does cultural diversity increase the rate of entrepreneurship?faculty.citadel.edu/sobel/all pubs...

Does cultural diversity increase the rateof entrepreneurship?

Russell S. Sobel & Nabamita Dutta & Sanjukta Roy

Published online: 10 June 2010# Springer Science+Business Media, LLC 2010

Abstract In the economic development literature, cultural diversity (for example,ethnolinguistic fractionalization) has been shown to have a negative impact oneconomic outcomes in many underdeveloped countries. We hypothesize that theimpact of diversity on economic performance depends on the quality of a country'sinstitutions. Under bad institutions diversity leads to conflict and expropriation,while under good institutions diversity leads to economic progress. A culturallydiverse society or interaction among different cultures encourages exchange of, andcompetition between ideas and different world views. Under good institutions, thisamalgamation of ideas and views leads to greater entrepreneurial initiatives. Weshow that higher levels of cultural diversity increase the rate of entrepreneurship inthe presence of good institutions using evidence from the USA.

Keywords Cultural diversity . Entrepreneurship

JEL L26 . 012 . 017 . P12

Entrepreneurship necessarily takes place within culture, it is utterly shaped byculture, and it fundamentally consists in interpreting and influencing culture.Consequently, the social scientist can understand it only if he is willing toimmerse himself in the cultural context in which the entrepreneurial processoccurs. (Lavoie 1991: 36)

Rev Austrian Econ (2010) 23:269–286DOI 10.1007/s11138-010-0112-6

R. S. SobelDepartment of Economics, West Virginia University, P.O. Box 6025, Morgantown WV 26506, USA

N. DuttaDepartment of Economics, University of Wisconsin-La Crosse, 1725 State St., La Crosse, WI 54601,USA

S. Roy (*)World Bank Institute; Internews Network, Washington, DC, USAe-mail: [email protected]

1 Introduction

In the literature on international economic development, fractionalization and ethnicdiversity have repeatedly been shown to result in inferior economic and socialoutcomes particularly in African nations. It is somewhat ironic then that when oneexamines developed countries, the most vibrant major cities, like New York City orSan Francisco, have in common a large diversity of cultures. Most foreign visitors toNew York City would easily find an area of the city in which they could find acluster of other individuals from their country and would have no problem findingrestaurants serving authentic food from their home country. Someone from India, forexample, would feel very much at home if they visited Jackson Heights in the heartof New York City or DeVon Street in Chicago. Similarly, a visitor from China wouldfind “Chinatowns” present in most major cities across the USA.

It is also interesting to note that many of the poorest areas of the USA havethe least range of cultural diversity. In West Virginia, for example, 94.5% of thepopulation is Caucasian, and foreign-born individuals make up only 1.1% of thestate's population. Could it be possible that this diversity among individuals can bedestructive to development in some countries, but serves as the foundation forinteractions that foster new entrepreneurial ideas in others? We propose that diversitycan be both detrimental to, as well as beneficial to, economic growth anddevelopment. The key determinant we argue is the institutional structure withinwhich these cross-cultural interactions occur. In areas like Africa with weakinstitutions, this diversity results in conflict and destruction, while in countries likethe USA with better institutions this same diversity results in progress andinnovation. With an abundant literature on the negative role of diversity indevelopment, we tackle the flip side of the coin, asking whether cultural diversityresults in more entrepreneurial ventures within a country with good institutions.

Different geographic areas across the globe are characterized by having their ownunique cultures. Culture is an amalgamation of both formal and informal institutionsof a country and is reflective of practices taken up by the nationals in every aspect oflife and living. When people migrate from one country to another they bring some oftheir unique “cultural capital” with them. A major outcome of this amalgamation isthe interchange of ideas, beliefs and practices. Because entrepreneurship is aboutcoming up with new and unique combinations of resources, this interchange of ideasmay lead to more new innovations, new products, and generally a higher rate ofentrepreneurial initiatives. The empirical prediction would be that areas with greatercultural diversity—that is those with a population of immigrants from many differentareas—and with good institutions, will have higher rates of entrepreneurship.

The idea that the amalgamation of different cultures within a given geographicarea promotes entrepreneurship is closely related to the idea discussed by Cowen(2002) that globalization leads to a merging of cultures which expands the menu ofchoices available to consumers. While trade between cultures or what we term“globalization” has been criticized by some, such as Barber (1995) who claim that itruins authenticity of traditional cultures, Cowen suggests just the opposite. Aspeople from different cultures interact with each other, they come up with new andinnovative ideas. Cowen argues this by saying that trading among different culturesessentially results in an expandable, flexible and diverse choice set for individuals.

