Case 2 Colombia’s entrepreneurial ecosystem

Despite its deep embroilment for a long time, in a war with guerrilla, paramilitary groups and drug cartels, Colombia has made drastic improvement in its entrepreneurial performance in recent years. According to a BBC World survey, the country was rated among the 24 "most entrepreneur-friendly nations". A high defense spending, family-business dominated culture, low level of investments in research and development (R & D) have, however, severely constrained the efficiency and productivity of the Colombian entrepreneurial ecosystem. Moreover, foreigners' perception of the country as “lawless” and “violent” has been difficult to change[endnoteRef:1]. [1: Farzad, R. 2007 Extreme Investing: Inside Colombia, May 28, 2007, http://www.businessweek.com/magazine/content/07_22/b4036001.htm, ]

Colombia’s entrepreneurial revolution is a result of a number of diverse, contradictory and conflicting forces. Many paradoxes thus exist in Colombian entrepreneurial ecosystem as well as its various components and processes. Colombian entrepreneurship-related institutions, for instance, are characterized by a recombination of old institutional elements with the introduction of new elements as it happens in an institutional change[endnoteRef:2]. [2: Campbell, J. L. (2004). Institutional change and globalization. Princeton, NJ: Princeton University Press.]

Indicators related to entrepreneurial performance and impact

Indicators related to entrepreneurial performance and impact are mixed. Colombia has become one of the most dynamic economies in Latin America. In 2011, Colombia was represented in Forbes’ Global 2000 list of the world's biggest companies[endnoteRef:3]. The country’s unemployment reduced from 17.3% in 2002 to 12.1% in 2009[endnoteRef:4]. During 2002-2007, Colombia's average annual economic growth rate exceeded 5% thanks to improved domestic security, greater foreign investment inflows, export growth and sound monetary policy. [3: DeCarlo, S. 2011. The World's Biggest Companies. Retrieved April 20, 2011, at http://www.forbes.com/2011/04/20/biggest-world-business-global-2000-11-intro.html .] [4: DATAMONITOR: Colombia. 2010. Colombia Country Profile, 2010, p1-75. ]

Colombia is Latin America's No. 4 oil producer as well as fifth biggest coal exporter in the world. It is also a top producer of mild, washed Arabica coffee. It also is a major flower exporter and textile producer[endnoteRef:5]. However, most Colombian companies have not been able to move beyond natural-resource based industries. Commodities make up more than 50% of Colombia's exports, while exports account for about 20% of its GDP[endnoteRef:6]. [5: \Markey, P. 2011. Colombia sees FDI rising to $10 billion in 2011, Mar 31, http://www.reuters.com/article/2011/03/31/us-latam-summit-colombia-trade-idUSTRE72U5EJ20110331] [6: Lesova, P. 2009.Interested in Colombia? A new ETF offers access, Market Watch, March 24, 2009, http://www.marketwatch.com/story/interested-colombia-a-new-etf-offers]

A significant informal economy has been a major challenge faced by the Colombian entrepreneurial ecosystem. One estimate suggested that Colombian informal economy employs about 60% of the country’s population[endnoteRef:7]. Moreover, the size of the informal sector is expanding[endnoteRef:8]. The country also performs poorly with respect to poverty reduction. A gini coefficient of 58.5 puts it among economies with the highest income inequalities between the rich and the poor[endnoteRef:9]. [7: Segun Sexo (2007). Departamenio Administrativo Nacional De Estadfstlca, Gran Encuesta Integrada De Hogares: Distrlbuclon Porcentual De La Poblacign Ocupada Total Informal Y Formal. available at http://www.dane.gov.co/index.php?option=com_content&sectionid=19&id=75&iteniid=257. ] [8: Economist, 9/11/2010, Efficiency drive Vol. 396 Issue 8699, special section p9-11,] [9: UNDP, Human Development report, 2010, http://hdr.undp.org/en/media/HDR_2010_EN_Complete_reprint.pdf. ]

