Does cultural diversity boost entrepreneurship?

Immigration is making regions noticeably more diverse and has become one of the major policy issues of the 21st century. In the UK alone, the foreign-born population has expanded by more than four million in the last two decades (making up more than 15% of the working-age population). What’s more, immigration is more diverse than ever. No longer strictly about Mexicans in Los Angeles, Turks in Berlin, or Romanians in Milan, immigration debates in cities and regions now concern more people from more places than ever before.

Naturally these changes have led to a surge in interest and concern. Most of the social and political unease relates to the increasing presence of minorities in regions, particularly when predominantly low skilled. Immigration is also beginning to invigorate interest into the economic impacts of diversity. Our working paper focuses on entrepreneurship, which taps into the Europe-wide government interest in new start-ups to drive post-recession growth and close the entrepreneurial performance gap with front-runners like the US (Rodríguez-Pose and Hardy 2014).

A cultural ‘diversity dividend’

A number of recent studies have built a strong case linking cultural diversity with a range of economic outcomes. Whether talking about creativity, innovation, or productivity, research in Western Europe and the US regularly finds support for a ‘diversity dividend’ (Anderson et al 2005, Niebuhr 2010, Ottaviano and Peri 2006). A number of factors are said to be driving this relationship.

Above all, diversity shapes the knowledge economy. It does so by expanding the knowledge base and enhancing a region’s ability to recognise, assimilate, and exploit this new knowledge. New immigrants are likely to be especially important to this picture as they bring new ideas and perspectives to stoke the fires of innovation – all the more so when they are highly skilled. Additional factors such as international networks generated through migrant mobility (which forge knowledge pipelines), skill complementarities between native and migrant workers, and a higher propensity for risky action among migrants (like start-up creation), reinforces the economic potential of diverse areas.

Of course, diversity does not come without potential downsides. All of the noted benefits rely to some degree on cohesion and interaction between the constituent communities. Without a culture of inclusiveness and tolerance, communication between diverse communities can become complex and costly. Left unfettered, cultural differences can give rise to limited interaction across groups, misunderstandings, lower social trust, and in the worst case, racial exclusion, crime, and social conflict (Easterly and Levine 1997).

Entrepreneurship and diversity in England and Wales

Entrepreneurship and cultural diversity are both highly variable across the regions of the UK.

The analysis is conducted using functional territorial units based on travel to work areas (TTWAs), meaning the results can be interpreted in terms of local economies.

We measure cultural diversity using two different categories: one based on ethnicity and another based on birthplace. Although linked through migration, the two measures are both statistically and conceptually different.

Figures 1a and 1b. Diversity indices based on ethnicity and birthplace, 2001

Source: Own elaboration using 2001 UK census data

As can be seen in Figures 1a and 1b, both measures reflect the concentration of diversity in major cities. However, it is clear that birthplace-diverse cities are more predominant in the south, reflecting the role of gateway cities such as London, Reading, and the surrounding cities as key destinations for new migrants.

Conceptually, the notion that people of diverse backgrounds can be complementary due to distinctive sets of skills, problem solving procedures, and strong, exploitable linkages to external markets would seem more relevant for people who grew up in different countries and were educated in different school systems than for people who – despite having a different ethnic origin – were raised and educated in the same areas and schools.

We are also able to break apart ethnic diversity into levels of skills associated with employment and education. Similar data by birthplace is not available for the 2001 census. We exploit this data to assess the extent to which diversity matters as a whole, or if it is diversity within a particular group (the highly skilled) that drives entrepreneurship.

Figures 2a and 2b. Start-up rates per 1,000 population, average for 2001-2007

Source: Own elaboration using 2001-2007 business registration data

Like diversity, entrepreneurship intensities across England and Wales vary considerably. Using business registration records we create measures of start-up intensity for all new VAT registered businesses1 as well as a sector-specific measure to represent knowledge-intensive services firms2 (see Figures 2a and 2b).

A visual comparison of the diversity and entrepreneurship maps reveals a number of similarities, particularly for the knowledge-intensive services firms.