270 R.S. Sobel et al.

As creative destruction unfolds, trade and globalization add to existing cultures,creating a new set of choices for individuals.1

Our hypothesis supports Cowen's line of argument and re-establishes theimportance of cultural capital for generating efficient outcomes. In the same wayas trade and globalization brings different cultures of the world together and resultsin greater benefit for everyone, greater interactions among individuals from differentcultures or greater cultural diversity generate new entrepreneurial ideas, enhanceexisting business ideas and replace inefficient entrepreneurial initiatives byproductive ones. Thus, entrepreneurial initiatives expand in the presence of greatercultural diversity or due to the production of higher cultural capital.

Our paper aims to tests whether the presence of different cultural groups booststhe level of entrepreneurship. We construct a “cultural diversity” index for each USstate based on the common method for measuring ethnolinguistic fractionalization inthe literature on international economic development (see, e.g., Easterly and Levine1997). Ethnolinguistic fractionalization measures the probability that two randomlychosen individuals belong to two ethnic groups. We use the same technique toconstruct our cultural diversity index. It is calculated as one minus the squaredshares of each cultural group (similar to a Herfindahl–Hirshman Index). This“cultural diversity index” reflects the probability that two randomly chosenindividuals within the state will belong to two different cultures. We are cognizantof the fact that the concept of culture is nuanced and multifaceted. While our culturaldiversity index is not intended to capture all aspects of culture, it does capture oneaspect—ethnic diversity or fractionalization—that has been found to be importantfor economic outcomes.

Controlling for other factors, we then examine whether any of the morecommonly used measures of state entrepreneurial activity are positively correlatedwith the degree of cultural diversity within a state. We employ five measures ofentrepreneurship: the rate of new small business creation (one to nine employee sizefirm births as a percentage of the total number of firms with one to nine employees),the rate of net new small business creation (one to nine employee size firm net birthsas a percentage of the total number of firms with one to nine employees), venturecapital investment dollars per capita, the number of patents per capita, and an indexof each state's entrepreneurial activity. Our results indeed show that higher culturaldiversity leads to more entrepreneurial activity in a state.

We run several robustness checks and test for nonlinearities in the relationship.One interesting finding is that cultural diversity increases entrepreneurship, but withdiminishing returns. This is one reason we argue that cultural diversity is moreproperly thought of within this context as “cultural capital.” The more heterogeneousis a state's cultural capital, the more entrepreneurial ideas will result, but like allother productive inputs, it is subject to diminishing returns.

The paper will proceed as follows. Because there are two unique strands ofliterature being bridged in our analysis, we present the literature review on economicimplications of ethnic fractionalization and that of entrepreneurship separately in

1 The idea of creative destruction has been provided by Schumpeter (1942) and later expanded andanalyzed extensively by economists such as Aghion and Howitt (1992) and Cowen (2002).

Does cultural diversity increase the rate of entrepreneurship? 271

Sections 2 and 3. In Section 4, we explain the data used in the analysis. Section 5elaborates the methodology and results and Section 6 concludes.

2 Fractionalization and economic performance

In previous literature, ethnic diversity has been repeatedly shown to result in inferioreconomic and social outcomes due to tensions and clashes within a society. Easterlyand Levine (1997) show that high levels of ethnic fragmentation are a root cause ofthe underperformance of African nations. They find that ethnic diversity results inworse government performance, worse infrastructure, and education systems.Alesina et al. (1999) show that spending on public goods is adversely affected bythe extent of ethnic fragmentation in an economy. Provision of basic infrastructurelike number of phones per 1,000 population, number of roads and highways hasbeen typically found to be low in highly polarized societies (Easterly and Levine1997; Alesina et al. 1999). The main explanation for these findings is thatfractionalized societies have a more difficult time co-coordinating on the type andquantity of public goods.

Alesina (1994) finds that “society's polarization and degree of social conflict” aredecisive factors for political decisions. Policy makers belonging to ethnic bases areparticularly concerned about the benefits of their own groups and are less botheredabout the utilities of other groups. This retards the performance of the economy andalso results in the adoption of biased policies. Ethnic diversity has also beencorrelated with the level of corruption in a country (Treisman 2000; Glaeser andSaks 2004). Polarized societies are prone to rent-seeking by different groups andalso impede agreement about the provision of public goods (Alesina and Tabellini1990; Alesina and Drazen 1991; Shleifer and Vishny 1993). The extent ofpolarization is crucial to the adoption of policy decisions (Alesina 1994).Furthermore, ethnic fractionalization has also been shown to be a major indicatorof electoral choices of individuals and voting support of political parties.

