following address: The views expressed in this paper are those of the authors and do not necessarily represent the views of the Willy Brandt School of Public Policy or ECIPE. i Global Entrepreneurship Research Association. (2018). GEM 2017/2018 global report. London ii Wagner, J., & Sternberg, R. (2004). Start-up activities, individual characteristics, and the regional milieu: Lessons for entrepreneurship support policies from German micro data. The annals of regional science, 38(2), iii Kottasová, I. (2018, Jan 9). Europe's economy is firing on all cylinders. CNN Money. Retrieved from iv v Kollmann, T., Stöckmann, C., Hensellek, S., & Kensbock, J. (2016). European startup monitor Universität Duisburg-Essen Lehrstuhl für E-Business. vi Kahneman, D., & Tversky, A. (1984). Choices, values, and frames. American Psychologist, 39(4), vii Wagner, J., & Sternberg, R. (2004). Start-up activities, individual characteristics, and the regional milieu: Lessons for entrepreneurship support policies from German micro data. The annals of regional science, 38(2), viii Eckel, C. C., & Grossman, P. J. (2008). Men, women and risk aversion: Experimental evidence. Handbook of experimental economics results, 1, ix Chaulk, B., Johnson, P. J., & Bulcroft, R. (2003). Effects of marriage and children on financial risk tolerance: A synthesis of family development and prospect theory. Journal of Family and Economic Issues, 24(3), x Montford, W., & Goldsmith, R. E. (2016). How gender and financial self efficacy influence investment risk taking. International journal of consumer studies, 40(1), xi Krueger, N., & Dickson, P. R. (1994). How believing in ourselves increases risk taking: Perceived self efficacy and opportunity recognition. Decision Sciences, 25(3), xii Tversky, A., & Kahneman, D. (1992). Advances in prospect theory: Cumulative representation of uncertainty. Journal of Risk and uncertainty, 5(4), xiii Carree, M. A., & Thurik, A. R. (2010). The impact of entrepreneurship on economic growth. In Handbook of entrepreneurship research (pp ). Springer New York. xiv Druckman, J. N., & Kam, C. D. (2011). Students as experimental participants. Cambridge handbook of experimental political science, 1, xv Carree, M. A., & Thurik, A. R. (2010). The impact of entrepreneurship on economic growth. In Handbook of entrepreneurship research (pp ). Springer New York. xvi Acs, Z. J Small business economics; a global perspective. Challenge, 35, November/December: 38 4 xvii Robbins, D. K., Pantuosco, L. J., Parker, D. F., & Fuller, B. K. (2000). An empirical assessment of the contribution of small business employment to U.S. state economic performance. Small Business Economics, 15: xviii Benz, M., & Frey, B. S. (2003). The value of autonomy: Evidence from the self-employed in 23 countries xix Manyika, J., Lund, S., Bughin, J., Robinson, K., Mischke, J., & Mahajan, D. (2016). Independent work: Choice, necessity, and the gig economy. McKinsey Global Institute. xx Existensgründungsportal des BMWI. Gründungszuschuss. Retrieved from Startposition/Gruendung-aus-Arbeitslosigkeit/Gruendungszuschuss/inhalt.html 5