New business formation and regional growth across regions with distinct initial industry structures

The paper focuses on regional determinants of entrepreneurship. It basically asks the question which effect different regional characteristics have on new business formation rates in an economy where the level of start-up activity is more or less "zero" across regions since entrepreneurship is restricted, but immediately allowed by a mainly exogenous shock to unfold. Such an exercise can be carried out by examining an economy that has experienced a heavy shock to its economic development, such as a transition from a socialist to a market economy. A snapshot of the socialist economy on the eve of its transition toward a market economy reflects its initial conditions, just before the unleashing of market forces. The introduction of the new economic system led to an emergence of new businesses which was mainly prohibited before. East Germany: the former German Democratic Republic (GDR) especially applies for this empirical exercise. There, the transition was a sudden shock, mainly induced exogenously. In a nutshell, the formerly socialist East Germany, where entrepreneurial activities were nearly absent, reunified with West Germany, an established market economy. The former East Germany adopted the market system immediately and the reunification implied a massive structural change of the East German economy, accompanied by the privatisation of state-owned firms (a "top-down transition") and - what is most important in the context of this paper - by new business formation (a "bottom-up transition"). So far, the regional dimension of new business formation, in the context of transition, has been explored only to a limited degree. However, after the transition, regional differences in regard to entrepreneurial activities promptly occurred. So, an analysis of regional factors that explain the rise of entrepreneurship are of interest in addition to the proposed the idea in regard to the role of initial regional condtions. Drawing from unique data about the industrial composition of East German regions on the eve of the country's transition toward a market economy, we find that initial regional conditions explain many differences of regional start-up rates in the aftermath of transition.