The literature finding these harmful effects that stem from ethnic diversitymostly focuses on Africa or other areas with weak political and economicinstitutions. A growing new literature has found that when one examines data fromall nations, the harm caused by fractionalization is lower, or even nonexistent, inareas with “good” political and economic institutions—those embodying theprotection of property, free markets, the rule of law, and a free media. Goodinstitutions have been shown to be an effective instrument in alleviating thenegative effects of ethnic diversity on economic performance (Easterly 2001).Leeson (2005) explains that a diverse community will prosper only if it caneffectively realize gains from trade. This in turn is made possible by goodinstitutions as they serve in the role of social-distance reducing signals in aneconomy. Bad institutions interfere with inter-community signaling and generatenegative impacts on the ability of individuals to realize gains from exchange acrosscommunities. Dutta (2009) establishes that the institution of free media helpsovercome frictions among ethnic groups, mitigating the negative impact of ethnictension on public policies and the occurrence of genocides. Free media achievesthese outcomes by increasing public awareness, making the populace more


conscious about the basic needs of an economy and dissipating perfect informationamong the masses.

While the USA may not have ideal institutions—when compared with most othercountries of the world, the USA scores well. In the commonly cited EconomicFreedom of the World Index, the USA ranks as having the sixth highest level ofeconomic freedom among countries of the world (Gwartney and Lawson 2009). Inthe presence of the relatively “good” institutions within the USA, we seek to examinewhether there are clear economic benefits associated with fractionalization—in terms ofa higher rate of entrepreneurship. We now turn to a brief review of the literature onentrepreneurship and attempt to integrate our idea of cultural capital into the frameworkof the literature on entrepreneurship. It is important at the outset to note that in theliterature there are a variety of interpretations of the concept of culture, diversity, andsocial capital. For our purposes we define cultural capital as the stock of different andunique knowledge that is assimilated from the individuals within a society. A societyfilled with individuals with diverse backgrounds has a greater breadth of knowledge thatspans a wider variety of cultures. This stock of cultural capital, we propose, is a vitalinput into the process of discovery and entrepreneurship—a process that can onlymanifest itself in the presence of inter-cultural interaction within a society governed bygood institutions.

3 The economics of entrepreneurship extended to cultural capital

Baumol (1990) stresses that individuals have a choice whether to use theirentrepreneurial talents to secure wealth through the private sector—by launchingnew entrepreneurial endeavors—or through the public sector—through governmentredistribution, lobbying, and lawsuits. In the first case, their efforts are productiveand wealth-creating for society as a whole. In the second case their efforts areunproductive in that they have used scarce resources to affect zero-sum transfers,shrinking the size of the overall economic pie. Toward which direction a country'sentrepreneurial efforts are directed is mainly influenced by policy in terms of how italters the corresponding rates of return—or profit rates—of these alternativeactivities. Capitalist institutions, or institutions providing for secure property rights,a fair and balanced judicial system, contract enforcement, and effective limits ongovernment's ability to transfer wealth through taxation and regulation, reduce theprofitability of unproductive political and legal entrepreneurship. Under thisincentive structure, creative individuals are more likely to engage in the creationof new wealth through productive market entrepreneurship.2

By reducing transactions costs and thereby allowing individuals to capture thegains from exchange, good quality institutions help to determine the productionpossibilities of an economy (Boettke and Coyne 2003) and thus we should seeregions with good institutions having high levels of positive-sum entrepreneurshipand high levels of growth (Boettke and Coyne 2006). With good formal institutions,the gains from exchange are far higher. The better “rules of the game” help to turn

2 For evidence that the relative levels of productive and unproductive entrepreneurship across states areinfluenced by state-level variations in economic institutions see Sobel (2008).


games of inter-culture conflict into ones of inter-cultural cooperation (Easterly 2001;Coyne 2008). In addition, the higher level of entrepreneurial productivity created byan environment of good institutions implies that more individuals will choose tobecome entrepreneurs as individuals only become entrepreneurs if their subjectiverelative return to entrepreneurship is positive, which is in part dependent on theexisting rate of entrepreneurship in the surrounding area (Minniti and Bygrave 1999).

Not only does having good institutions enhance the productivity of entrepreneur-ship, research has found that, across the board, better institutions result in higherlevels of productivity from all factors of production. Gwartney et al. (2006), forexample, find that the marginal productivity of a country's capital investment riseswith institutional quality. Hall et al. (forthcoming) similarly find that the productivityof both physical capital and human capital (specifically the returns to education) areenhanced by better institutions. The argument we wish to advance here is that asimilar logic can be applied to the productivity of cultural capital.

As a productive input in a society, cultural diversity will also vary in itscontribution to economic growth with different degrees of institutional quality.Under good institutions, cultural capital will be a productive force channeled into ahigher rate of new entrepreneurial endeavors. Under weak institutions, culturalcapital will be an unproductive force channeled not only into higher rates of politicaland legal plunder, but also potentially into wealth-destroying violent conflict outsidethe political, legal, or market regime.

