# **III. HOW DOES ENTERPRISE RISK MANAGEMENT THROUGH REALLOCATION AND INNOVATION IMPACT PEOPLE?**

This section discusses how resource reallocation and innovation supported by investments in KBC can help most people better manage risks, both indirectly through their impact on the enterprise sector’s risk management, and directly through their impact on people as consumers and as owners of physical capital, ideas/technologies and labor.

# **_III.1 Impact on the enterprise sector_**

Efficient resource reallocation and innovation by enterprises can positively affect the risk management of the enterprise sector as a whole, by helping all enterprises to self-protect and capture opportunities from better adapting to changes. In particular, the decisions by firms to scale up existing activities or invest in new activities, even when these decisions result in failure, are helpful, as they allow evolutionary learning both for the failing firms (provided the business environment allows them to re-enter with renewed access to financing following efficient bankruptcy proceedings) and for the enterprise sector as a whole (provided that the business environment has mechanisms in place to facilitate such positive learning and spillovers).<sup>30</sup> However, absent appropriate policies, enterprise reallocation and innovation can lead to a concentration of productivity gains in a small number of formal firms in only one or a few industries, and insufficient spillovers and economy-wide learning – with negative broader impacts including an insufficiently resilient enterprise sector with not enough creative destruction across industries (see Box 3).

**Box 3. Israel’s software development: Insufficient spillovers leading to a less resilient “dual economy”.**<sup>**31**</sup> As documented by Trajtenberg (2009), Israel’s pre-2000 innovation policies largely benefited its ICT (Information and Communications Technology) and especially software industry. It provides a compelling illustration of how innovation-driven growth is not necessarily resilient and inclusive. It also provides valuable lessons in the design of more diversified (across industries and hence less risky from an economy-wide perspective) and more inclusive innovation policies. By the late 1960s, Israel had reached what may now be termed a middle-income trap: the big waves of immigration had subsided, and though Israel had few natural resources, it had highly skilled manpower and scientific and technological prowess. The question facing policymakers was how to mobilize these assets for faster growth. Public support policies, together with other contributing factors, resulted in growth of 16% per year in the ICT industries during the 1990s, with ICT exports growing over the 1990s by a factor of 6 and accounting for one third of total exports. However, in many other industries, TFP actually declined on an annual basis between 1996 and 2004, including transportation (-0.4% per annum), construction (-2.0%) and retailing and business services (-3.3%), leading to a dual economy with a large share of the benefits flowing to firms and consumers abroad. Trajtenberg argues that this was in large part due to inappropriate policies that focused on: (i) product innovations rather than also on other types of process, design and organizational innovations; (ii) exports rather than benefits for the rest of the economy; and (iii) local MNC labs only serving the global needs of the parent companies located outside the country. A key conclusion is the desirability of avoiding narrowly-targeted policies, and instead for policies to be directed at fostering spillovers to the rest of the local economy, ensuring wherever possible that the

> 30 See Taleb (2012). 31

> In addition to Trajtenberg (2009), on which this box draws heavily, see also Teubal and Kuznetsov (2012).

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