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In Praise of Big Business: Part 1

It’s become almost a truism that small business is good, big business is bad. After all, small businesses are run by red blooded mom and pop Americans rooted in their local communities, while big faceless corporations are run by profit hungry CEO’s only out to maximize shareholder value. In this narrative, it’s Main Street that deserves help while big corporations deserve ridicule, or at least suspicion. But it’s worth looking at the facts:

The companies that export and successfully compete against foreign companies in global markets are much more likely to be large companies. Firms with fewer than five hundred employees employ 49 percent of U.S. workers but account for just 25 percent of U.S. exports. The companies that are more productive and pay higher wages are large companies. Small firms are significantly less productive than large ones, meaning that their workers earn less. Workers in large firms earn 57 percent more than workers in companies with fewer than one hundred workers.

The companies that provide their workers with better working conditions and benefits are large companies.  Workers in large companies get 3.5 times more retirement benefits than workers in Main Street companies, 2.7 times more paid leave, and 2.4 times more health-care benefits.

There is at least one area where Main Street outperforms big companies and that’s workers’ compensation and unemployment insurance. Their workers get 9 percent more, presumably because they get injured more and laid off more.

But surely small businesses are more innovative than big corporations. This too has become conventional wisdom. For example, an SBA study finds that “Small businesses develop more patents per employee than larger businesses, with the smallest firms, those with fewer than 25 employees, producing the greatest number of patents per employee.” Another one finds that “Small patenting firms are roughly 13 times more innovative per employee than large patenting firms.” And this is true if the sample is only firms that patent.  Among firms that patent, small businesses do produce more patents per employee than large firms. But that doesn’t stop SBA from misleadingly stating on their FAQ page that small firms produce 13 times more patents per employee than large patenting firms. Note the omission of the word “patenting” before the words “small business.” Also note, the top 1.5% of patenting firms are responsible for 48% of all patents from 1999-2008.

The reality is only a tiny fraction of small firms actually patent.  In 2011, there were 108,626 utility patents granted of U.S. origin. Just 50 U.S. companies getting the most patents (all large corporations) were responsible for over 30 percent of these patents. The reality is only a tiny fraction of the nation’s 6 million small firms patent or innovate. This is why even though they account for half of all jobs, small firms account for only 19 percent of the funds invested in R&D. This is not to say that some small technology-based firms are not highly innovative. But to assume that small always equates with innovative or entrepreneurial is not accurate.

Finally, at time when jobs is the number one priority in Washington, aren’t small firms the real jobs engine? After all this is the widely held view. But to understand why the jobs claim is wrong, or at least distorted, it’s important to understand the difference between what regional economists refer to as local-serving and export-serving businesses. Consider the Maytag factory that closed in Newton, Iowa a few years ago. It was an export-serving business, meaning that it shipped products outside of the local labor market. While a small share of the washers and dryers coming off the assembly line were sold to local Newton residents, most were sold to customers throughout the nation or even the world, who sent money back to Maytag, who gave some of it to their local workers. In contrast, the local restaurants, dry cleaners, clothing stores, and barber shops are local-serving, as the lion’s share of their output is sold to Newton residents, including Maytag workers. If one of these local-serving “Main Street” businesses had gone out of business, it would have had virtually no effect on the output of the Maytag factory. Moreover, another business would more or less automatically expand or emerge to meet local demand. But the Maytag factory closure had an immediate negative impact on the local-serving businesses, whose customers (Maytag workers, its suppliers, and their workers) had much less money to spend locally on meals, haircuts, dry cleaning, and other needs and desires. Conversely, if Newton Iowa were to attract a large company to occupy the abandoned Maytag facility, the health of Newton’s small businesses would immediately revive.

The reality is the majority of U.S. businesses are local-serving. These include, for example, the 219,986 doctors’ offices, 166,366 auto repair facilities, 151,031 food and beverage stores, 115,533 gas stations, 111,028 offices of real estate agents and brokers, 93,121 landscaping companies, 75,606 nursing homes, 36,246 furniture stores, 28,336 veterinary offices, 15,666 travel agencies, 4,571 bowling alleys, 2,463 amusement arcades, 858 radio networks, and 26 commuter rail systems. These and millions of other local-serving businesses will neither prosper nor suffer principally on the basis of economic policies targeted at them. They will not prosper unless large companies (and high growth entrepreneurial “gazelle” companies) in the United States prosper.

Moreover, most small businesses don’t create jobs. One study of a sample of companies created from 2004 to 2008 found that only 3 percent added more than 10 employees during that time. Another study found among small companies in their second, third, fourth, and fifth years of business, more jobs were lost to bankruptcy than were added by those still operating. In fact, only a relatively small number of high-growth “gazelle” firms created most of the jobs. So to the extent the focus is on small companies, it should be on entrepreneurial, high-growth firms, not on small business per se.

This is not in any way to denigrate smaller Main Street businesses. Most small business owners take risks, work hard, and contribute to their communities. But we should not let our emotions get in the way of reality. The engines of a nation’s competitiveness, innovation, and productivity are not mom and pop small businesses but rather the firms in traded sectors, high-growth entrepreneurial companies, and U.S.-headquartered multinational corporations. In short, it’s “Industrial Street” and “Office Complex Street,” not Main Street that predominantly drive the nation’s jobs and growth. To be clear, Industrial Street and Office Complex Street include companies of all sizes, but they are characterized particularly by companies that compete internationally, that are high-growth and innovative (regardless of their size), and that are manufacturing-, research-, or information-based.

Next week, I will look at the politics of our small business obsession (and how certain groups play it for all it is worth) and what size agnostic economic policies would look like.

This blog is based on ITIF’s forthcoming book, Innovation Economics: The Race for Global Advantage.

Read In Praise of Big Business: Part 2

Image credit: Wikimedia Commons User Ragesoss


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