Thus, our first argument for why we expect higher rates of cultural diversity to beassociated with higher rates of entrepreneurship across USA is that, analogous toBaumol (1990), good institutions result in cultural capital also being a productiveforce within a society. This logic is deeper than it might first appear as not only dogood institutions result in more productive entrepreneurship, but the process bywhich this occurs is that good institutions result in a higher rate of productivity fromthe cultural capital within a society. Or, more simply, the reason why betterinstitutions result in more productive entrepreneurial activity is that it turns culturaldiversity into a positive, wealth-creating force within a society.

It is also worthwhile to introduce the theories of entrepreneurship from Kirznerand Schumpeter into the context of cultural capital. Schumpeter ((1934), 1942)stressed the role of the entrepreneur as an innovator—a person who discovers newcombinations of resources that did not previously exist. The number of possible newcombinations that can be created from a given set of ingredients (or inputs) isgoverned by a statistical formula that is often underappreciated. Two quickillustrations will help to clarify. The typical automobile license plate has threeletters, a space, and three numbers. The total number of combinations—the totalnumber of possible different license plates—that can be created using three lettersand three numbers is 17,576,000. More impressive is 68-digit answer to the number ofpossible ways to arrange a deck of 52 cards: 80,658,175,170,943,878,571,660,636,856,403,766,975,289,505,440,883,277,824,000,000,000,000, a number so large thateven if every human that has ever lived on the Earth did nothing but shuffle cards24 h a day their entire life, and even unrealistically assuming they could shuffle thedeck 1,000 times per second, we would have not even come close to making itthrough a fraction of the number of total possible arrangements of the deckthroughout all of human history.


Within this context the important idea to uncover is that whenever the number ofunderlying inputs that can be combined is increased, the resulting number of newpossible combinations increases exponentially. If, as we hypothesize, immigrantsbring their own unique cultural capital with them, then a society with moreheterogeneous immigrants should have a larger number of underlying ideas,experiences, knowledge, and insights, which then produces a significantly largernumber of ideas for possible new entrepreneurial endeavors.

Kirzner's (1973, 1997) view of entrepreneurship is one in which individualsdiscover previously unnoticed profit (or arbitrage) opportunities and act on them.Holcombe (1998) attempts to bring together the Schumpeterian and Kirznerianviews by explaining that a Schumpeterian innovation (such as, say, the introductionof the automobile) creates multitudes of new profit opportunities (in areas like autoaccessories and fuel delivery) that are there to be exploited by Kirznerianentrepreneurs. Even movements of people within the USA create opportunities tobuy items in one geographic area and resell them in other areas at a profit with thetwo sets of local knowledge the individual possesses. This leads to two distinctchains of logic on which to proceed. Firstly, simply having individuals immigrate toone country from another creates clear opportunities for them to see opportunities tobuy or produce things in their new country that can be shipped back and sold in theirhome country at a profit, and in reverse opportunities for them to import productsfrom their old home country and bring them to market in their new one. Culturaldiversity creates more knowledge of opportunities for cross-country arbitrage.

The second chain of logic focuses more specifically on the aspect of localknowledge and its productivity in society. Hayek (1945) shows how good, marketbased, institutions help to make the best use of available local knowledge—the realproblem faced by every society. Immigration and the resulting cultural diversity helpto increase the types of new and heterogeneous local cultural knowledge available inan area which can be brought to bear on the existing labor, capital, and naturalresources within a geographic area. Under a system of good institutions, a widervariety of heterogeneous local knowledge will result in an expansion in a society'sproduction possibilities.

Our final chain of logic is embedded in the theories expressed by Storr (2008), Harper(2003) and Lavoie and Chamlee-Wright (2000). As noted by Virgil Storr (2008) themarket can be viewed as a social structure that harnesses exchange and competition.However, he affirms that the importance of the market goes beyond this and is in fact a“social space” where non-economic and economic interactions happen. He emphasizesthat the sociality of the market humanizes it allowing it to “create and sustaincommunities, promote identity, and cement fraternal and familial bonds.” He furtheremphasizes that this view of the market as a platform for social dialogue is an alternateto the idea that market and community are completely opposite concepts.

This concept also brings forth an interesting aspect of trade beyond that ofeconomic exchange and competition—that of a method of building extraeconomicrelations. In this light, a culturally diverse society can be envisioned as an aptenvironment where effective inter-cultural exchanges bloom as also does inter-cultural relations beyond market competition. In this regard, a culturally heteroge-neous society seems to be the most viable incubator for exchange of practices andideas, in the context of business and general societal relations alike.


