Politicians often extol the virtues of small business as a way to demonstrate support for dynamism and entrepreneurship while distancing themselves from the cruelties of global capitalism and the mega-rich of big CEOs. But it turns out that some of Europe’s most troubled economies are precisely those most dominated by small businesses. And it is not a hazard. An economy in which a large portion of the population works in small businesses is not an entrepreneur-friendly economy, but rather one characterized by widespread corruption and poor regulation. The key to prosperity is not coddling small businesses, but giving people the tools they need to start one and existing businesses the ability to thrive and compete.
John Schmitt, an economist at the Center for Economic Policy Research in Washington, DC, gathered striking data last fall, of an Organization for Economic Cooperation and Development entrepreneurship report showing that the United States has a surprisingly small percentage of its workforce employed by small businesses. Countries at the other end of the spectrum, however, are not dynamos: they are basket cases. If you look at the labor share employed by companies with fewer than 10 employees, the leaders among OECD members are Greece, Italy, Portugal, Mexico and Spain. Only 11 percent of employed Americans work in companies with fewer than 10 employees, compared to 58 percent of Greeks. Expand it to examine the share of labor employed by companies with 50 employees or less, and you get Greece, Italy, Portugal, Spain and Hungary. About a third of employed Americans work in companies with fewer than 50 employees, compared to 75% of employed Greeks.
What went wrong?
One of the problems is trust and corruption. One of the most difficult aspects of modern social life is that the world is big and it is difficult to cooperate with strangers. After all, they could be scamming you. You can appeal to the authorities, but it is likely that they will also be foreigners. In societies characterized by poorly functioning institutions, high levels of corruption, and low levels of social trust, it makes sense to try to stick to smaller-scale entities. Business relationships are governed by family and personal ties rather than contracts, and a small scale is used to resolve the difficulties of impersonal administration.
This is no coincidence if we look at the Transparency International report Corruption Perceptions Index, the four worst-performing eurozone members are our old friends Greece, Italy, Portugal and Spain. The opposite is that employment in large companies is most common in the English-speaking and Nordic countries which have the least corruption.
Keeping economic units small is a completely reasonable response to a less than ideal situation, but it is very limiting economically. Economies of scale can make large firms more productive and allow middle-skilled workers to specialize more and earn higher wages. A bigger issue is that big ideas deserve to start small, prove themselves, and then grow. Not every business owner wants to build a Fortune 500 company, but sticking forever with a headcount of less than 10 people is very limiting.
And corruption is often reinforced by poor regulation. In the United States, for example, the independent pharmacy landscape has been disrupted by larger chains, such as CVS, Rite Aid and Walgreens, which have been able to exploit economies of scale and reduce prices. In Italy, on the other hand, pharmacies are essentially prohibited from competing with each other. The mechanism is a restrictive licensing system that prohibits the creation of large chains and ensures that to start a new pharmacy you must first acquire a license from an existing pharmacist. It’s a handy system if you’re the son of an elderly pharmacist who doesn’t work particularly hard. Dad will pass the license on to you, and while you’ll never get rich running just one store, you don’t have to worry about being put out of business by a busier or more business-savvy entrepreneur.
This situation is crippling for Italy’s hardest-working and most skilled pharmacy owners. It’s also bad overall for pharmacy staff. The worst-run stores should close and the best-run stores should diversify and prosper. This way, more people would end up working for managers who know what they are doing, rather than managers who have inherited a license. Such competition-stifling rules are not uncommon in the United States. An idiosyncratic regulatory framework explains why you traditionally have to buy a car from a local car dealership rather than from a national retail chain or directly from a manufacturer. But the fact that most Americans work in companies with more than 250 employees, while nearly 70 percent of Italians work in companies with fewer than 50 employees, highlights the magnitude of the difference. The strength of the Nordic and English-speaking models, from an entrepreneurial point of view, is that these are the places where it is easiest to to start a company and also the places where it is easiest to grow.
These problems do not explain all the problems of the euro zone. In terms of business regulations, Ireland is much more like the United States or Denmark than its PIIGS counterparts. In the short term, issues related to financial flows, land bubbles, bank bailouts and inflexible monetary policy dominate corporate regulation. But Greece, Italy, Spain and Portugal were economic laggards in Europe before the acute crisis hit.
Italian Prime Minister Mario Monti is trying to improve pharmacy regulation, and Silvio Berlusconi’s center-left predecessor Romano Prodi also attempted to introduce more competition into Italian markets. But while there is room for improvement, the corruption data is telling. Building effective governance institutions that give citizens confidence in their relationships is much more complicated than simply passing a law or two. And yet, creating a framework in which it is possible for small businesses not only to exist but to thrive seems crucial to long-term prosperity.