Externalities generated by violence, insecurity and the drug entrepreneurship

By the early 2000s, about 4% of the country’s population, mostly from rural Areas, was forced to leave homes due to violence[endnoteRef:10]. Likewise, during 2000-2005, about 1 million Colombians migrated to the U.S., Spain, and Costa Rica[endnoteRef:11]. However, institutional framework for entrepreneurship has emerged through the stable coexistence of violence and democracy. Seemingly “normal” institutions in the country have emerged and operated in its “abnormal” environment characterized by violence and insecurity[endnoteRef:12]. [10: Arboleda, Jairo, and Helena Correa. 2002. Forced Internal Displacement, in Colombia: The Economic Foundation of Peace, edited by Marcelo M. Giugale, Oliver Lafourcade and Connie Luff. Washington,] [11: Inter-American Development Bank. 2006. Remittances 2005: Promoting Financial Democracy. Washington, DC: Inter-American Development Bank.] [12: Portes, Alejandro; Smith, Lori. 2008. Institutions and Development in Latin America: A Comparative Analysis, Studies in Comparative International Development, Jun2008, Vol. 43 Issue 2, p101-128]

Stereotypes and a negative perception of the country have been nurtured and sustained by many foreign investors. A Business Article notes: “The handful of Wall Street analysts who cover Colombia supply their clients with charts of murder rates and kidnappings” [endnoteRef:13]. [13: Farzad, R. 2007 Extreme Investing: Inside Colombia, May 28, 2007, http://www.businessweek.com/magazine/content/07_22/b4036001.htm, ]

A major challenge facing Colombia is related to a fertile ecosystem developed around unproductive and destructive entrepreneurship. Colombia arguably has the world’s most powerful drug cartels and the illegal drug industry in the country has more dramatic social, political, and economic effects on Colombia than any other country. Guerrilla fighters as well as counter-guerrilla and paramilitary groups benefitted tremendously from entrepreneurial activities in the drug economy. They employed unemployed and semi-employed workforce in the country[endnoteRef:14]. One estimate suggested that drug cartel groups owned about one third of the country’s agricultural land in the early 1990s[endnoteRef:15]. [14: Palacios, M. 1995 Entre la legitimadad y la violencia. Colombia 1875-1994. Bogotá: Editorial Norma.] [15: The Economist (1994) ‘The Wages of Prohibition’ (24 December 1994/ 6 January 1995).]

Drug entrepreneurship took place in Colombia in all shapes, sizes, and forms. Estimates suggest that about 10 million acres (4 million hectares) have been taken from peasants by paramilitaries, drug lords and ranchers[endnoteRef:16]. Traditionally drug entrepreneurship allowed peasants and everyone else involved to reap the rewards with little effort[endnoteRef:17]. For instance, for many peasants in remote parts of Colombia, coca yielded much higher returns than corn, rice, potatoes and vegetables[endnoteRef:18]. Some suggest that cocaine in Colombia has been a "small entrepreneur's dream"[endnoteRef:19]. As is the case of Afghanistan, drug eradication campaigns in Colombia have little effect on drug production but alienated the local population, which has led to a higher political capital to insurgents[endnoteRef:20]. [16: Rosenberg, Mica. May 23, 2011, Colombia shifts from drugs to food in farm expansion, http://www.reuters.com/article/2011/05/23/us-colombia-agriculture-idUSTRE74M4OQ20110523] [17: Garcés, L. 2005. Colombia: The link between drugs and terror, Journal of Drug Issues, 35(1), 83-105,] [18: Carroll, R. 2010. Why the war on drugs in Colombia may never be won, guardian.co.uk, 16 February 2010] [19: Kirk R (2003). More Terrible Than Death: Massacres, Drugs, and America's War in Colombia. Public Affairs.] [20: Felbab-Brown, Vanda. 2009. Shooting Up Counterinsurgency and the War on Drugs: Terrorism and al Qaeda, Transnational Security Threats, Counternarcotics Policy, Brookings Institution Press.]

