The Importance of New and Small Firms Policy Implications

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The Importance of New and Small Firms-- Policy
Implications?

• Per Davidsson
• Queensland University of Technology
• Brisbane Graduate School of Business

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• Whats attributable to new and what is
  attributable to small?
• Correlated and confounded
• Some probably genuinely due to small other to
  new
• On balance, my personal conviction is that new
  is the major issue

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Small/New Firms Very Important for Job Creation

• David Birch (1979) first longitudinal analysis
  surprise finding that the vast majority of net
  new jobs was attributable to small firm birth and
  expansion (over contraction and death)
• Confirmed in numerous studies in many countries
  in 80s and onwards (e.g., Davidsson et al., 1994
  BLS, 2006 Oz data see, e.g., www.abs.gov.au/Ausst
  ats/abs_at_.nsf/0/5ebe1496169c5d31ca2569de002842b6?Op
  enDocument
• Critique Harrison (1994) Davis et al. (1996)
  Parker (2006Oz)
• Even more than meets the eye Young and Small
  firms grow organically old and large ones grow
  via acquisition (Davidsson Delmar, 2006)

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Small/New Firms Important for Innovation

• Schumpeter (1934) Innovation drives the economy
  outsiders innovate
• Recent example of (partial) support Cliff et al
  (2006)
• Arrow (1983) Organisational properties of small
  firms make them overrepresented as innovators as
  long as development costs are not prohibitive
• Acs Audretsch (1990)
• Largely supports Arrow
• Input vs. Proxy vs. Output measures
• Innovation backtracking multiple-case studies
• Critique Kleinknecht debate Small Business
  Economics, early 90s

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Small/New Firms Important for Regional/National
development

• Reynolds (1994 1999)
• Davidsson et al (1994 1995)
• EIM-GEM research on national level micro data
  Stel et al (2005) Wennekers et al (1999 2005)

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New entry important for industry development

• E.g. Geroski (1995) Stylized result 5 High
  rates of entry are often associated with
  innovation and increases in efficiency
• i.e., innovation again, but not just product
  innovation
• NB! Entry NE New Independent Firm

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Mice vs. Gazelles

• Some find/argue it is a small elite that creates
  all the effect others find/argue the aggregate
  effect is the result of the many, many minuscule
  contributions by countless, mundane firms
• Gazelles (high-growth firms) e.g., Birch
  Medoff (1994)
• High-tech/high-potential firms e.g., Storey
  (1994) Wong et al (2005)
• Mice e.g., Delmar Davidsson (2006) BLS
  (2006)

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Small/New Firm Policy some general sources

• Louis Stevenson and Anders Lundstrom (2001 and
  onwards various works)
• David Storey (1994 2000)
• Rachel Parker (2001 Aus/QUT-based critical
  perspective)

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Policy Alternatives

• Start-up support to all / broadly
• Selective support to high-potential start-ups
• Hands Off
• Create a supportive institutional framework

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Government should provide support for new
businessBen Ives

• The Government should provide support for new
  business either broadly or selectively

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Governments role in the economy

• Government has a great deal of knowledge and
  dedicated personal examining the National economy
  in a local and global context.
• Despite the common stigma that is held by the
  general public, Government personnel are well
  researched and acting for the benefit of the
  nation.
• Part of their role in managing a nation is
  providing a supportive economic climate, both now
  and for the future.

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Governments role in the Economy

• Government is a place where ideas come together,
  research is undertaken and rational views and
  informed decisions take place.
• Government is the medium where initiative can be
  shown to further economic development and
  prosperity.

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Governments role in the Economy

• Government is the elected body whos role
  (amongst other roles) is to oversee Economic
  development.
• Thus, it should prudently provide support for
  business.

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Reasons to Support New Business The Usual
Reasons Given (for right or wrong)

• Innovation.
• New jobs/decrease unemployment.
• More choice.
• More diversification (in the national economy).
• Support Emerging Industries.
• Increase Competition.

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Inefficiencies related to the Unrestricted Market
Detrimental to New Business

• Unfair Competition.
• Often, business would be profitable and efficient
  if it existed, however often there is a similar
  business already in operation.
• The previously existing business could have an
  advantage in that it is able to take a loss and
  price unprofitably low for an amount of time that
  results in a impediment for the new business to
  enter and remain.
• Thus, Government can support the new business
  through the development of Unfair Competition
  regulations. However, this is probably
  categorised as institutional environment related
  support.

