Small is beautiful

One of the key myths of neoliberalism is the all-round wonderfulness of the small business. It is held up as the engine of innovation and job-creation, the founders as wealth-creators and entrepreneurs. The reality is that most small businesses are doomed to failure due to a lack of innovation and basic business competence. Even if it survives the initial baby turtle rush to the sea, the odds are that a small business will stagnate under a surfeit of egomania, delusion and complacency, and little more than a quarter will actually produce any employment beyond the founders themselves. In part this unjustified praise is just misdirection away from the practices of large corporates, but it also satisfies a sincere yearning for a more organic and human-scale economy. There was a good example of this, and the way it has infected thinking within the Labour Party, by Jackie Ashley in today's Guardian. There is an element of "good cop, bad cop" about the article, as she contrasts an almost comically-Blairite paper from Progress with a more "left" analysis from the IPPR. What's depressing is that both assume that encouraging small businesses can be the key to social justice.

The Progress paper is a mish-mash that tries to tie pro-growth (what it terms "pro-jobs") policies together with public service reform (i.e. cuts) and better targeting of tax and benefits (i.e. more cuts). What caught my eye was its advocacy of reductions in employers' national insurance contributions - a long-standing demand of the CBI and their ilk. National Insurance is routinely criticised as a "tax on jobs", and particularly as a disincentive to small businesses that want to grow, though it is no more so than corporation tax or income tax. What makes it unpopular is that it is difficult to avoid. Profit can be artificially depressed or transferred to lower tax jurisdictions, while income can be disguised through share options or payments in kind. NI isn't perfect, notably because the upper limit means that a high-profit hedge fund can end up paying no more than a break-even small firm, but it does generally correlate with turnover. It is a tax on jobs in the narrow sense that it is an incentive to automation, however this benefit is dwarfed by the savings on salaries, so it has a weak role at best. NICs are also a small consideration when deciding whether to employ another worker. You'll only expand production if you're confident of generating turnover way ahead of the increment in the cost base, as you'll need sufficient slack to cover the risk of a downturn in demand. NICs are too small to influence this calculation. If they become an issue, then your investment is already too marginal and you should back off.

The paper's proposed reforms to tax and benefits focus on restoring the contributory principle in order to discriminate between the deserving and the undeserving (i.e. the workshy). This takes the form of channelling benefits to those who have worked or have a reasonable expectation of working again (e.g. "funding an expansion of childcare by holding down increases in benefits to families" and "increasing maternity and paternity leave for those who have worked prior to having children"). The reform of welfare is predicated on the usual demographic scare stories, which provide justification for the pro-jobs strategy, i.e. we must boost employment and expand tax revenues to pay for elderly care. This in turn justifies the trade-off of lower tax credits for improved childcare, as well as freezing child benefit and means-testing pensioner benefits.

If you take a step back, it should be obvious that these policy proposals are pure neoliberalism, despite some gestures towards wealth taxes to fund social care. They aim at using the state's resources to maximise labour productivity for the benefit of business. Thus state-funded childcare frees up women to enter the labour market and benefits are biased towards the "employable" unemployed. While the conservatives worry about a tiny platoon of the feckless poor breeding, social democrats seek to add whole divisions to the reserve army of labour. What the authors fail to acknowledge is that the increase of women in the workforce since the 70s has merely served to ameliorate stagnating male wages, and there is no reason to believe that this dynamic will change as the pay gap between the genders continues. If anything, the recent evidence on the increase in part-time roles and the number of working families dependent on benefits means that the proposed trade-off is a mirage.

The IPPR paper is better insofar as it proceeds from an analysis of the real world, rather than popular prejudice, specifically the relative ineffectiveness of a New Deal-style stimulus (dismissed as "vulgar Keynesianism"), the economically damaging practices of high finance, and the deleterious impact of inequality on growth and debt. It makes a key observation: "In all major economies in the world, the most important, wealth-creating innovations have come increasingly to be concentrated in advanced sectors of the economy and among wealthy elites". The problem is that it then veers off into the land of popular myth when it comes to solutions: "The key goal of a reinvented industrial policy should be to expand the scope and reach of the vanguard sectors. Its chief target should be the small and medium-sized businesses that in every major economy in the world represent the chief sources of jobs and output."