Experts say that Colombia illegal drug industry was the result of the weakness of the state and its institutions and de-legitimation of the governmental system. It is also argued that the development of the illegal drug industry is an effect rather than a cause of the structural and institutional weaknesses of the country[endnoteRef:21]. [21: Thoumi, Francisco E. 2005. The Colombian Competitive Advantage in Illegal Drugs: The Role of Policies and Institutional Changes. Journal of Drug Issues, 35(1), 7-25]

Regulatory framework

While significantly improved, laws and enforcement mechanisms in Colombia are weak due primarily to the fact that defense spending is draining the civilian economy in general and entrepreneurial development in particular. In the 1990s, defense budget averaged 1.35% of GDP. Even until the early 2000s, the country’s defense spending was significantly lower compared to most other countries in conflict and even other Latin American countries at peace[endnoteRef:22]. [22: Sweig, J. E.2002. What Kind of War for Colombia? History Repeating Itself?. Foreign Affairs, 81(5), 122-141,]

Starting 2002, President Uribe significantly increased the country’s defense spending to intensify military actions against the guerillas. Colombia’s spending on defense increased from $2.6 billion in 2001 to over $9 billion in 2009[endnoteRef:23]. Laws and enforcement mechanisms are, however, often ineffective due to a lack of funding for police forces and civil law enforcement [endnoteRef:24]. [23: U.S. Department of State. 2011. Background Note: Colombia, July 13, 2011, Bureau of Western Hemisphere Affairs. http://www.state.gov/r/pa/ei/bgn/35754.htm ] [24: Fandl, K. J. 2008. Making Trade Liberalization Work for the Poor: Trade Law and the Informal Economy in Colombia. Texas International Law Journal, 43(2), 161-184.]

According to the World Bank’s Doing Business 2011 report (http://www.doingbusiness.org/reports/global-reports/doing-business-2011/), Colombia ranked No. 3 in Latin America for the ease of doing business. The country’s performance is better than the average for Latin America in terms of time taken, costs and the number of procedures for starting a business. Colombia is the best country in the region to protect an investor.

Colombia has also implemented some pro-SME policies that are based on direct government support of SMEs. The government has increased the availability of micro credit for small entrepreneurs[endnoteRef:25]. In a study of 53 countries in terms of their friendliness to small businesses, Colombia ranked 29th[endnoteRef:26]. [25: Datamonitor: Colombia. 2010. Colombia Country Profile, 2010, p1-75. ] [26: Lewis, G. 2007. Who in the World is Entrepreneurial? FSB: Fortune Small Business 17(5), 14.]

Signs of oligarchic capitalism

Compared to other South American countries, multinationals and state enterprise played a much smaller role in Colombia in the twentieth century[endnoteRef:27]. Revenues of the four largest Colombian business groups (grupos) were estimated at 12.5% of the country's GDP[endnoteRef:28], compared to the Latin American average of 9.6%[endnoteRef:29]. Likewise, revenues of the 10 largest business groups in 1995 was 28% in Colombia compared to 11% in Argentina, 10% in Mexico and 8% in Brazil and 14% in Latin America [endnoteRef:30]. [27: Miller, R. M. 2010. Latin American Business History and Varieties of Capitalism. Business History Review, Winter2010, Vol. 84 Issue 4, p653-657,] [28: Rettberg, Angelika. 2001. The Political Preferences of Diversified Business Groups: Lessons from Colombia (1994-1998). Business & Politics 3, 1: 47-63.] [29: Peres. Wilson, ed. 1998. Grandes empresas y gnipos indtistriales latinoam,ericanos: expansion y desajtos en la era de la apertura y la globalizadon. Mexico City: Siglo Veintiuno.] [30: Schneider, B. R. 2009. A comparative political economy of diversified business groups, or how states organize big business , Review of International Political Economy, May2009, Vol. 16 Issue 2, p178-201,]