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Inefficiencies related to the Unrestricted Market
Detrimental to New Business

• Inability to access capital/loans due to excess
  focus on Net Present Value of cash flows and
  disregard of intangible benefits of business.
• This could include improvements in societal
  well-being, skills improvement, environmental
  factors.
• Many financial institutions, when processing loan
  requests, only look at the Net Present Value of a
  Project. Businesses with negative NPV would then
  be disregarded. Thus, through its support,
  Government can ensure that a business is
  reimbursed for the positive externalities it
  produces.

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Redistributive Benefits

• Another role of Government is to redistribute
  wealth throughout society.
• Often, the low/negative profit margins of a
  business may result in it being an underdeveloped
  project.
• However, in the interest of redistribution,
  supporting a business may result in benefits to
  lower-wealth groups of society.

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Redistributive Benefits

• For example, a business may be unprofitable,
  however through its existence may result in
  employment and skill development of individuals
  who would not otherwise obtain this opportunity.
• Thus, through the use of high-income individuals
  tax-revenues, Government can support
  low-profitability business to enhance the well
  being of society through increased employment and
  skill-development of low-income low-skilled
  groups.
• This could be seen to have greater societal
  benefits than simple welfare-payment systems.

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Redistributive Benefits

• The redistributive effects of the additional
  employment in the business to low income/low
  skill groups could be seen as a preferable
  situation.
• The New Business and employment opportunities may
  be the only/optimal means of obtaining this
  situation.
• This may be seen as an economic dead-loss, but a
  more social ideological climate could favour such
  a situation.
• For example, the increased employment of this
  low-income, low-skilled group may be seen as
  being preferable than distributing the wealth
  through welfare payments/institutional training
  etc.

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Methods of support

• Subsidised/cheap/available loans.
• Tax Breaks.
• Monetary Payments.
• Through these methods, Government can give an
  inherent value to any beneficial externalities
  that may be derived form the business.

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Selective Support/Criteria

• Obviously, providing broad support to all new
  businesses is not efficient or rational. However,
  providing broad support that has underlying
  selective requirements that business must
  accomplish to be eligible for support makes
  intuitive sense.
• Support for new business shouldnt be made
  available to new business unless it has a
  rational purpose that is beneficial to society
  (i.e. those who are providing the funds to supply
  the support).

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Selective Support/Criteria

• Thus, selection criteria are required to
  determine which businesses should receive
  support. These could include
• Providing support to Businesses who provide a
  positive externality to society (thus, the
  support paid by government could account for the
  positive value of the externality).
• Providing support to Businesses that is
  forecasted to be prosperous in the future however
  has difficulty obtaining capital at present for
  certain reasons.
• Providing support to Businesses that creates a
  desired social impact, for example a benefit to
  lower skill groups/lower income groups that is
  otherwise not readily obtainable or replicable.

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Requirements of Business to receive Support

• In providing support of business, Government can
  incorporate requirements that the business must
  abide by to receive the support.
• This allows government to further ensure or
  increase the positive externalities received from
  the business.
• Thus, through its support, the Government can
  optimise the positive externalities associated
  with the business receiving support.
• These requirements may have low cost but low
  development to the business, and otherwise would
  not have been implemented.

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Requirements of Business to receive Support

• Requirement that business could be required to
  meet to ensure maximising positive externalities
  could include
• Businesses having to meet certain levels of
  employment standards, such as training. Training
  provides a level of skills to employees that
  otherwise would not be obtainable elsewhere.
• The use of environmentally friendly processes.
• Incorporating certain employment practices.

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The Public are Better Deciders on how to Spend
their Money

• If this was so, why do externalities with
  positive benefits continue to arise?
• If the market was efficient, there would be no
  need for Government to support new businesses
  impeded from entering the market, as all business
  opportunities that were overall beneficial to
  society would be undertaken.

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The Government Cant Pick a Winner

• Government is the best body available to oversee
  policy construction related to business
  prosperity.
• If there is a perceived need to adjust for
  inefficiencies caused by the market, it is the
  Governments role to remedy this situation.
• Thus, emphasis must be placed on selection
  criteria for what businesses receive support,
  thus ensuring diligence and completeness in
  assessment of support given.

