SMEs not the magic “Open Sesame” that unlocks growth & jobs (1)

Johannes Wessels
@johannesEOSA1

Within a week of his inauguration as Finance Minister, Tito Mboweni muttered the magical “Open $e$ame” words that, according to legend, will reveal the treasures of economic growth, job-creation and the eradication of inequality.

Addressing the Association of Black Securities and Investment Professionals, Mboweni said “to get the economy performing, government needed to create an environment which allowed small and medium enterprises to operate at an optimum level.”

“We must think in particular how to support small and medium enterprises. In Germany the economy is driven by the hidden champions that are small and medium enterprises,” Mboweni said.

The religious preacher built his sermon on the inspired text of the syncretic National Development Plan, chapter 3 verses 115 & 139:

“Most jobs are likely to be created in small, often service-oriented businesses aimed at a market of larger firms and households with income” and therefore the country needs “an enabling environment for small, micro and medium enterprises and entrepreneurs to thrive. This includes inculcating the spirit of entrepreneurship in schools, lowering the cost of doing business in the economy, and reducing barriers to entry in various value chains.”

There are, however, two distinct features to the utterances by Mboweni, the text of the NDP and Ramaphosa’s 2017 New Deal Manifesto:

• Is the conviction that SME’s are the key to growth and job creation anchored in hard evidence and fact or based on the dominating popular paradigm?
• Regardless whether the central role accorded to SMEs is based on fact or fable, is the Government’s approach to the SMEs a market-oriented entrepreneurial approach or a state-manipulated one? This blog will focus on the first: the evidence (or lack thereof) that small firms are the key to job creation.

SMEs and modern myth-making

Benjamin Waterhouse (University of North Carolina and author of The Land of Enterprise: A Business History of the United States) refers to the almost worldwide consensus on SMEs as job creators as a powerful myth that propels itself.  “A key moment in the modern myth-making around small business came in 1978…  when MIT economist David Birch published claims that small firms had accounted for 80 per cent of all new employment opportunities between 1968 and 1976. In 1970, eight American universities offered courses on starting a new business; by 1980, 137 did. Whole magazines devoted to entrepreneurship emerged.”

Birch repeated his claims at Congress hearings. It became the paradigm shaping enterprise policies and disciples are spreading the gospel of SMEs as Saviour. Policymakers, small enterprise promotors, politicians and the popular business media all regularly state small businesses create most net new jobs, often claiming that to be in the order of two-thirds or more.

• “Small businesses create eight out of every 10 new jobs”. – Richard Lesher, president of the US Chamber of Commerce.
• “A single-minded approach to making it easy for SMMEs to start, run and grow to create the millions of jobs we need would be extraordinary and doesn’t have to be complicated”. – Bernard Swanepoel, Director of the Small Business Institute.
• “We’re going to create an environment for small business like we haven’t had in many, many decades!” – Donald Trump
• “We need to massify the creation, funding and development of black-owned small businesses, township businesses and co-operatives.”  – Cyril Ramaphosa LINK
• “The share of SMEs in the economy should be promoted by supporting SME linkages in global value chains.” – Angela Merkel
• “90 percent of jobs will be created in small and expanding firms.”- NDP, Chapter 3 p. 119.

Waterhouse refers to “a fetish about entrepreneurship” that disregards reality.

SMEs:  70% jobs or 38%? 

Haltiwanger (University of Maryland and the National Bureau for Economic Research) refers to several studies that revealed statistical and measurement pitfalls in the work of Birch including unsuitable data, failure to distinguish between net and gross job creation and statistical problems associated with enterprise size classification.

Birch (using Dun & Bradsheet data from 1969 to 1976) counted as small firms those with less than 100 employees. The figure of 80% plus jobs created by SMEs went viral, but from the start there were questions about the data base and conclusions. Hans Landström recorded that the Brookings Institute conducted a study using the same data but for 1976 to 1980 and were unable to replicate Birch’s findings: only 38% of jobs were created by small firms. The US Small Business Administration then asked Birch to use the same data as the Brookings Institute and he found that 70% of jobs in this period were created by small firms.

The difference can be ascribed to the difference between gross jobs and net jobs:  are jobs lost by firm death considered or not?   A second problem was the issue of branches or establishments:  was a new Walmart store with fewer than 100 employees a small firm or not?

The SMEs of McDonalds and Burger King

Firms and branches apart:  counting the roll-out of franchise-outlets for Pizza Hut, Burger King, McDonalds and all others that mushroomed all over America from the sixties onwards as small businesses seriously distorted the issue of small, medium and large enterprise.

