aversion’. Many formal firms do not even _decide_ not to invest in fragile states: they know not to pose the question.

This uncertainty also affects the investors that a firm needs to attract. In the absence of an established industry, it is difficult for investors to evaluate the risk profile of an investment. Investors like to model risk based on data. But at the point at which pioneering firms need to invest, there are little or no data to guide their investment decisions. Again, the activities of the pioneering firms that do go ahead benefit the firms entering later because the risk premium of investors can be better calibrated by looking at the experiences of the pioneer firms.

# **_Who pioneers in fragile states?_**

The World Bank Enterprise Surveys (WBES) is a unique source of economic data to address this question. The WBES uses a pool of 131,000 firms from 139 developing countries, including many that are listed as fragile and conflict-affected. The data have been collected since 2006 using a harmonized methodology to ensure cross-country comparability.<sup>12</sup> Pioneering firms in the survey are identified as those that have innovated by introducing new products or services to the fragile state over the last three years. These include new products or services for an establishment’s main market, or a new or significantly improved process during the last three years. The new firms among the pioneers, which are of particular interest because of their financial needs, can be identified as firms that are less than five years old.

Since pioneer firms play such an important role in economic development, it is unsurprising that there is a clear relationship between the proportion of firms that are pioneering, and the income level that the country has reached. In states that are not fragile, this pattern emerges strongly: the proportion of firms that are pioneers is highest in low-income countries, where the opportunities for harnessing scale and specialization in production abound. Conversely, pioneers decline as income rises, and countries become lower-middle income countries and upper-middle income countries (see Figure 1). This is important because it implies that the impediments are not so overwhelming that feasible public policy interventions would be doomed to ineffectiveness. If pioneering is already common in fragile states, it could be increased to the level appropriate for the state’s level of income.

But fragility systematically undermines the process through which opportunities are discovered. At each income level, fragile states have a substantially smaller proportion of pioneer firms. And, to the extent that fragile states are among the poorer within each income group, then the effect of fragility might be even more pronounced than what the summary statistics suggest. However, while fragility systematically discourages pioneering, it does not kill it off. Despite the disadvantages, the evidence suggests that almost half of firms innovate in one way or another (see Figure 1, left panel). This is important because it implies that the impediments are not so overwhelming that feasible

> 12 The surveys only represent a country's non-agricultural economy. Manufacturing and services are the primary sectors of focus, with services including construction, retail, wholesale, hotels, restaurants, transport, storage, and telecommunications. Mining and financial services, which attract significant investment in fragile states, are excluded. This also excludes firms that employee fewer than five workers, as well as wholly state-owned enterprises.

6