Creating more innovative and dynamic economies is one of the fundamental challenges facing both advanced and emerging market economies. An important ingredient of this involves the creation of entrepreneurial firms which can quickly translate creative ideas and scientific discoveries into viable products. These firms, however, need financing because it takes time and money to turn ideas into marketable products. However, investing in these types of activities is risky as a lot of new ideas simply don’t work out in practice. Because of these risks, banks tend to avoid lending to these types of firms. There is, however, a small segment of the financial sector referred to as the venture capital market that specializes in finding and developing these entrepreneurial businesses. This paper provides an overview of this important financial sector and concludes that public policies have historically been quite important in nurturing a venture capital industry as it is an area characterized by numerous market imperfections. From these experiences some lessons are drawn as to what actions governments can take to overcome the obstacles in establishing a venture capital market which can adequately finance dynamic new companies. It is also emphasized that although obtaining finance is often a significant constraint it is nevertheless just as important to ensure that the other ingredients for entrepreneurship are also present; these include a proper regulatory and legal framework including protections for intellectual property, low start-up costs with minimum paper work, a favourable tax regime, and a well-educated workforce. More generally, it is pointed out that the policies needed to promote innovation in advanced economies may not be appropriate for catching-up economies.
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Length: 9 pages Date of creation: Jun 2008 Date of revision: Publication status: Published in United Nations ECE 2008 Annual Report Handle: RePEc:ece:annrep:2008_5
Find related papers by JEL classification: G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation D24 - Microeconomics - - Production and Organizations - - - Production; Capital and Total Factor Productivity; Capacity H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies O14 - Economic Development, Technological Change, and Growth - - Economic Development - - - Industrialization; Manufacturing and Service Industries; Choice of Technology O16 - Economic Development, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment O31 - Economic Development, Technological Change, and Growth - - Technological Change - - - Innovation and Invention: Processes and Incentives