The Wrong Lesson From America

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John Schmitt
The Guardian (London), August 30, 1999

The United States has become an unlikely point of reference in the debate over policies to promote small enterprise in the UK. Unlikely because, despite the hype, the US is far from Nirvana for traditional small businesses - the quantity of jobs created is greatly exaggerated and the quality of those jobs is substandard.

Where the US has succeeded is with hi-tech start-up companies. Yet the architects of the British government's small-enterprise policies have failed to grasp the difference between traditional small businesses and hi-tech start-ups. As a result, the government is developing an approach that is likely to be of little use to either category.

The US experience with traditional small businesses is disappointing. They have not, for example, been the driving force behind recent job creation. Small business has created millions of jobs, but it has destroyed almost as many in the process.

The US data also show that jobs in small businesses are worse than those in larger enterprises. Employees earn less, are less likely to be eligible for pensions and, critically in a country without a free public health system, are less likely to be eligible for employer-sponsored health insurance.

Jobs in the small-business sector are also insecure. US research shows that the average time spent in a job in small firms is 4.4 years - about half the 8.5 average for large firms. The data also un derscore an irony about the British debate. By reasonable measures, the British small-enterprise sector outperforms that of the US.

In 1998, just over 7% of the US workforce was self-employed, while the UK figure was a shade under 12%. Britain also has more employment within small enterprises than the US: 37% of British workers are in firms with fewer than 20 employees, compared with 27% in the US.

Given that workers in British small enterprises also suffer economically relative to those in larger enterprises, the high rate of employment in small firms may be more of a problem than a positive feature of the UK economy.

Nevertheless, the facts suggest that Britain should be teaching the US about creating and sustaining small businesses.

But the British government's focus on traditional small businesses risks missing the real lessons of the US.

The department of trade and industry has focused on cutting red tape in small-business markets and on the possibility of exempting small businesses from basic labour market standards, including the minimum wage. Yet such regulations barely factor into investors' decisions about hi-tech start-ups.

Instead, the key lesson from the US concerns financing start-ups. The US experience can serve as a guide to the features good policy should include. The first is direct government investment in infra structure, research and development, and broad access to higher education. Public investment and government research subsidies have given US hi-tech firms a head start over competitors in the rest of the world.

The second is a financial system that facilitates both private-venture capital funds and small-capitalisation equity markets. Venture capital firms provide much of the financing for US start-ups, in part because investors can more than recoup their initial outlay when start-ups list on Nasdaq and other small-cap stock exchanges.

The final ingredient is a reform of bankruptcy laws. The US is the land of the second chance. Trying and failing in business carries no personal stigma and, more importantly, does not permanently disqualify bankrupts - a word whose moral taint is entirely absent from American English - from trying again.

More lenient bankruptcy procedures ensure that entrepreneurs can use the lessons learned from their initial failures to improve the survival odds of their subsequent enterprises.

Also, sensible policy for small enterprises requires distinguishing between traditional small businesses and hi-tech start-ups.

With respect to traditional small enterprises, the government should leave well enough alone. The sector is thriving by international standards. Most of the proposals under consideration will have little positive effect and may well have unintended social consequences.

Reducing red tape for firms, for example, will also reduce protections for consumers. And allowing small businesses to side-step labour standards will contribute to the further erosion of pay and working conditions in those enterprises, while putting employers who do treat their workers fairly at a competitive disadvantage.

As for hi-tech start-ups, the most urgent reforms - greater public financing, surgical changes to banking and securities laws, and bankruptcy reform - require not deregulation but re-regulation within the financial sector.

The government's push for deregulation of product and labour markets is almost completely irrelevant for hi-tech ventures, and potentially dangerous for everyone else.