Businesses Big and Small

James Surowiecki in the latest New Yorker takes a look at the championing of small businesses - particularly timely now that the presidential primary is hotting up.

Given that the overwhelming number of American businesses are small, and that, as we’ve all heard, small businesses create most new jobs, this seems reasonable enough. But the truth is that, from the perspective of the economy as a whole, small companies are not the real drivers of growth. One can see this by looking at the track record of the world’s economies. The developed countries with the highest percentage of workers employed by small businesses include Greece, Portugal, Spain, and Italy—that is, the four countries whose economic woes are wreaking such havoc on financial markets. Meanwhile, the countries with the lowest percentage of workers employed by small businesses are Germany, Sweden, Denmark, and the U.S.—some of the strongest economies in the world.

This correlation is not a coincidence. It reflects a simple reality: small businesses are, on the whole, less productive than big businesses, and though they do create most jobs, they also destroy most jobs, since, while starting a business is easy, keeping it going is hard. This is true around the world. A recent study by the World Bank that looked at ninety-nine developing countries found that large firms had significantly higher productivity growth. And in the U.S. the connection between size and productivity is, as a 2009 study showed, especially close. In part, this is because big businesses are able to enjoy economies of scale and scope. Big businesses are also better able to make investments in productivity-enhancing technologies and systems; in the U.S., for instance, big companies account for the vast majority of R. & D. spending.

I think another way of thinking about this is that very successful small businesses tend to grow. So when you observe a cross-section the smaller ones are the ones that either are not good enough to grow (and here I am not talking about the little grocery store on the corner which serves a local market but ones where scale economies exist) or are on the path but haven't gotten there yet.  So I think the emphasis should not be on small versus large but on start-ups: a healthy economy produces many start-ups, most of whom will fail but a few will become the Googles of the future.  Here is a very interesting academic paper that I think makes essentially the same point (judging only from its abstract- it has been added to the pile of paper in my "to read" stack).