The recovery policy debate

by Mar 15, 2010 No Comments
Small businesses are good for the economy but are some better than others?

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When Lord Mandelson steps up to speak to the Federation of Small Business (FSB) annual conference in Aberdeen this week, he will no doubt attempt to present a positive outlook for Britain’s economy. The ebullient Secretary of State for Business, Innovation & Skills believes that Britain still has one of the best environments in the world for starting and growing a new business. And he contends that the country is emerging from the financial crisis and the downturn with its key industrial strengths intact, unlike in previous recessions.

Mandelson will underline what the Government has been doing to support business during this difficult time. Among its several initiatives that have been adopted was the £13.6m fund to provide university graduate internships in small businesses.

Around 7,000 places have already been made available on the scheme, a partnership between 50 universities and the FSB, with more to come. The business secretary may also use his speech in Aberdeen to reveal progress on the establishment of a state-run investment bank, modelled on the KfW Bank in Germany, a move which would be welcomed by small businesses who say that the cost of borrowing from high-street banks is dampening investment and growth.

In his pre-Budget report statement last November, Chancellor Alistair Darling declared that “small and medium firms are the engine of our economy. They make up the vast majority of businesses and employ around 60 per cent of the private sector workforce.” The sector is looking forward to Darling’s forthcoming Budget for further proof that the Government regards small businesses as central to economic recovery; the FSB has launched an election manifesto, Small Business, Big Vote, urging its members to vote in the General Election on the basis of what candidates say about supporting small business.

But is this focus on broad support for small business the correct strategy for recovery and lasting growth? Or should policymakers be re-thinking the way enterprise is supported with an approach that is instead targeted at a small number of companies which can have a disproportionate effect on employment and prosperity?

John Wright, FSB chairman, has no doubt: “Yes, the average payroll of a small business may be around four people and there are those that think that makes us insignificant.

Well, they’re wrong and I think the message is getting through.” Wright argues that when taken cumulatively, the impact of small businesses on the UK economy is transformational. There are 4.8m small businesses in the country – 300,000 in Scotland – and 98 per cent employ fewer than 50. But simply multiply that number by the average headcount, said Wright, and you have a 21m-strong workforce, far outstripping traditionally high-profile employment sectors.

The reason the FSB is targeting marginal constituencies is to drive home this point: “We are not party-political,” said Wright.

“But if candidates don’t provide the right answers on small businesses, the economy, the banks, then we say don’t vote for them.

The amount of influence our membership can have on these seats could be dramatic.” Small business is not only a significant current employer; the FSB produces statistics to show that it has played an important role in creating new jobs. In Scotland over the last decade, ‘big business’ has shed 33,900 jobs while small business has created 67,400. “For every job scrapped in the large businesses, small business has created two,” said Wright.

“The writing is on the wall; big business is going to continue to downsize and we know that the public sector will be shedding jobs, so who is going to be picking up the pieces? Small business is going to be the job-creator for many years ahead and we need politicians to realise that they should support small business. If each of those 4.8m small businesses employed just one more person, we wouldn’t have an employment problem.” The FSB says that their members account for more than 50 per cent of Britain’s GDP, “not the banks or the oil industry.” They are also the hope for new sources of wealth; 68 per cent of commercial innovation comes from small business, says the federation.

FSB Chairman John WrightWith these statistics behind them, FSB members are calling on the Governments in Westminster and Holyrood to think about the impact of any legislation. It is calling for a moratorium on new employment law and businesses taxation. “We need to make it easier for small business to employ people, not harder,” said Wright.

But does broadly-based business policy really have the desired economic effect? Not necessarily, according to two studies by the National Endowment for Science, Technology and the Arts (NESTA), which invests in early-stage companies and contributes to policymaking with the aim of transforming the UK’s capacity for innovation.

NESTA says that a small minority of highgrowth businesses – those that experience average annual growth in employment of 20 per cent or more over three years – hold the key to job creation and wider prosperity.

The so-called ‘6 per cent’ of UK businesses with the highest growth rates – in Scotland, the figure is 7 per cent – were responsible for half of the new jobs created by existing companies between 2002 and 2008 (see Key findings panel).