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The Government Cant Pick a Winner

• We arent asking Government to be Fund
  Investments Managers
• Government is societies organisation for
  correcting market failure, so it is its role to
  be supportive of industry that would be
  beneficial to society. Perfect economic
  efficiency and maximising returns/profits may be
  obtainable in theory, but economic theory rarely
  translates perfectly to the real world. Part of
  the use of economics is to accept the
  imperfections in the world and incorporate them
  into positive policy setting. As soon as
  trade-offs begin to be made through social
  policies and it is accepted that information
  isnt homogenous across individuals, the prospect
  of society being anywhere near optimal economic
  efficiency cant hold.
• Economic theory isnt the only objective
  dictating public policy. A purely liberal economy
  would have no government intervention, and
  assuming rational, informed individuals could
  reach economic efficiency and maximise
  returns/profits. But society also has additional
  values aside from maximising overall returns.
• Government is entrusted to fulfil this role of
  organising public projects across many sectors
  including health, education and defence. They
  should also fulfil this role in supporting
  business that fails due to imperfect markets.

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A Metaphor Imagine if Libraries didnt exist

• Libraries are extremely low revenues, however
  there is no doubting the high social benefits
  they have, including
• Developing library professionals with a skill set
  that can be utilised by the community that is
  unobtainable anywhere else.
• An obtainable source of information to society,
  again not replicated elsewhere in society.
• Many library-based programs that add value to the
  community.
• Allows skills of employees to develop.
• Furthers the education and culture of society.

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A Metaphor Imagine if Libraries didnt exist

• No financial institution would provide loans to
  develop a Library as its cost of capital would
  not be realised. The entirety of the Libraries
  value falls upon externalities to all of society.
• People in a community may be willing to support
  the development of a Library, however a project
  such as organising the gathering of capital
  requires an organised institution overseeing the
  project.
• Thus, it is in societies best interests for
  Government to realise and ensure the libraries
  of society are developed.
• Governments role is not entirely focused on
  maximising returns, but to oversee societys
  wellbeing, manage inequality and be a central
  organiser of public wide projects.

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Summary

• All of these above points discussed have one
  underlying point
• If there are positive benefits to be gained from
  the existence of a business to society that is
  not encapsulated in the businesss
  returns/profits, then it is in the Governments
  interest to intervene and provide assistance to
  this business to ensure its continual operation.

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Summary

• Government should be seen as an entity that
  allows the inefficiencies caused by market
  failures (i.e. not accounting for the positive
  effects of externalities) to be remedied.

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Dont pick winners but allow them to emerge

• Redzo Mujcic

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Past and potential failures

• US govt ? retain textile and footwear jobs at
  home via limits on imports and a host of local,
  state and government subsidies.
• US uncompetitive in nearly all sectors of textile
  industry (relative labour costs too high)
• Market Solution- allow industry to die off in US
  and shift labour to other industries where the US
  retains comparative advantages (e.g. services).
• Similar story about US govt interference in
  domestic steel industry.

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Past and potential failures

• EU govt supporting uncompetitive farm industry.
• Total employment of around 7 of EU workforce in
  agriculture.
• However, half of the EU budget spent on
  agricultural support.
• Each European cow receives 2.50 a day in
  subsidies.

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Past and potential failures

• EU subsidies to aircraft manufacturer Airbus
  (infant industry).
• Airbus has 50 of market share (relative to
  Boeing).
• Ongoing conflict US demands removal of subsidy

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Market failure surrounding govt intervention

• Asymmetric information (potential entrepreneurs
  know more than the policy maker)
• Can the govt identify innovative/strategic firms?

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• Some firms at the margin that are more valuable
  to the economy than others
• Require some reasonably reliable way of
  identifying which firms these are
• One possible criterion firms within
  industries/sectors where there is substantial
  rent where the return to labour or capital is
  exceptionally high.

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Complications

• Several factors complicate the process
• 1. Separating rent from quality differences
• 2. Only counting the successes, not the failures
• 3. Windfalls do not accrue to new firms

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Contradictive government intervention

• 2 examples

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Market for good A
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Market for loanable funds
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Institutions

• The state has a critical role in fostering and
  nurturing a competitive market place. Property
  rights, an adequate legal system, and
  infrastructure.
• level playing field / easily observable quality
  indicators (education qualifications / quality
  marks) transparent and relatively low red tape
  tax and health/safety regulation close down
  alternative opportunistic avenues (corruption/
  market distortions) etc.