These grupos, which are mostly family-owned, had close ties with high government officials and relied on the state for various resources such as credit, contracts, and favorable regulation thrived in the closed system and dominated several industries[endnoteRef:31]. Politicians, on the other hand, depend on the grupos for campaign supports. This dynamics formed the basis of mutual interdependence and ongoing institutional “partnership” relationship between them. In addition, the state relies on the grupos for jobs, investment, and taxes[endnoteRef:32]. Not only the grupos but also the paramilitary groups are able to penetrate state institutions[endnoteRef:33]. [31: Andrade, Luis F.; Barra, Jose M.; Elstrodt, Heinz-Peter.2001. All in the familia. McKinsey Quarterly, Special Edition, Issue 4, 81-89.] [32: Rettberg, A. 2005. Business Versus Business? Grupos and Organized Business in Colombia, Latin American Politics & Society, 47(1), 31-54.] [33: Hristov, J. 2010. Self-Defense Forces, Warlords, or Criminal Gangs? Towards a New Conceptualization of Paramilitarism in Colombia, Forces d'autodéfense, seigneurs de guerre, ou bandes criminelles? Vers une nouvelle conceptualisation du paramilitarisme en Colombie, Labour, Capital & Society, 2010, 43 (2),13-56]

Banking, financial and capital markets

Colombian stock market is small with low market capitalization, has a few listed companies, low volume of transactions and shallow with a few types of funds. Colombia’s principal stock exchange, the Bolsa de Valores de Colombia created in 2001. By 2007, the Bolsa’s stock market capitalization was $59 billion[endnoteRef:34]. As of 2010, the Bolsa had about 20 shares actively traded with market capitalization 60% of GDP compared with 100% in Chile[endnoteRef:35]. The Bolsa was also criticized on the ground that it lacked proactivity, was inward-looking in orientation and failed to go beyond just fulfilling its institutional mandate, contributed very little to economic development[endnoteRef:36]. In May 2011, Chile, Peru and Colombia created a common trading platform-- Latin American Integrated Market (Mercado Integrado Latinoamericano, or Mila) -- by formally combining operations of their stock markets. This development is expected to contribute to the development of the Colombian equity market by drawing more liquidity. [34: Farzad, R. 2007 Extreme Investing: Inside Colombia, May 28, 2007, http://www.businessweek.com/magazine/content/07_22/b4036001.htm, ] [35: Rathbone, J. P. 2010. Capital markets: Investors require patience more than nimble financial footwork, April 6 2010, http://www.ft.com/intl/cms/s/0/53e3395e-4042-11df-8d23-00144feabdc0.html#axzz1VLe1OWo0 ] [36: Portes, A., Smith, L. 2008. Institutions and Development in Latin America: A Comparative Analysis, Studies in Comparative International Development, Jun2008, 43 ( 2),101-128]

According to Venture Equity Latin America (VELA), Colombia is highly underrepresented in venture capital transactions. For instance, Colombia represented only 37 transactions of the 1403 in VELA[endnoteRef:37]. The environment is, however, improving. According to the Latin American Venture Capital Association (LAVCA), Colombia ranked fourth among Latin American economies with the most favorable environment for private equity investment (only behind Chile, Brazil and Mexico). [37: Charvel, R. 2009. Is Private Equity Out of Control in Latin America?, Journal of Private Equity, 13(1),80-88,]

The underdevelopment of the Colombian stock market can be attributed to the demand and the supply sides. In terms of the structure of corporate Colombia, the largest firms in the country have shown reluctance and resistance to list on the stock market. Being mostly family-owned, they are characterized by a conservative mindset and thus tend to avoid volatility in equity markets[endnoteRef:38]. As in Mexico, the Colombian middle classes are much more inclined toward real estate investments than putting their money in the stock market[endnoteRef:39]. Due primarily to underdeveloped capital market, Colombia-bound foreign investors do not have a lot of investment choices other than in the property market[endnoteRef:40]. [38: Rathbone, J. P. 2010. Capital markets: Investors require patience more than nimble financial footwork, April 6 2010, http://www.ft.com/intl/cms/s/0/53e3395e-4042-11df-8d23-00144feabdc0.html#axzz1VLe1OWo0 ] [39: Portes, Alejandro; Smith, Lori. 2008. Institutions and Development in Latin America: A Comparative Analysis, Studies in Comparative International Development, Jun2008, 43 ( 2), 101-128] [40: Rathbone, John Paul. 2010. Capital markets: Investors require patience more than nimble financial footwork, April 6 2010, http://www.ft.com/intl/cms/s/0/53e3395e-4042-11df-8d23-00144feabdc0.html#axzz1VLe1OWo0 ]

