Fostering Economic Growth: Important Factors in a Legal Regime Encouraging Entrepreneurship

Fostering Economic Growth: Important Factors in a Legal Regime Encouraging Entrepreneurship

Kevin Kitchen, MJIL Staff Member

Hovering just above a 20% unemployment rate, Spain has yet to recover from the Great Recession in 2008, nor from its decline since the late 1600s.[1] An important factor in economic growth rests on the country’s ability to foster development through small business. However, most of the discussion on entrepreneurial growth focuses on technology, business models, or infrastructure. One of the baseline components to an entrepreneurial-friendly environment comes from the legal establishment that can foster the growth. This articles sets out to show the important factors in a legal regime that foster entrepreneurial growth. It then compares those factors with Spain as an example showing areas of opportunity to restructure its existing system to help vitalize its economy.

Factors Helping Foster New Business Development

Overall, “[w]hat is good for the economy in general is good for entrepreneurs.”[2] The most important aspects of a legal system for increasing entrepreneurial development are:

  • Leveling the playing field
  • Protecting property and intellectual property rights
  • Enforcement of rights
  • Lowering of risk for entrepreneurs.

The first important factor as Viktor describes, is how the law works as a leveler. The liberalization of the market allows for competitors to enter as well as entrepreneurs to break up the existing monopolies and oligopolies. This level effect occurs when regulations impose a fair fight between both entrepreneurs and large oligopolies. The government need not simply throw out regulations, because in some industries that solidifies monopolies. Instead, “markets often require not a legal void to be successfully ‘liberalized,’ but rather a skillfully crafted and carefully implemented legal framework that offers newcomers a chance to enter and stay competitive.”[3] One of the most important factors of giving entrepreneurs a fighting chance against the established businesses is lowering barriers to entry.[4] Forming a business should be easy and inexpensive.[5]

The law must also work to protect entrepreneurs’ intellectual property. Copyright and patent rights allow entrepreneurs to capitalize on the application of new science in a business context.[6] The policy behind intellectual property law is well recognized that a guarantee of regaining costs expended on new development encourages new research and innovation. Entrepreneurs need something that will protect their advantage when bringing it to the market.

Next, the law must act as an enforcer, or have an established rule of law. The possibility of legal action allows people to enter into business relationships without first establishing a personal relationship of trust. The parties rely on a “trust substitute” or a legal system that will enforce the contract.[7] A strong rule of law reduces idiosyncratic risk.[8] And as described next, lowering risk encourages entrepreneurship.

Finally, the legislature should structure regulations to lower the risk for the entrepreneur. An example of lowering the risk is enacting flexible labor laws. This allows the entrepreneur to easily hire and fire employees as the demand for labor changes in development. Another risk-lowering regulation is lowering the cost and difficulty for applying for patents. Or, structure the corporate tax regime to make it easy to attract outside funding.[9] Governments can reduce the uncertainty for investors by making clear policies and regulations.[10] This initiative includes everything from simplifying tax laws to making trial outcomes more certain.

These four factors are actions governments can take to shift the market focus to entrepreneurship. Laying a foundation of ease of startup, protection while operating, and reduced risk encourages innovation.

Current Spanish System and Areas for Improvement

An efficient way to lift Spain out of its slump would be to encourage small business growth. However, the World Bank ranks Spain as 33rd on its rankings of ease of doing business index.[11] The World Bank Group also ranks Spain as 82nd in the ease of starting a business.[12] It is twice as hard to start a business in Spain compared to other OECD countries.[13]

In terms of acting as a leveler, the regulations impose difficulties for Spanish entrepreneurs who are faced with a system that does not care whether the business is a large corporation or a small start-up. New companies are forced to pay massive amounts of taxes for the Social Security system.[14] These companies must pay Social Security and VAT taxes regardless of whether they make a profit. The corporate tax rate in Spain is 25 %.[15] The government provides a reduced rate of 15% for companies during their first years in which they operate at profit.[16] Otherwise, small businesses will be charged at the normal corporate rate. High taxes makes it extremely difficult for a company to start up and has the effect of reinforcing big business’s dominant positions.

Furthermore, the structure of employment laws hinders the ability for companies to grow efficiently. A Spanish worker can either work full-time or as a freelance, but not both. If someone wants to do some business after her day job, then she must either conduct it under the table or get creative with the system of invoicing.[17] One example of circumscribing the system is workers who “work” eleven months and then on the twelfth month they go on “vacation,” but in reality switch to a freelance for that month and bill all of the work they did for the previous eleven months. This obviously creates issues for cash flows making it harder for the company to develop.

Another regulatory problem is the amount of bureaucracy that stands in the way.[18] It takes around one thousand euros in paperwork and a month-long process to start a business.[19] This bureaucratic nature is enforced by the Spanish skepticism towards its corrupt government. Many distrust the government after its political parties and leaders have been accused of not paying taxes or embezzling funds.[20] The difficulty in starting a business adds to the obstacles a new venture must try to overcome while it is also focusing on developing its business.

In order for Spain to begin to foster entrepreneurial development, it needs to shift its focus to creating an environment that provides incentives to starting new businesses. Lowering the regulations and barriers to entry will increase the number of entrepreneurs as well as lower the amount of risk they face.

[1] Spain Unemployment Rate, Trading Econ., (last visited Feb. 28, 2016).

[2] Amir N. Licht, The Entrepreneurial Spirit and What the Law Can do About It, 28 Comp. Lab. L. & Pol’y 817, 852 (2007).

[3] Viktor Mayer-Schönberger, The Law as Stimulus: The Role of Law in Fostering Innovative Entrepreneurship, 6 I/S: J.L. & Pol’y for Info. Soc’y 153, 161–62 (2010).

[4] See Zoltan J. Acs & Laszlo Szerb, Entrepreneurship, Economic Growth and Public Policy, 28 Small Bus. Econ. 109, 115 (2007).

[5] Id. at 116.

[6] Schönberger, supra note 3, at 164–65.

[7] Id. at 168.

[8] Licht, supra note 2, at 853.

[9] Schönberger, supra note 3 at 175.

[10] Id. at 178.

[11] Ease of Doing Business Index, World Bank, (last visited Feb. 28, 2016).

[12] Doing Business, Starting a Business, World Bank Group, (last visited Feb. 28, 2016).

[13] Stable Levels of Entrepreneurial Activity – Albeit Lower than Pre-crisis Levels and the European Average, Global Entrepreneurship Monitor, (last visited Feb. 28, 2016) [hereinafter Stable Levels].

[14] Id.; see also Jennifer Riggins, Why the Spanish Can’t Be Entrepreneurs, ZDNet, (July 8, 2013).

[15] Spain Corporate – Taxes on Corporate Income, PriceWaterhouseCoopers, (Feb. 15, 2016).

[16] Id.

[17] Riggins, supra note 14.

[18] Stable Levels, supra note 13

[19] Starting a Business in Spain, Advoco, (last visited Feb. 28, 2016); see also Riggins, supra note 14.

[20] Riggins, supra note 14.