We further strengthen our hypothesis through the effective interplay of cultureand enterprising activities as explained by Harper (2003) and Lavoie and Chamlee-Wright (2000). Harper describes how each different culture has its peculiarcharacteristics that influence their entrepreneurial choices and behavior. Theseunique cultural traits can be compared to “comparative advantage” in trade and insimilar lines, each cultures when specializes in entrepreneurial activities based ontheir unique traditions, perspectives and different strengths, they prosper. Hence,each different culture has the potential to promote different patterns of economicdevelopment. Therefore, when different cultures come together and coexist, thereoccur different entrepreneurial manifestations particular to each culture. This in turnleads to a dynamic process of development and generates trajectories of economicgrowth beyond and unlike the country's indigenous growth pattern. Emphasizingwords of (Freeman 2000); “comparative advantage is a story of diversity; of gainsthat come from differing from one's neighbor, not from aping him.”

4 Data

Our dependent variables are a variety of measures of entrepreneurship available atthe US state level. In the literature, there is not one generally agreed upon index ofentrepreneurial activity, but rather a list of variables that are often employed. Weconsider five measures of entrepreneurship: the rate of new small business creation(one to nine employee size firm births as a percentage of the total number of firmswith one to nine employees), the rate of net new small business creation (one to nineemployee size firm net births as a percentage of the total number of firms with one tonine employees), venture capital investment dollars per capita, the number of patentsper capita, and an index of each state's “productive entrepreneurial activity’ fromSobel (2008). Three of these measures are available for all 50 states, while two areonly available for the continental 48 states (i.e., excluding Alaska and Hawaii).

The first two measures, related to the rates of small business creation, measurenew enterprises defined as a business that has a payroll above zero in any given yearand did not exist in the previous year (Godin et al. 2008). The first simply measuressmall business start-ups as a percentage of small businesses, while the second usesthe net rate of small business creation by taking into account business failures. Thedata source for these two measures is the Company Statistics Division of the USCensus Bureau (http://www.census.gov/csd/susb/susb.htm). A detailed description ofeach variable with the data sources is provided in Appendix 1.

The next measure we consider, venture capital investments in each state per capita,measures entrepreneurship because it captures, at least partially, whether new innovationsare being brought in the marketplace through shareholder investments.3 The data sourcefor venture capital is National Venture Capital Association's (NVCA) Yearbook. Thenext measure of entrepreneurship we consider is the number of patents per capita ineach state, which reflects the innovative aspect of the entrepreneurial process. The US

3 According to Lerner (2002) and Kortum and Lerner (1998), venture capitalists not only supply funds forbusiness investments but also provide the entrepreneurs with the necessary expertise which is required toinnovate and sell their products and ideas in the market. Thus, venture capitalists fulfill the functions ofboth a capitalist and an entrepreneur.


http://www.census.gov/csd/susb/susb.htm

Patent and Trademark Office (USPTO) is the source for patent data. Our final measureis a state-level index of productive entrepreneurship from Sobel (2008).4

Our main explanatory variable of interest in this analysis is cultural diversity. Weconstruct an index for each US state based on the common method for measuringethnolinguistic fractionalization in the literature on international economic develop-ment (see, e.g., Easterly and Levine 1997). This measure, calculated as one minusthe squared shares of each cultural group (similar to a Herfindahl–Hirshman Index),essentially reflects the probability that two randomly chosen individuals from apopulation belong to two different groups. Here we use the same idea but applied tocultural diversity in each US state measured by presence of nationals of foreigncountries within the populations of each state. Mathematically, the formula we usefor calculating cultural diversity is:

Diversityi ¼ 1�XN

i¼1

S2ij ð1Þ

For our measure, the share of each group is the total number of people from eachparticular world country in the state as a fraction of total population. One group isthe share of U.S. native population as a share of total population. The data for theforeign born population (classified by their country of origin) in each state is takenfrom US Census (2000). This measure essentially reflects the probability that tworandomly chosen individuals within the state will belong to two different cultures—or the probability of cultural interaction when two individuals in that state meet.

In addition to explaining state entrepreneurial activity using our measure ofcultural diversity, we include several other controls that are generally included inmodels of entrepreneurial activity. The first is a measure of institutional qualityvariation among the US states. We use the Economic Freedom of North America(EFNA) index from Fraser Institute (Karabegovic and McMahon 2005).5The indexranges from zero to ten with higher scores implying greater degree of economicfreedom. This will control for any direct effects that state policy has on the overallrate of entrepreneurship, allowing us to estimate simply the marginal impact ofcultural diversity holding constant state institutional quality. We also control forother variables which capture demographic characteristics of each state. Thesecontrols are median age in each state, population density, percent of male populationper 100 female and percent of the population with college degree or higher. The datafor these demographic variables is from the US Census (2000).