Colombia’s small businesses and people have traditionally lacked access to banking and finance. One estimate suggested that even in the capital city, Bogotá, fewer than 40% of families had access to the financial system in 2007[endnoteRef:41]. [41: Moreno, L. A. 2007. Extending financial services to Latin America's poor.McKinsey Quarterly, Special Edition, 83-91]

While banks in many developing countries seem to be adopted too conservative lending policies, Colombian banks have been reasonably well managed. One indicator to look at is the liquidity ratio of liquid assets to total deposits. Banks in most developing countries tend to exhibit a high propensity to maintain high proportions of their assets in liquid forms such as cash, deposits with other banks, central bank debt, and short-term government securities. For instance, in a study of a of sample of 35 developing countries, the mean of liquidity ratio was 45% and the ratio was 126% in Argentina compared to 2% in the United Kingdom and 6.5% in the U.S.[endnoteRef:42] Liquidity ratio for Colombia was 33%. [42: Freedman, Paul L.; Click, Reid W. 2006. Banks That Don't Lend? Unlocking Credit to Spur Growth in Developing Countries. Development Policy Review, 24(3), 279-302.]

Colombia’s foreign remittances are higher than most Latin American countries. In 2006, Colombia ranked third among Latin American countries in total remittances received, just behind Brazil and Mexico. As a proportion of GDP, remittances accounted for 3.3% of GDP in Colombia compared to 0.3% in Brazil and 2.9% in Mexico[endnoteRef:43]. [43: International Fund for Agricultural Development. 2007. Sending Money Home: Worldwide Remittance Flows to Developing Countries. Rome: International Fund for Agricultural Development.]

Big multinationals such as Citibank and McDonald's have entered the country. Call centers serving the world are proliferating in the capital city, Bogota[endnoteRef:44]. FDI in Colombia averaged $9.1 billion a year between 2005 and 2008[endnoteRef:45] and was $9.5 billion in 2010[endnoteRef:46]. This surge in FDI can be primarily attributed to an improvement in security. The FDIs were market access-seeking types, focusing on national as well as regional market. The “principal focal points” of FDI in Colombia included financial services, electricity and gas distribution[endnoteRef:47]. During the 1990s, foreign ownership increased from 10% to 24% in the Colombian banking sector[endnoteRef:48] . [44: Dawsey, Josh; Arora, Rupali. 2011. The Best New Cities for Business Fortune, 7/25/2011, 164 (2),151-158] [45: falseMapstone, Naomi. 2009. Economy: Safer, calmer, lucky, more prosperous FT.com (Sep 23, 2009).] [46: \Markey, P. 2011. Colombia sees FDI rising to $10 billion in 2011, Mar 31, http://www.reuters.com/article/2011/03/31/us-latam-summit-colombia-trade-idUSTRE72U5EJ20110331] [47: Mortimore, M., Vergara, S. 2004. Targeting Winners: Can Foreign Direct Investment Policy Help Developing Countries Industrialise? European Journal of Development Research, 16(3), 499-530.] [48: Andrade, Luis F.; Barra, Jose M.; Elstrodt, Heinz-Peter.2001. All in the familia. McKinsey Quarterly, Special Edition, Issue 4, 81-89.]