Haltiwanger, working with a country-wide Census data, concludes that “there is no real difference in net job creation between small or large firms once we control for firm age.” His team found that business start-ups (young firms) account for roughly 3% of U.S. total employment in any given year compared to the net average around 2.2%. However, young firms have very high job destruction rates so that after five years, about 40% of the jobs initially created by start-ups have been eliminated. Conditional on survival, young firms grow more rapidly than their more mature counterparts.

Large mature businesses account for a large fraction of jobs. Firms older than 10 years with more than 500 workers account for about 45% of all jobs in the U.S. private sector and 40% of job creation and destruction. “The share of jobs created and destroyed by different groups of firms is roughly their share of total employment.”

Brown, Hamilton & Medoff in their book Employers Large and Small (1990) remarked: “Perhaps the most widespread misconception about small businesses is that they generate the vast majority of jobs and are therefore the key to economic growth. … Small employers do not create a particularly impressive share of jobs in the economy, especially jobs that are not short lived.”

The largest 4 firms are 37% more productive than the rest in any enterprise sector

This year, Innovation think tank manager Robert D Atkinson and Dr Michael Lind published “Big is Beautiful:  Debunking the Myth of Small Business”.  Using data from the US Census Bureau, the Inland Revenue Service, the Labour department and the National Science Foundation, they conclude:

• The largest four businesses in any industry are 37 percent more productive than all the other businesses in the same field.
• Small firms trail large firms substantially in R & D and innovation.
• Small business is not responsible for most of the country’s job creation.
• The only kind of small firm that contributes to technological innovation is the technological start-up and its contribution depends scaling up, that is stopping to be small.
• The idea that self-employed citizens are the foundation of democracy is a relic of the Jeffersonian dream of an equal agrarian society.

Let us look at what the data tells us.

Sound policies, effective institutions more important than firm size for job creation

The World Bank traced a data set of me-only firms in the US, Mexico and India that were still operating after 35 years.  The outcomes vary significantly:  what started as full-time self-employment firms in India were now only supporting a partial job, in Mexico surviving firms employ one person in addition to the manager/owner, whilst in the US the surviving firms employed in addition to the owner/manager 8 other persons.

If it is true that SMEs are the best job creators, why then the stark difference between firms starting from the same point of departure?  Other factors (policies, business-friendly environments, regulatory framework) clearly were of more importance for job creation than firm size.

One out of 43 Start-ups employs 10 years later more persons than the entrepreneur

US Labor Bureau data analysed by Atkinson & Lind indicate that of every 43 start-ups just one firm employs anyone person apart from the founder after 10 years. The average number employed by that surviving start-up:  nine. (See figure on the right:   considering that on average 350 out of 1 000 start-ups still operate after 10 years, Atkinson & Lind’s findings imply a mere 23 (2.3%) of these 350 are employer firms.

Firm size distribution follows a power law

Robert Axtell has shown that the distribution of firms in the US according to size (based on number of employees) follows a power law.  On a log-log scale the 5.5 million US firms plot almost perfectly on or close to the regression line with R² = 0,98425.

That is an extremely strong correlation that, according to Axtell, is invariant over time.

The implication is that there appears to be a self-regulating order within a country between SMEs and employment.

High enterprise birth rate no guarantee for economic growth

The “mass production” of new (small) firms promised in Ramaphosa’s New Deal is also no guarantee for growth or job creation.  Based on the World Bank’s data it is clear that there is no correlation between numerous new firms being registered and GDP growth over the period 2006 to 2016.

In this figure, South Africa has had the 12^th highest New Business Density rate for the 11 years (new firms registered per 10 000 of the population) but was 50^th in per capita GDP growth rate for the 69 countries assessed.  The Philippines in contrast was 65^th with New Business Density, but the tenth highest per capita growth rate for the period.

A mass of young firms per se is no guarantee for growth:  a complex combination of enterprise-friendly policies, low regulation, property security and productive knowledge is required.

The champions for growth is neither small nor big, but both

• There’s no absolute proof that SMEs are the best job creators.
• Large firms are important drivers for innovation, exports and growth.
• Massification of new businesses – a goal of Pres Ramaphosa – is totally uncorrelated to economic growth.
• There are hidden regularities at work in the world of enterprise. The distribution of firms according to size (number of employees) follow a power law. It is another manifestation of the spontaneous self-regulating order that characterise the world of enterprise.

In the next blog on SMEs EOSA will look at the SA Government’s approach “to massify” enterprises and to which extent that approach takes note of the inherent forces of the enterprise world.

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