Enterprise and Small Business Principles

The case for government action for SMEs

In general, government action for SMEs has been justified by three main arguments: that market failures exist which inhibit small firm development; that there is a special public interest in SMEs because of their capacity to create jobs; and that government can develop and act on a strategic vision for the economy which individual SMEs cannot.

The market failure argument suggests that small firms will not invest or develop some fields and, therefore, government should assist. The main basis of this argument is that, because SMEs are small, they lack control of the markets in which they operate and will, therefore, underinvest. An example might be training, where SMEs may be dis­couraged from training their personnel because they are concerned about other firms ‘poaching’ them at higher salaries - particularly larger firms. This is a so-called ‘free rider’ problem where the non-training firm gains cost advantage over the firm that trains. Similar examples may apply to implementation of environmental controls or research and development, where those firms that do invest may not be able to gain full benefits because of undercutting or poaching by others. These arguments suggest a role for government as a regulator (to impose an obligation on all firms e. g. to train, to conform to regulations, etc.) or as a supplier (to provide government-financed train­ing or a subsidy to private provision).

A further component of the market failure argument has been that small firms are less aware of advice, information or other business services that are available, are more sceptical about their value and can be more unwilling to seek external support (see Gibb and Dyson 1984; Storey, 1994). This argument is frequently used to justify gov­ernment advice and information initiatives. But whilst there may have been reluctance by small firms in the 1970s, there is little evidence to suggest that it is true today. Extensive surveys of the small firm take-up of external advice, consultancy, training and other services suggests that they are usually just as likely to use these supports as any other firm, with the possible exception of the start-up and very early stages of growth (Bennett and Robson, 1999a; Ramsden and Bennett, 2005).

The most important aspect of possible market failures for small firms is that they suffer specific barriers or unequal treatment which, on grounds of equity, government should help to remove. This was a fundamental plank of the argument by the Bolton Report (1971) which suggested that a level of government action was justified to help SMEs because they were disadvantaged compared with larger firms. In the market, larger firms will gain advantage of economies of scale in a number of ways, for example the purchase of inputs at lower unit costs because of bulk purchasing discounts or eco­nomics of administration arising from having specialist skills available in personnel, financial, managerial and other fields. Ironically, however, one of the strongest argu­ments that is usually used to justify government action is that government itself creates disadvantages for small firms because the costs of compliance with its regulatory and administrative requirements tend to have severe diseconomies of scale. For example, studies of the costs of compliance with government procedures suggest that they are two to ten times higher for small firms as costs per employee, on cost per £ of turnover, than they are for large firms (Bannock and Peacock, 1989; Sandford, 1989, 1995; Cressy, 2000; Poutziouris et al., 1999, 2001, 2003).

This disadvantage is particularly strong for the smallest businesses (of under ten employees) and tends to diminish with size; diseconomies are of little consequence for firms with over 200 employees. There is also variation between different regulatory streams: compliance costs with labour market directives tend to be more costly than taxation requirements, which are in turn more costly than licensing processes. For some businesses, health and safety requirements, in terms of both the costs and the form of regulatory monitoring and inspection, can be so costly as to close the business.

A summary of some of the main market gaps is as follows (see e. g. Bolton Commit­tee, 1971; Bannock, 1981, 1990; Storey, 1994; Curran and Blackburn, 1994; Curran and Storey, 2002; DE, 1990; DTI, 1998a, 2003a; SBS 2002, 2004; SBC, 2004a):

■ Taxation distorts incentives and the capital market and places proportionately higher burdens of compliance costs on small firms.

■ Regulation and bureaucracy is highly regressive with firm size (proportionately much higher on small firms).

■ Purchasing - large firms and public sector purchasing is heavily biased towards other large firms and public sector suppliers.

■ Competition policy is a largely discretionary aspect of government activity in the UK and generally has to reach high levels of abuse before government acts: it thus tends to strongly weaken the possibilities of entry by small firms.

■ Education and research has tended to have little focus on business and enterprise, particularly in the small firms sector: it has been biased towards either management or employee status rather than entrepreneurship and pure research rather than tech­nological innovation and development.

■ Social legislation - as with other regulatory impacts, the effects on incentives to individuals, costs to businesses (especially labour costs), and forms of employment (part-time, full-time) all have regressive effects on small firms.

These arguments have been used as a basis for a range of special policies to help small business, ranging from subsidies to reducing regulatory requirements, and to specialised provision of advice and information. The range of initiatives is considerable and the size and complexity of these initiatives is large in almost all countries. A survey for EU countries is contained in the European SMEs Observatory reports (1994, 1995, 1996). A survey of the main market gaps in policies to meet them is shown in Table 4.1.

The second argument for government action for small businesses is that they have become major parts of the economy. Hence, specific policies for small business are a way to encourage the growth of the economy as a whole. This has been viewed as particularly important since small businesses can create a major growth in jobs. This argument gained considerable popularity in the 1970s and 1980s, which was a period in which large firms, mainly in the manufacturing sector, were shedding jobs at an enormous rate. An influential study was that by Birch (1979) that suggested that two thirds of the increase in employment in the US between 1969 and 1976 was in firms employing less than 20 workers. Although these findings are disputed, there is no doubt that all governments in western economies see job creation as one of the major motives for SME policies.

The third argument, that government can develop and act on a strategic vision for the economy that small firms cannot, overlaps with the objective of job generation. With a shift from the scope for government to act as protectionist sources of support to their economies, governments instead have sought to take on a role in trying to boost eco­nomic growth. This is often framed in terms of increasing a nation’s competitiveness. This strategy has been summarised in a range of competitiveness white papers (e. g. DTI, 1998, 2001, 2003a; HM Government, 1994, 1995; Cabinet Office, 1996b) and has found its way into specific small business policy (e. g. SBS, 2002, 2004). An indi­vidual firm is unlikely to be able to see the whole economic picture, even if it is a large firm, so government has a role in taking the larger strategic view and seeking to plug gaps or stimulate what would not otherwise occur. This has led to a burgeoning of reports on how countries should fill their skills gap, infrastructure gap, research gap, financing gap, etc. For example, the British government has argued that ‘it is govern­ment’s role to offer support to business to increase productivity and invest in innova­tion. Government investment in training should particularly address areas of market failure, by supporting employers in training their low-skilled workers’ (DfES, 2003a, pp. 22-3).

A good statement of the objectives of small business policy is that by the European Commission (2003a, 2004) which in a green paper has sought to identify a perceived problem of EU business development and possible policy solutions. The perceived European problem is that people prefer employee over self-employed status with a resulting lower business birth rate in the EU than many other countries, a less dynamic business sector as a whole and hence higher unemployment levels. The chief policies advocated are reduction of entry barriers to starting a business, trying to reduce risk and increase reward levels, fostering capacity and skills and broadening the account­ability of businesses across society. Specific policy actions are in the fields of education, better regulation, reducing financial gaps and improving cultural supports.

The argument for government action for small firms is, however, much more dif­ficult to implement as specific and effective actions than they are to dream up as a policy designer. Even in the words of one of the economists who is most widely drawn on to justify government intervention, effective actions are very constrained: ‘The important thing for government is not to do things which individuals are doing already’ (Keynes, 1926, p. 47). Keynes felt that actions should be restricted to the aggregate level - the economy as a whole. Analysed below are the difficulties of government action for SMEs.