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A Question of Size

Everybody loves small business. Politicians use plucky little enterprises as the cover for schemes to cut taxes and ease regulations for their Fortune 500 constituencies. Pundits assure us that small business is a fount of jobs and innovation, a hotbed of entrepreneurship led by iconoclasts who thrive on making life difficult for sclerotic megacorporate bureaucracies. Tininess has earned additional press in recent years, as the network model of business organization—weightless decentralized units linked by fiber optics—is celebrated in business journals and MCI ads. Even postmodernish greens, no friends of business, celebrate the small variety as localist, friendly, and sensitive—not cold and alienating like the global behemoths.

Almost none of which is accurate. Small business creates jobs, yes, but it also destroys them in large numbers, since small firms go under so frequently. Small business pays less, innovates less, invests less, and probably does more physical damage to nature and workers than the big guys. There may be social or aesthetic reasons to prefer small firms—informality, face-to-faceness, whatever—but their much-heralded economic virtues don’t survive scrutiny.

The political prestige of small business comes from the widely circulated but untrue “fact” that it’s the source of 80 percent of the new jobs in America. This factoid can be traced to work done by a consultant, one David Birch of Cognetics Inc., who analyzed some computer tapes from the credit rating and business information firm Dun & Bradstreet in a report he did for the Commerce Department in 1979. From there the factoid ascended into sound bite fame in the eighties and early nineties. Other researchers also used the D&B data, and even the U.S. Small Business Administration did for a while too. But a closer examination conducted some years later showed the D&B tapes to be full of errors, at odds not only with official unemployment insurance registration info, but even with the phone book. And Birch’s methodology was pretty idiosyncratic, to put it kindly. One particularly goofy example: The Small Business Administration defines a small firm as one with fewer than five hundred employees. In Birch’s rendering of the D&B data, if a firm with six hundred employees had a bad year and canned two hundred of them, this would show up as a gain of four hundred jobs for the small business sector! Other enthusiastic studies count job growth, but forget job loss when putting the numbers together. Strangely, these devastating discoveries—outlined by Dan Cordtz in the April 26, 1994, issue of Financial World—have caused not even the slightest downturn in the ideological prestige of small business.

More rigorous work, like that done for the U.S. Census Bureau based on its industrial surveys and that by New School economist Bennett Harrison, shows that there’s absolutely no relation between firm size and the propensity to create jobs. The same with age: Startups may be glamorous, but they are also the most likely to crash and burn.

Big business pays a lot better than small, has a better record of hiring people other than white guys and is more likely to be unionized.

What about the other virtues of small business—say, innovation? Sometimes new firms do create new industries—like DEC in minicomputers or Apple in PCs (neither of which is thriving in 1997)—but after a while, big firms that innovate through organized industrial research take over the new industry. This is because big firms have a big productivity edge. They have capital to spend, huge economies of scale, and a financial cushion sufficient to absorb failures. This is not just true of individual firms: Whole industrial sectors dominated by big firms also have the best productivity numbers. In Creating the Computer, Kenneth Flamm demonstrates that IBM’s market dominance in the fifties and sixties enabled it to fund R&D that would have been beyond the capacity of firms earning lower competitive rates of profit.

Of course, one could argue that innovation isn’t all it’s cracked up to be, and that much of it is designed to increase profit and stimulate sales rather than improve human welfare. One could also argue that the production of more stuff more cheaply isn’t really all that winning a basis for a civilization. But regardless of where you stand on such fundamental questions, one ought to be clear on which part of the economy does what.

The facts, unfortunately, speak for themselves. Big business pays a lot better than small, has a better record of hiring people other than white guys and is more likely to be unionized. In 1994, just 35 percent of workers toiling for bosses with fewer than one hundred employees had health insurance, and 19 percent had a pension plan—compared with 68 percent and 62 percent of workers at employers (including governments) with more than 1,000 employees.

But those bigger enterprises employed just 38 percent of the workforce, compared with 43 percent for the smaller. If you take away government workers, just 13 percent of private sector employees work at firms where they have 1,000 or more colleagues. If you ascend the scale of grandness to the Fortune 500, you’re talking about even fewer workers.

One way to think about the U.S. economy might be this: Giant businesses, which employ only a fraction of the labor force, are so monstrously productive that we all live off their crumbs. Their high-paid employees produce the cheap light bulbs and expensive CAT scanners that make industrial life possible, and provide the supplier contracts that keep smaller firms going. They also buy and sell politicians, fund think tanks, and make advertising—in other words, they (try to) tell us how to think and feel.

Maybe official celebrations of small business should be seen in another light—as a more or less open admission of the owning classes’ desires to cut pay and slash benefits. Whatever the facts about small business, the U.S. economy shows lower levels of real investment and productivity growth than its peers, plus dismal wage performance. What the U.S. economy does best is keep lots of low-paid workers in low-productivity service jobs, just the kind small businesses excel at providing. Why most of us are supposed to be happy about this situation is anyone’s guess. But to the American elite, there is no mystery—it’s wonderful for stock and bond prices, and isn’t that the real test?