5 Methodology and results

Before testing the relationship between cultural diversity and entrepreneurshipempirically, we investigate the presence of such an association with the help of

4 This single measure incorporates data on venture capital investments per capita, patents per capita, thegrowth rate of self-employment activity, the establishment birth rate (all new firms), and the large-establishment birth rate (new firms with 500 or more employees). Thus, it is probably more heavilyweighted toward larger-scale establishment birth than our other variables.5 The three main components based on which the index is created are size of government, takings anddiscriminatory taxation, and labor market freedom.


scatter plots. Even without the use of regression methodology, or even controllingfor other factors, there exists a clear positive relationship between state culturaldiversity and our measures of entrepreneurship. Figure 1a shows the clear positiverelationship between the rate of new small business start ups and cultural diversity,while Fig. 1b shows the similar positive relationship with the measure of net newsmall business creation. In both cases, the linear upward-sloping trend line suggeststhat greater cultural diversity results in the generation of more new productive ideaswhich manifests itself as a higher rate of entrepreneurial activity.

The association is further established when we use other proxies for entrepre-neurial activity. Figure 2a, b show that again, cultural diversity is clearly positivelycorrelated with measures of venture capital investments and patents per capita. Thetrend lines shown in the figures are clearly positively sloped, suggesting that greatercultural diversity is associated with higher levels of these other measures ofentrepreneurial activity. Finally, Fig. 3 shows the positive correlation betweencultural diversity and the index of productive entrepreneurial activity for each state.

The above figures clearly show that higher cultural diversity is associated with ahigher rate of entrepreneurial initiatives across the US states. We now turn to asimple regression analysis to see if the results hold up to statistical analysiscontrolling for other factors that might impact each state’s rate of entrepreneurialactivity.6 Our benchmark regression specification is:

Entrepreneurshipi ¼ b0 þ b1Diversityi þ "i ð2Þwhere Entrepreneurshipi is each different measure of entrepreneurial activity in statei and Diverisityi is the measure of cultural diversity in a state i. We test our theory foreach proxy of entrepreneurship using Ordinary Least Squares (OLS) estimationmethods.

Our benchmark specification does not contain any other demographic oreconomic control variables. These are essentially fitting the lines shown in thepreviously presented figures to see if they are really statistically significant. Table 1reports result of this basic specification.

The results in Table 1 clearly show that the positive relationships shown in thefigures are statistically significant. As is shown in Table 1, while cultural diversityhas a positive and significant impact on all measures of entrepreneurship, some ofthe relationships are stronger than others as is witnessed by higher levels ofstatistical significance. The coefficient on cultural diversity is significant at the 1percent level for the productive entrepreneurship measure and the venture capital percapita measure. For business start ups and patents per capita cultural diversity issignificant at the 5 percent level, and for the net business creation measure thecoefficient is significant at the 10 percent level.

Table 2 shows the same regressions, but this time adding the other controlvariables as per the following equation:

Entrepreneurshipi ¼ b0 þ b1Diversityi þ b2Xi þ "i ð3Þ6 There is a potential problem of endogeneity in our specification. It is possible that areas with higher ratesof entrepreneurial activities attract more immigrants. To address this we checked the benchmark results ofTables 1 and 3 with the cultural diversity measure calculated from the 1990 census. The results remainrobust and comparable.


where Xi refers to the matrix of control variables pertaining to each state i. So theaim of specification (2) is to see if our results are robust to the inclusion of additionalcontrol variables.

As the results of Table 2 reveal, even after adding these controls, cultural diversityremains positive and significant as a determinant of measures of state-levelentrepreneurial activity. While the coefficient on cultural diversity remains positiveand significant in these specifications with additional controls, the significance levelsare generally a little lower than the results in Table 1. While the coefficient issignificant at the 1% level for the measure of productive entrepreneurship, it issignificant at the 10 percent level in all other specifications.

While we have to this point focused on the signs and significance of our maincultural diversity measure it is important to mention that all of our controls have thesigns that should be anticipated based on previous literature. For example, medianage has a negative impact on entrepreneurship as younger individuals are more likelyto be entrepreneurs. Similarly, economic freedom is positive showing that there is adirect effect of better institutions on the rate of entrepreneurial activity in a state. Aswe have stressed throughout the paper, better institutions are supportive of moreentrepreneurial activity—and this significant relationship with economic freedom isconsistent with this idea. In addition, this matches the significant impact of economic

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Fig. 1 a Average BusinessStart-ups Versus CulturalDiversity. b Average NetBusiness Creation VersusCultural Diversity.


freedom on entrepreneurship rates found previously in Sobel (2008) and Kreft andSobel (2005). Finally, population density has a positive impact on entrepreneurship,a reflection of several factors including the scale of the marketplace and increasingreturns to knowledge.

