Small Businesses Are not the Key to Economic Growth
Small businesses are usually touted as the driving force behind economic growth in modern societies. Throughout the world, politicians earnestly argue that small businesses are the backbone of the economy. In America, there is even an administration dedicated to building the capabilities of small businesses known as the “Small Business Administration.” The SBA oversees a dazzling suite of services to small businesses and is strangely insulated from criticisms.
Republicans and libertarian commentators in the media have upbraided the EXIM Bank for fostering crony capitalism. Generally, right-leaning economists scrutinize subsidies and special privileges, but despite the benefits accrued to small businesses – they remain a venerated symbol of American capitalism. Few seriously question their impact on economic growth or contribution to innovation. Instead, it is automatically assumed that small businesses generate prosperity.
But how did America’s fascination with small businesses emerge? According to historian Benjamin C Waterhouse the perception that small businesses hold the keys to economic dynamism is fairly recent. Waterhouse posits that the influential position occupied by small businesses in America, coincided with the election of Jimmy Carter who by situating himself as the first “small business owner” in the white house since Harry Truman infused lobbyists with energy.
Small businesses were also given a major boost when the findings of economist David Birch submitted that they were responsible for 80% of all new employment opportunities during 1968-1996. Although Birch recanted by admitting that the figure is dubious this statistic is frequently adduced to justify support for small businesses. Luckily, today there are ample studies guiding analysts to properly dissect the efficacy of small businesses.
Based on the data furnished by researchers it is evident that the importance of small businesses has been greatly embellished. For instance, innovation charity NESTA reported that during 2002-2008 in the United Kingdom, six percent of high-growth firms generated half of employment growth. Moreover, in their piece featured in the Harvard Business Review of Tuesday, February 3, 2014, Isenberg and Ross assert: “The literature consistently shows that a very small number, from one percent to six percent, or so, of all ventures in a region account for the lion’s share of net job creation and spill overs from entrepreneurship. However, increasing the number of start-ups has not increased the number of high-growth ventures.”
In fact, it appears that the reverse is true: small businesses are adept at making jobs redundant, since by the end of a decade 30 percent of small businesses remain viable. With such a dramatic failure rate the view that small businesses are initiators of jobs is indeed untenable. Similarly, libertarians may challenge Mariano Mazzucato’s theory that the state is necessary for innovation, but at least she is accurate in her summation of small businesses. Writing for the Economist she enunciates a clear case against prioritizing small businesses in Britain: “Once you take into account the number of SME jobs lost after the first three years of their creation, there is very little net job creation by these firms. Only 1% of new enterprises have sales of more than £ 1million six years after they start.”
On closer inspection, these findings are unsurprising because entrepreneurs are unequal in potential. Opportunity-driven entrepreneurs, on average, are more educated and often start businesses to capitalize on new challenges, whereas necessity-driven entrepreneurship is motivated by economic needs and typical of low-growth economies. Specifically, Robert Atkinson, the founder and President of the Innovation and Technology Innovation Foundation revealed to this writer in an interview that the typical small business owner rarely intends to form the next superstar, in essence, he is running a lifestyle business with little aptitude for expansion.
Economic literature also suggests that since firm productivity is associated with firm age, then on average, newer firms are less efficient in the management of resources. Economist Scott Shane in a seminal paper informs readers that high rates of new business formation are indicative of economic sluggishness: “As countries become wealthier the rate at which they create start-ups goes down. Societal wealth leads average wages to go up, which encourages business owners to use machines to replace work that used to be done by hand. As a result, the increased use of capital leads companies to grow in size and hire people who would have otherwise gone into business for themselves.”
Compared to large corporations small businesses are inept at ameliorating the conditions of workers as analysts based at ITIF points out in a recent report:
- Workers in firms with more than 500 employees earn 38 percent more than workers in firms with less than 100.
- Stores with 500 plus employees pay high school educated workers 26 percent more than stores with fewer than 10 employees, and they pay workers with some college education 36 percent more.
- In 2012, workers in goods-producing industries were injured 25 percent less frequently in firms with more than 1,000 employees than they were in firms with 10- 49 employees.
Big firms even offer more lucrative benefits:
- Workers in companies with more than 500 employees receive 85 percent more overtime and bonuses, 2.5 times more paid leave and insurance and 3.9 times more retirement benefits than workers in companies with fewer than 100 employees.
Large firms are resourced to provide an incredible array of benefits due to superior productivity:
- The four largest firms in any industry have an average 37 percent higher productivity and 17 percent higher wages for production workers.
Meanwhile the notion that Americans would be better off if the economy was dominated by small businesses is refuted by data:
- If the United States had the same firm size distribution as Europe which has more small firms then average annual income in America would be $5,200 lower. Shrinking the size of large firms in the United States to match Canada’s firm structure, would decrease U.S. per capita GDP by 3.4 percent.
In short, small businesses are not the pillar of the economy and neither is their performance superior to large corporations. Although the bureaucracy designed to enrich small businesses appears untouchable, the evidence presented should convince us that welfare for small businesses is unwarranted and must be gutted. Research foundations and private incubators can fill the gap created by the exit of government welfare. Funding unsustainable businesses is too costly for taxpayers.