Presentation to SAEF meeting on ‘Inclusive Innovation’ 9th February 2013 by Professor Gavin C Reid Director, CRIEFF

1. Presentation to SAEF meeting on ‘Inclusive Innovation’ 9th February 2013 by Professor Gavin C Reid Director, CRIEFF University of St Andrews http://www.st-andrews.ac.uk/crieff/CRIEFF.html

2. Attitudes to risk, and the potential role of informal investors in inclusive innovation Gavin C Reid Professor of Economics School of Economics & Finance

4. Format of talk • Inclusive innovation • Risk, innovation and investment • Investors and investees • Contractual possibilities for informal investors

5. Economics of Innovation The economics of innovation (cf. Swann, 2009) uses a much narrower interpretation of ‘innovation’ (e.g. focussing on price signals, factor productivity, and downplaying institutions) than we find in a variety of inter-disciplinary studies (cf. Hamel, 2011). More recently, even economists have broadened the conception, especially in their emphasis on end-user innovation (e.g. focussing on innovation communities, self development etc. ) (cf. von Hippel, 2005)

6. Extent of Innovation The extent of innovation is usually examined by economists under two headings: Cost reduction e.g. Dasgupta and Stiglitz (1980), Telser (1982), Spence (1984) Product diversity e.g. Spence (1976), Dixit and Stiglitz (1977) and Judd (1985)

7. Inclusive Innovation • In its broadest sense, this refers to embodying core concepts of social responsibility into the strategy and management of organizations. • Then organizational innovation is ‘inclusive’ in that it intrinsically links responsibility, strategy and operations. • This inclusion should embrace principal stakeholders like employees, customers, suppliers, financiers, NGOs and the local community. Ref: Nijhof, A., O. Fisscher, and J. KeesLooise (2002), Inclusive innovation: a research project on the inclusion of social responsibility, Corporate Social Responsibility and Environmental Management, Vol. 9, 83-90

8. Innovation and Inclusiveness More narrowly, ‘inclusive innovation’ is seen as a way of the poorest members of a community (e.g. the informal sector) being involved in innovation that is ideas-intensive, and highly economical. See next slide!

10. The Dabbawala (i.e. lunch-box carrier) • A system of meal distribution in Mumbai. • It meets criteria of economic innovation (cost reduction, product diversity) and of inclusion. • 5k workers, mostly illiterate, deliver 200k lunches per day, with errors at 1 in 6m. • Efficiency is high, and workers are included who might otherwise be inactive. Ref: M Dutz (2007) Unleashing India’s Innovation

11. The Inclusive Business Model • Targets low income communities, especially in developing countries • Seeks engagement in both goods (e.g. as final consumers, as BTB customers, as clients) and factor markets (e.g. as employees, entrepreneurs, producers) • Aims to foster innovation in terms of products, processes or business models Ref: Creating Value for All: strategies for doing business with the poor (2008), United Nations

12. Informal Investors Worldwide: GEM • The data collected over 6 years (1998-2003) from over 40 countries, using 138 separate surveys.  • Find self-funding and informal investment are the lifeblood of entrepreneurship. • 99.9 % of entrepreneurs launch new ventures without formal outside equity. • Entrepreneurs provide 65.8% of the start-up capital; informal investors provide the rest.

13. Young Entrepreneurs (GEM) Half of the world’s entrepreneurs are aged between 25 and 44 years. The highest rates of entrepreneurial activity are amongst 25-34 year olds, for all regions. Ref: S. R. Xavier, D. Kelley, J. Kew, M. Herrington, A. Vorderwülbecke(2013) GEM 2012 Global Report, launched on 17th January 2013, Kuala Lumpur, Malaysia.

14. Entrepreneurship and Inclusiveness ‘While entrepreneurship may not be a panacea, it can surely be part of the solution. Yet, growth for growth’s sake alone is not enough. Economic growth through entrepreneurship needs to address issues of inclusiveness and ensure these efforts advance societal well-being.’ Ref: GEM 2012 Global Report, Executive Summary, p. 6

15. Risk Risk is of two types: insurable (i.e. actuarial) risk, and uninsurable (i.e. uncertainty). Both can be relevant to innovation, and inclusive innovation is no exception. In principle, insurable risk can take care of a wide variety of risk types, especially if they are founded on settings in which individual risks are small, independent and frequently occurring (e.g. the risk of damage done in a car crash)

16. Insurance markets Failure in insurance markets is common, especially in economic development settings. Difficulties arise from: • Enforcement (a loan is not a grant!) • Adverse Selection • Moral Hazard • Bank Runs • Monopoly power of lenders Ref: Timothy Besley (1994)How Do Market Failures Justify Interventions in Rural Credit Markets?, The World Bank Research Observer, Vol. 9, No. 1, pp. 27-47

17. Uninsurable Risk: Uncertainty Since the work of Frank Knight (1921), economists have tended to reserve uncertainty for uninsurable risk. This type of risk represents one-off situations that have not occurred before, and may not occur again. By its nature innovation involves something new, and if its novelty is indeed genuine, it will not have been seen before. A problem therefore arises: how you evaluate the riskiness of the innovation? See next slide, which is based on Reid and Smith (2007)! Refs: F. Knight (1921), Risk, Uncertainty and Profit; Reid, G.C. and J.A. Smith (2007) Risk Appraisal and Venture Capital

18. Most important factors in risk appraisal: venture capitalists

19. Most important factors in risk appraisal: entrepreneurs

20. Illustration: Some Indian Start-Up Data Average number of owners per firm 1.2 % Selling products to new customers 25% Average investment needed per firm 72k rupees Average investment by owners 39k rupees Opportunity based/ necessity based = 1.43 Source: Global Entrepreneurship Monitor (GEM)

21. Conclusions • Inclusive innovation can involve entrepreneurship. • Investors will typically be informal. • Sums required, and funded, are small. • Investor – investee relations cannot evade agency effects. • Having an age distribution leaning to the youthful favours entrepreneurship

22. Thank you! Your questions are invited

23. Selected References Besley, T. (1994) How Do Market Failures Justify Interventions in Rural Credit Markets?, The World Bank Research Observer, Vol. 9, No. 1, pp. 27-47. Hamel, G. (2011) What Happens Now, HUP. Knight, F. (1920) Risk, Uncertainty and Profit, Chicago UP. Nijhof, A., O. Fisscher, and J. KeesLooise (2002), Inclusive innovation: a research project on the inclusion of social responsibility, Corporate Social Responsibility and Environmental Management, Vol. 9, 83-90 Reid, G.C. and J.A. Smith (2007) Risk Appraisal and Venture Capital, T&F. Swann, P. (2009)The Economics of Innovation, EE. United Nations (2008) Creating Value for All: strategies for doing business with the poor von Hippel, E. (2005) Democratising Innovation (Creative Common Licence) Xavier, S.R., D. Kelley, J. Kew, M. Herrington, A. Vorderwülbecke (2013) GEM 2012 Global Report, launched on 17th January 2013, Kuala Lumpur, Malaysia.