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We now attempt to see whether there are significant non-linearities in thisrelationship. To test for this we repeat our two earlier specifications but this timeinclude both cultural diversity and cultural diversity squared in our regressions asfollows:

Entrepreneurshipi ¼ b0 þ b1Diversityi þ b2Diversity2i þ "i ð4Þ

Entrepreneurshipi ¼ b0 þ b1Diversityi þ b2Diversity2i þ b3Xi þ "i ð5Þ

The general idea is that as a form of capital input, cultural capital is productivebut is subject to diminishing returns. So for similar increases in cultural diversity, astate with a lower starting level of diversity should gain more compared to a statethat starts with a higher initial level of diversity. For example, a state like WestVirginia with low cultural diversity should experience a much greater increase inentrepreneurship compared to already highly diverse New York if both states were toexperience identical changes in the index of cultural diversity. In the regressionestimates this would be confirmed if the coefficient on the linear term is positive,while the coefficient on the squared term is negative (e.g., cultural diversity expandsentrepreneurship, but at a decreasing rate). Tables 3 and 4 present the results fromthis re-estimation of the models shown in Tables 1 and 2.

Our results for the average business start-up rate, the net business start-up rate,and the measure of productive entrepreneurship seem to reflect the presence ofdiminishing returns to cultural diversity. Each increases with cultural diversity, but ata decreasing rate. Venture capital investments per capita and patents per capita donot seem to show this type of non-linear relationship. The two terms are jointlysignificant, but individually insignificant. The results are the same in Table 3, thebasic version, and Table 4, the extended version with the added control variables.The signs of the control variables remain identical to those in Tables 1 and 2.

Table 1 Impact of Cultural Diversity on Measures of Entrepreneurship: Linear Basic Regressions

Variables Average businessstart-up rate

Net businesscreation rate

Venture capitalper capita

Patents percapita

Measure ofproductiveentrepreneurship

Culturaldiversity

0.0942a 0.0333b 396.2c 0.565a 71.03c

(0.0366) (0.0175) (128.4) (0.219) (9.967)

Constant 0.133c 0.0131c −6.678 0.174c 14.46c

(0.00432) (0.00228) (11.62) (0.0419) (1.672)

Observations 50 50 48 50 48

R2 0.148 0.082 0.304 0.080 0.468

Robust standard errors in parenthesesa Statistical significance indicated as 5%b Statistical significance indicated as 10%c Statistical significance indicated as 1%


6 Conclusion

In the literature on economic development, the presence of a fractionalized society isgenerally detrimental to economic prosperity. These developing countries, however,most often have weak or failed institutions that do not adequately protect contractsand private property, nor provide a framework of the rule of law. In contrast, incountries with good institutions this paper hypothesizes that a diversified societyhelps to promote economic growth and progress.

Good formal institutions allow situations in which there are many subgroups withdiffering informal, cultural, institutions to work together. In the marketplace, mutually-beneficial exchange among people from different cultures helps to make the best use ofthe local (cultural) knowledge in society, spurring new branches of melded local culturalinformation, and injecting new combinations into the entrepreneurial process.

We empirically examine whether the degree of cultural diversity is a significantdeterminant of entrepreneurial activity, using five different measures of entrepre-neurship in a cross-state analysis. We indeed find that the states with the mostdiversity in their cultural makeup have higher rates of entrepreneurial activity.

Our results have important implications for policy, both within developing anddeveloped nations. For developed nations, such as the USA, a higher rate ofentrepreneurial activity caused by more cultural diversity clearly argues in favor ofeasing immigration restrictions into the USA. A higher inflow of citizens from other

Table 2 Impact of Cultural Diversity on Measures of Entrepreneurship: Linear Extended Regressions

Variables Averagebusinessstart-up rate



Patentsper capita


Culturaldiversity

0.102a (0.0528) 0.0471a (0.0275) 341.6a (188.5) 0.642a (0.349) 54.20b (16.99)

Economicfreedom

0.00693 (0.00650) 0.00116 (0.00348) 2.358 (14.93) 0.0342 (0.0449) 3.209 (2.546)

Median age −0.00280 (0.00272) −0.00111 (0.00137) −6.321c (3.029) −0.0128 (0.0224) −1.243b (0.455)

% Collegedegree

−0.000167(0.00102)

0.000532 (0.000535) 3.875 (3.472) 0.0223c (0.0102) −0.0773 (0.355)

% Male 0.00248a

(0.00135)0.00106 (0.000663) −3.774 (2.996) −0.0119 (0.0105) −0.169 (0.495)

Populationdensity

0.00127 (0.0137) 0.00384 (0.00888) 48.9 (91.5) 0.0349 (0.0190) −6.09 (5.72)

Medianhouseholdincome

−0.00079(0.00097)

−0.00067 (0.00056) 0.0979 (2.38) −0.00173(0.0103)

0.493 (0.325)

Constant −0.00216 (0.177) −0.0733 (0.0885) 233.9 (289.2) −0.249 (0.950) 42.42 (40.39)


