Why big business is better

The Business Secretary Vince Cable speaking at the Lib Dem party conference in 2011The Business Secretary Vince Cable speaking at the Lib Dem party conference in 2011 (Source: Dave Radcliffe)

Received wisdom tells us that small business is important. Political parties representing all shades of opinion clamber to show that they are the ones who have the interests of small businesses at heart, even if they have more mixed opinions of large corporations. The Conservatives describe small business as the “lifeblood of our economy”; Labour promise to decrease small business rates while reversing cuts to the corporate tax rate; UKIP are in good company in claiming to be “the party of small business”; The Green Party want to tax small business at a lower rate than multinationals; The SNP proudly talk of their record in offering small business rates relief to the north of their desired border. For some reason, our collective imagination places small business on a pedestal, imagining small business owners to be stoic individuals at the cutting edge of economic growth. There is a great deal of evidence to suggest otherwise.

Hurst and Pugley from the University of Chicago find that more than 50% of new small businesses are created for non-pecuniary reasons such as “wanting flexibility over schedule” and “wanting to be one’s own boss”. In contrast, it would be difficult to find a manager of a FTSE 100 company who went into that field so they could knock-off at four and avoid checking their emails over the weekend. This means that measures to help small businesses may partly be effective subsidies of the lifestyle decisions of owners. In contrast, a very small proportion of large firms do much social good. The UK Business Statistics Report finds that just 0.1% of firms provide 40% of employment and produce 53% of turnover. In contrast, 76% of firms have no employees and produce just 7% of turnover. Many of these will be simple vehicles created to undertake activities without putting the owners’ assets at risk. Others will be sole-traders in industries where the benefits of organising with other individuals are low. Regardless of these motives, it is not clear why these ought to be encouraged beyond other types of businesses. Small firms are also likely to have less robust HR practices and are significantly more likely to hire on the basis of previous friendship or relation than larger organisations with greater accountability.

Net job creation data appears to paint a more cheery picture of small business. However, Kelly Edmiston of the Kansas City Federal Reserve Bank shows that these data are misleading. Although 80% of net new jobs in the United States between 1990 and 2003 were created by small business, they are responsible for just 30% of gross new jobs. The apparent success of small businesses is therefore explained not by superior job creation ability, but rather job losses in larger firms. This may partly be explained by the decline of some large firms clustered in sunset industries. Remuneration statistics also paint a gloomy picture: in 2004, the Bureau of Labor Statistics found that businesses with less than 100 workers paid almost 25% of their employees less than US$8/hr as compared with 3% at businesses with more than 2,500 workers. Wage growth is also higher at larger firms, suggesting this gap might increase over time. These differences remain after controlling for demography, levels of monitoring of workers, industry and fringe benefits (which also tend to be lower at smaller firms). One possible explanation comes from differing levels of unionisation, with collective bargaining being more likely to be implemented at larger firms. However, it seems unlikely that Labour’s appeal to small businesses is supposed to be based on the justification of reducing wage levels by encouraging the success of less unionised firms.

In 2011, wages at small firms in the United States were on average 66% of those in larger firms. However this does not imply that traditionally lower wage groups are more likely to gain employment in SMEs. In fact 48% of the workers in large enterprises are female, compared to 45% at small firms. Similar results are found for most ethnic minorities, with the exception of Hispanics. Large firms are frequently criticised for a lack of diversity in company leadership, with women making up just 22% of the membership of FTSE 100 boards. Small business is no different, with 18% of SMEs in the UK being led by women.

Obviously some of the large businesses of the future will be found among the small businesses of today. However, it should be clear from this discussion that this should not necessarily be used as an excuse to help all small firms uniformly. There may be a place for policies that seek to target high-growth small firms. We do, however, tend to overemphasise the role played by disruptive innovations like Uber relative to the micro-innovations that occur all the time at companies like General Electric, Philip Morris International and Procter & Gamble. While more efficient methods of manufacturing toothbrushes may be substantially less interesting, these small inventions form a substantial part of overall growth. Large firms have a clear edge on overall research and development. The Economist reports that American firms with at least 5,000 workers spend more than twice as much per worker on research and development than firms with 100-500 workers. Unless we can create incentives that specifically target disruptive and innovative small firms, it seems prudent for policy makers to abandon the focus on small business as a homogenous class and instead work on helping all firms to achieve success. Considering the relative lack of research spending, high wage jobs and wage growth in smaller firms, we have cause to be concerned if SMEs really are the lifeblood of our economy.

  • Graeme Bird

    False advertising. The conclusion in the title is in no way shown in the article itself.

    “Economist reports that American firms with at least 5,000 workers spend more than twice as much per worker on research and development than firms with 100-500 workers.”

    This is neither here nor there. Technological improvement is imbedded in capital accumulation and update in a competitive economy. Its not a function of research department spending. Of course the little guys don’t open an R&D department. It means nothing.

    “Considering the relative lack of research spending, high wage jobs and wage growth in smaller firms, we have cause to be concerned if SMEs really are the lifeblood of our economy.”

    Small business may not be the lifeblood of a CRAP economy. Like the useless embarrassment of an economy the English-speaking countries have in this day and age. But small business has always been the lifeblood of a HEALTHY economy. When northern England and Southern Scotland were kicking off the industrial revolution Napoleon said that England was a “nation of shop-keepers.” That is to say a nation of small business owners. Thats when they were on their way to being unbeatable.

    Artificial persons are an imposition of the free market. What you have to show, and what you cannot show, is that these big businesses are what drives a HEALTHY and durable economy. Not a losing economy, dominated by proven failures in banking, unable to pay its way in the world, and basically on the way out if it doesn’t get a small business revival. There was a small business revival in the late 70’s early 80’s in the US. But thats over now. These are crap economies, these ones where proven losers get a free ride in gigantic businesses.