Although the firms came from across the country and from all sectors of the economy, they had one important factor in common: they were far more likely to be innovative, and the research showed that their innovation was a source of growth. “This has important implications for the Government; it suggests that economic policy should focus on promoting innovation and on the small number of companies with high growth potential, rather than broadly based business support programmes for new start-ups and SMEs,” said NESTA, summarising the studies. “More importantly, it shows that an approach of backing excellence and innovation is not an elitist policy: in fact, it is the best way of generating employment and opportunity.” These types of businesses should be central to the economic policy of any government, NESTA argues. It is especially important during a recession when the route to recovery is uncertain and what policymakers do is critical. “Both new entrants and SMEs play an important role in the UK’s economy. But many start-ups do not survive and many small firms remain small for long periods of time.

It is fast-growing innovative businesses that can challenge and eventually replace weak incumbents. They are the engine of creative destruction, driving long-term productivity growth.” NESTA says that the implications of its report are not altered by the advent of a recession. Even though the research focuses on a period of relative economic stability, studies of growth businesses in other countries at other times have indicated that growth businesses are similarly important. A study of US businesses from 1981 to 1985 – a period that included a sharp recession from July 1981 to November 1982 – showed that 18 per cent of firms generated 86 per cent of new jobs.

There is also evidence that suggests that high-growth businesses are resilient to downturns, continuing to grow despite worsening economic conditions. NESTA argues that although the economy will change radically as a result of the global financial crisis, with new opportunities emerging and formerly lucrative businesses vanishing, the contribution that high-growth firms make to the economy applies both to times of growth and times of contraction, and offers a robust basis for policy.

So has Lord Mandelson chosen to speak to the wrong audience this week? “The answer to that is no, but …” said Stian Westlake, head of NESTA’s policy and research team.

“Small businesses have an absolutely vital role to play in economic growth and recovery. The difficulty with the received wisdom is the idea that small businesses themselves are uniquely an engine of economic growth.

“Our report says not that small business is not important, but that it is growth businesses, rather than specifically small businesses, that act as this engine of economic recovery. Many of these growth businesses are indeed small businesses. But they are not important just by virtue of being small, but because of their ambition and ability to grow.

“Because this minority of high-growth businesses generates more than half of all the new jobs the idea that policy should focus on promoting these firms rather than funding across the board is, paradoxically, not elitist. Since growth businesses create the largest number of jobs, if you want to help the greatest number of people and create a broad-based recovery then focusing on them is the way to do it.” Westlake said that some government policy is focused on high-growth business, through the Co-investment Fund in Scotland and the Innovation Investment Fund south of the border. But a great deal of support is broadbased.

It is not necessarily a bad thing to support businesses of any size, said Westlake, and if they were supported for other reasons, for example, post offices or local shops to promote social cohesion or healthy eating, that was a good thing but that should be clearly stated.

“All businesses are important, but if your resources are limited and you care about creating jobs then you should make highgrowth businesses a priority,” he said. “The most important message of this research is that supporting excellence and innovation in the economy is not an elitist policy, benefiting only a small group of winners.

On the contrary, the job creation record of growth firms suggests that it is the best way of creating widespread prosperity and opportunity.” The challenge for government is how to do this, said Westlake. The links between innovation and growth suggest that a government that encourages and supports innovation – whether by ensuring an appropriate financial architecture for growth businesses, effective use of government procurement to encourage innovative businesses, functional technology transfer policies, or support for innovative clusters and networks – can help create the environment for business growth.

Earlier this month, Singapore said its latest budget would not spread benefits equally across all businesses; dynamic companies, which are investing in innovation and upgrading, will gain more than others (see International comparisons panel). The NESTA report also points out the importance of policies that facilitate the emergence of high-growth firms without requiring the Government to try to pick winners. Ensuring that the UK has effective markets for venture capital and growth finance is one way to do this. And making sure that companies that want to expand do not face unnecessary barriers to expansion from the tax or regulatory system is also crucial.

“I think the FSB should champion the fast-growing businesses among its members,” said Westlake, “not least because the ambition of every business, large or small, is to prosper, to increase their success with customers and to grow. It’s a message that I think would resonate with the membership and something I would urge them to play up.”

Will Peakin Will Peakin

Beginning as a reporter on weekly newspapers in the North-East of England, Will moved to Glasgow and worked as a freelance for a number of UK national newspapers. In 1990 he was appointed News Editor of Scotland on Sunday and in 1995, Scotland Editor of The Sunday Times. In 1999, he and his family moved to the south-west of France where he wrote for The Sunday Times Magazine. Returning to Scotland in 2002, he was Assistant Editor (Features) and Deputy Editor at The Scotsman before joining Holyrood Magazine in 2004. He writes for the magazine's business pages and edits its series of...

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