Access to market

For many Colombian firms, maximum potential is reached in their home market. The domestic market thus offers little growth opportunity. They have realized that the only way to grow would be to expand in foreign markets, possibly through M&A. An underdeveloped equity market has been a major challenge[endnoteRef:49]. The country reached a free trade agreement with the U.S. in 2011, which has increased market access for its firms. [49: Rathbone, J. P. 2010. Capital markets: Investors require patience more than nimble financial footwork, April 6 2010, http://www.ft.com/intl/cms/s/0/53e3395e-4042-11df-8d23-00144feabdc0.html#axzz1VLe1OWo0 ]

Entrepreneurial capabilities: R&D, innovation, and technology adoption

Colombians have an abundance of entrepreneurial curiosity and interest. For instance, the world’s top two cities from where per capita Google search for the management thinker "Peter Drucker" originated from were Bogotá and Medellín[endnoteRef:50]. An article published in Brand Strategy[endnoteRef:51] even goes as far as to say that Colombia’s Medellin city has “the most dynamic and professional business culture”. Colombia also has an advantage in the development of business process outsourcing. Analysts point out that Colombians speak “clear, unaccented Spanish” [endnoteRef:52] [50: Farzad, R. 2007 Extreme Investing: Inside Colombia, May 28, 2007, http://www.businessweek.com/magazine/content/07_22/b4036001.htm, ] [51: Clifton, D. 2007. Mas y mejor for Latino brands. Brand Strategy, Issue 217, 54-55.] [52: Dawsey, Josh; Arora, Rupali. 2011. The Best New Cities for Business Fortune, 7/25/2011, 164 (2),151-158]

One observation was that Colombia lacks absorptive capacity and has failed to develop its technological capabilities to effectively utilize FDI inflows as well as foreign development assistance[endnoteRef:53]. The country spends very little on innovation and technology. Colombia’s R&D is spending is estimated at around 0.3% of GDP [endnoteRef:54]. According to a study conducted by Microsoft across 30 countries, investment in IT was the lowest in Colombia[endnoteRef:55]. Among the BBC World Service’s 24 "most entrepreneur-friendly nations" Colombia was found to have "the least well-developed culture of innovation and entrepreneurship"[endnoteRef:56]. About two-thirds of the Colombian respondents surveyed by the BBC World Service disagreed with the statement that innovation and creativity were valued in the country. [53: DATAMONITOR: Colombia. 2010. Colombia Country Profile, 2010, 1-75. ] [54: DATAMONITOR: Colombia. 2010. Colombia Country Profile, 2010, 1-75. ] [55: Bahree, M. 2008, Knitters Without Windows. Forbes, 9/29/2008, 182(5), 74-77,] [56: Alsema, A. 2011. Colombia lacks 'culture of innovation and entrepreneurship': BBC, http://colombiareports.com/colombia-news/economy/16532-colombia-lacks-culture-of-innovation-and-entrepreneurship-bbc.html 25 May]

For many Colombian businesses local diversification was traditionally the only way to grow due to factors such as protectionism and foreign-exchange restrictions[endnoteRef:57]. One upshot of this tendency, as in many other Latin American countries, is that Colombia lacks a mature corporate governance culture. Many industries in Colombia are dominated by pre-modern traditional patriarchal family-owned businesses, which are characterized by concentrated ownership structures. They tend to have an expectation of family succession. The country’s businesses are adopting responsible business practices and codes of conduct[endnoteRef:58]. [57: Andrade, Luis F.; Barra, Jose M.; Elstrodt, Heinz-Peter.2001. All in the familia. McKinsey Quarterly, Special Edition, Issue 4, 81-89.] [58: Rumsey, J. 2008. High standards are the exception. Euromoney, 39 Issue 467, 134-135. ]

Conclusion

Various elements of the Colombian entrepreneurial ecosystem have witnessed a dramatic progress in the past decade. To some extent, a whole ecosystem developed around drug entrepreneurship has made it challenging to develop productive entrepreneurship in the country. Dismantling the ecosystem is not an easy task. On the plus side, security situation in Colombia has drastically improved, which is an important precondition for entrepreneurial development. Most potential foreign investors, however, have not yet realized this progress. Policy makers, entrepreneurs and other institutional actors need to take measures to change the country’s image as a lawless, violent and dangerous place.

Case questions:

1. As noted in Chapter 1, the OECD has described the determinants entrepreneurial performance in terms of six categories: regulatory framework, access to capital, access to R&D and technology, entrepreneurial capabilities, market conditions, and culture. How did violence in Colombia affect each of these determinants? How have some of them changed in recent years?