In terms of statistical correlations, birthplace diversity (0.35) is much more highly correlated with general start-ups than ethnic diversity (0.06). The pattern remains the same for knowledge-intensive services start-ups, although the relationship is strengthened considerably (birthplace 0.68, ethnic 0.37).

Recent immigrants and skills matter

Using spatial regression techniques – to account for the possibility of inter-regional spillovers – and a large set of alternative explanatory variables3, we find support for the contention that cultural diversity matters for entrepreneurship.

Of the control variables we can highlight the role of human capital, in the form of the proportion of graduates in the region, low rates of unemployment, and a diversified industrial structure, as factors closely associated with entrepreneurship.

Our principal finding, however, is twofold:

First, birthplace diversity is more strongly associated with start-ups, particularly when knowledge-intensive in nature. This supports the idea that it is new migrants, with skills and perspectives that complement the local labour force, who are the real enhancers of the environment for entrepreneurship.

Secondly, it is diversity within the ranks of the highly skilled that matters most, again especially for knowledge-intensive start-ups. This finding is consistent with the idea that more skilled minorities and migrants are better able to integrate and share their knowledge, perspectives, and complementary skills to unlock the benefits of diversity. For the unskilled, not only are complementarities less significant in magnitude, but the ability to share is hindered by barriers to integration.

However, the question of what causes what is an important matter for analysis of this type to be valid. Do regions become entrepreneurially successful because they are diverse, or does entrepreneurial success attract migrants and generate diversity?

Although both channels are likely at play, we employ an instrumental variables specification to check the robustness of our findings to causality issues. The instrument employed is a Card (2001) inspired shift share instrument, as typical in the literature.

Using this strategy we find substantial evidence of causality going from diversity to the entrepreneurial performance of each region.

The bottom line for policy

Our findings raise a number of important policy concerns.

Recent migrants from different origins, rather than the descendants of past migrants, create the conditions for a more dynamic entrepreneurial environment. This effect is most clearly substantiated in terms of knowledge-intensive start-ups. In this respect, recent legislation by the UK Home Office to restrict migration is likely to lead to a serious dent in entrepreneurship, affecting in turn the potential for employment generation and economic growth.

Second, our results underline that, at least in the short-term, any restrictions associated with the entry of highly skilled migrants will potentially have negative economic consequences in terms of entrepreneurship. If Britain is to enhance its status as a country open for business, the attraction of highly skilled migrants from around the world is the best bet to turn this from a mere slogan into reality.

References

Anderson, R, J M Quigley, and M Wilhelmsson (2005), “Agglomeration and the spatial distribution of creativity”, Papers in Regional Science, 83(3): 445-464.

Card, D (2001), “Immigrant inflows, native outflows, and the local labour market impacts of higher immigration”, Journal of Labour Economics, 19(1): 245-257.

Easterly, W and R Levine (1997), “Africa’s growth tragedy: policies and ethnic divisions”, Quarterly Journal of Economics, 112: 1203-1250.

Niebuhr, A (2010), “Migration and innovation: Does cultural diversity matter for regional R&D activity?”, Papers in Regional Science, 89(3): 563-585.

Ottaviano, G and G Peri (2006), “The economic value of cultural diversity: evidence from US cities”,Journal of Economic Geography, 6(1): 9-44.

Rodríguez-Pose, A and D Hardy (2014), “Cultural diversity and entrepreneurship in England and Wales”, CEPR Discussion Paper No. DP10241.

Footnotes

[1] VAT (or value added tax) is required for all UK businesses with a turnover exceeding a set threshold (£52,000/yr in 2001).

[2] Financial intermediation and real estate, renting and business activities (2003 Standard industrial classifications [SIC 2003] J and K).

[3] We control for levels of human capital, the unemployment rate, income levels, industrial diversity, population density, population growth, age structure, and levels of homeownership within each region, as well as spatial spillovers.

Published in collaboration with VoxEU

Authors: Daniel Hardy is an Advisor at the International Monetary Fund.

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