SMEs do not provide the chief source of jobs or output. In the UK there are 4.8 million businesses, but 3.6 million of these have zero employees - i.e. they are sole traders, partnerships, or personal services companies. These 3.6 million "firms" account for 3.9 million workers out of the total of 23.9 million private sector employees. There are 1 million micro-businesses (1-9 employees) accounting for 3.8 million workers; 177,950 small businesses (10-49 employees) accounting for 3.5 million workers; 29,750 medium-sized businesses (50-249 employees) accounting for 2.9 million workers; and 6,455 large businesses (250+) accounting for 9.8 million workers. In terms of turnover, large businesses account for £1.6 trillion, while the micro-businesses account for about a quarter of this at £416 billion. The total turnover for the private sector is £3.1 trillion, so large businesses account for slightly over 50% on a basis of 41% of employees. If you include medium-sized businesses, i.e. all firms with 50 or more employees, this accounts for 53% of all private sector workers and 66% of total turnover (see this BIS report from October 2012 for the stats).

In summary, excluding firms with zero employees, small businesses (i.e. 1-49 staff) account for 37% of employed private sector workers and 30% of turnover; medium-sized firms account for 14% of workers and 15% of turnover; and large businesses account for 49% of workers and 55% of turnover.

As the ratio of employee share to turnover share shows, larger companies are more efficient than smaller ones, which is what you would expect given economies of scale and market power. This is important to bear in mind, as a growth in small businesses at the expense of large ones (i.e. net employment remains the same) would result in a reduction in GDP. It should also be borne in mind that many of these firms are business-to-business, i.e. they are specialist providers in a supply-chain. In other words, many of the smaller firms are dependent on the eco-system created by a larger firm, so a growth in small firms independent of large ones is improbable. It is possible for export-focused SMEs to coat-tail on foreign growth, at a time when domestic large firms are not expanding, but these are obviously a minority (it is estimated that only about a quarter of all businesses, excluding zero-employee ones, do some exporting, though the number whose turnover is predominantly export-led will be much lower).

Significant domestic jobs growth is usually the result of primary growth in big domestic firms (e.g. opening a new plant), which is then amplified among smaller suppliers, particularly in the locale. As an example, a new plant or office will almost always result in new sandwich shops opening nearby. Micro-business startups have a much smaller impact, even in aggregate, because they tend to minimise their needs as a cost-saving strategy (take sarnies to work) and are more likely to rely on favours from friends and families (go round your mum's for lunch). Of course, some small firms today are the large businesses of tomorrow, but it's worth emphasising what an exceptional minority they are. Most small businesses go bust within 5 years, and many that survive are essentially lifestyle companies that have no appetite for major expansion or risk-taking. The evolution of the personal services company as a tax avoidance vehicle has been the single largest driver of the growth in the number of UK businesses since the 80s. In contrast, the number of medium-sized businesses has remained at roughly 30,000 for a decade, which means negligible net employment growth over the period among this cohort.

This belief in the magical properties of small firms leads Ashley to some wishful thinking: "The founders of socialism dreamed of an economy in which workers had a sense of ownership and creative involvement. We may be a long way away from the world of Robert Owen or the Chartists, but we are also moving towards an economy less dominated by corporate giants. There is now widespread agreement that an economy of niche companies, constantly innovating, is the way forward for smaller western countries. And it's in smaller companies of skilled people working together – architectural practices, computer start-ups, specialist retailers, high-end engineers – that you tend to find the greatest effective workplace democracy."

The idea that we are moving towards an economy "less dominated by corporate giants" is nonsense. Even in Germany, the paragon of an economy with a healthy, export-oriented SME sector, the Mittelstand (firms of up to 500 employees) may account for 70% of jobs but it produces only 50% of GDP. Globalisation has accentuated the ability of businesses to super-size, including large German firms like Volkswagen, Allianz, Daimler, Siemens etc. A local example of this is that 31% of private sector employees in London now work for an ultra-large firm (employing more than 2,500 in the UK). That's not even counting those working for global multinationals with a small UK footprint, such as the HQs of businesses that have offshored production. The combined figure for employees of large (250+) private sector and public sector organisations is 60% of all London workers (see this GLA report from 2008).

The giveaway in Ashley's panegyric is the namecheck of middle-class jobs, not to mention the buzzword bingo of "niche", "constantly innovating" and "skilled people". The use of the adjective "effective" in respect of workplace democracy might appear redundant at first sight, but I think it's meant to imply that this is not a plea for the more vulgar forms of democracy or even (heaven forfend) workers' control - i.e. the traditional trades union activity or general bolshiness found in larger firms. Workplace democracy is clearly something that only the middle classes can be trusted with. This is a vision of liberal orthodoxy in a pleasant working environment. Perhaps a Soho loft or a converted barn in Sussex. I bet they even let you wear jeans. The bottom line then is a continuation of Labour's policy during the Blair-Brown years: a benefits system geared to producing a compliant labour supply for an increasingly low-wage economy, with the consolation of permanent dressdown Fridays and social media for the employment elite.