R2 0.451 0.331 0.399 0.253 0.644



Table 3 Impact of Cultural Diversity on Measures of Entrepreneurship: Non-linear Basic Regressions


Net business creationrate

Venturecapital percapita

Patents percapita


Culturaldiversity

0.276a (0.100) 0.124b (0.0492) 253.0 (417.2) 1.584c (0.832) 174.2a (31.09)

Culturaldiversity 2

−0.482b (0.228) −0.239b (0.103) 377.9 (1,150) −2.704 (2.511) −274.7a (80.96)

Constant 0.122a (0.00654) 0.00760b (0.00352) 2.158 (22.26) 0.112b (0.0521) 8.211a (2.104)


R2 0.200 0.139 0.307 0.104 0.569


Table 4 Impact of Cultural Diversity on Measures of Entrepreneurship: Non-linear Extended Regressions




Patents percapita

Measure of productiveentrepreneurship

Culturaldiversity

0.359a (0.136) 0.167a (0.0729) -213.8 (399.3) 0.580(0.943)

148.6b (31.57)

−0.632a (0.252) −0.295a (0.135) 1,356 (1128) 0.152(2.555)

−229.1b (59.73)

Economicfreedom

0.00617 (0.00574) 0.000808(0.00325)

3.594 (15.23) 0.0344(0.0457)

3.074 (2.373)

Median age −0.00223(0.00274)

−0.000840(0.00138)

−7.493a (2.954) −0.0130(0.0225)

−1.042a (0.448)

% Collegedegree

−0.000535(0.00100)

0.000360(0.000529)

4.661 (3.350) 0.0224a

(0.0101)−0.187 (0.334)

% Male 0.00253c

(0.00125)0.00108c

(0.000616)−3.699 (3.292) −0.0119

(0.0107)−0.193 (0.483)

Populationdensity

−0.00375(0.0133)

0.00150(0.00729)

61.70 (89.8) 0.0361(0.188)

7.97 (5.41)

Medianhouseholdincome

−0.00110(0.00089)

−0.00081(0.00052)

0.692 (2.47) −0.00165(0.0107)

0.358 (0.298)

Constant 0.00521 (0.161) −0.0699(0.0825)

206.1 (287.2) −0.251(0.961)

47.02 (38.39)


R2 0.521 0.399 0.437 0.253 0.699



countries would result in higher rates of new business—and new wealth—creation. Fordeveloping nations, many of whom already have significant degrees of cultural diversitywithin them, the policy implications are equally clear. If political and economicinstitutions can be improved, this will transform this negative social force into aproductive one. Similar to how good economic institutions better channel physicalcapital (and labor) into productive projects, improved institutions also channelheterogeneous social capital into productive activities (entrepreneurial endeavors) ratherthan political and social plunder (rent seeking and social conflict).

Table 5

Variable name Minimum Maximum Average Obs. Source Definition

Dependent variables

Average businessstart-up rate

0.114 0.229 0.145 50 a Average business births as a percentage oftotal businesses with 1–9 employees(2002–2003)


0.001 0.052 0.018 50 a Average net business creation as apercentage of total businesses with 1–9 employees (2002–2003)

Venture capital percapita

0 379.39 46.635 48 b Venture capital invested (bydestination) per capita (2005)

Patents per capita 0.044 1.086 0.249 50 c Number of patents granted (all types)per 1,000 people (2005)

Productiveentrepreneurship

3.2 43 23.583 48 d Index of entrepreneurial activity fromSobel (2008) based on severalmeasures of entrepreneurship

Independent variables

Cultural diversity 0.021 0.44 0.132 50 e Probability that 2 randomly chosenindividuals from a state were born indifferent countries, calculated like astandard Herfindahl–Hirshman Index(2000)

Median age 27.1 37.9 35.536 50 f Median age of state population (2000)

Percent male 88.8 107.6 94.114 50 f Percent of 18 years and over statepopulation that is male (2000)

Percent collegedegree

14.8 33.2 23.776 50 f Percent of state population with abachelor's degree or higher (2000)

Population density 0.0011 1.1344 0.1819 50 f Population density per square mile ofland area in state (2000), in thousands

Median householdincome

29.696 55.146 41.371 50 e Median household income (1999), inthousands

Economic freedom 5.6 7.8 6.684 50 f Economic freedom of North America(EFNA) index (2005)

Data Sources: a Company Statistics Division of the United States Census Bureau (http://www.census.gov/csd/susb/susb.htm), b Venture Capital Association's (NVCA) Yearbook, c the US Patent and TrademarkOffice (USPTO), d Index constructed in Sobel (2008), e US Census 2000 (http://www.census.gov), fFraser Institute (Karabegovic and McMahon 2005)

Appendix 1: List of Variables and Sources




http://www.census.gov

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