Corner Shop

One of my favourite things about my neighbourhood is my local grocery store, the Supermarché P.A. It’s a half block away, which means that my partner or I shop there almost every day for dinner makings. It’s tiny, maybe twice the size of my apartment; yet it almost always has the produce I am looking for and has a wider variety of prepared food than the big chain store I was in most recently – plus the prices are better. The staff are friendly (and bilingual!), the owner greets us when we come in the door, it’s a huge provider of jobs in the neighbourhood and I often run into friends when shopping for dinner. So.

Hurst and Pugsley, two University of Chicago economists, have written a paper to confront the recent (and not-so-recent) enthusiasm for small businesses, asking What Do Small Business Do? [pdf] Small businesses are often cast as being the haven of “entrepreneurs,”  manna from heaven for productive innovation, jobs creation and economic growth. So they surveyed people starting new businesses. What’s their conclusion?

…few small businesses intend to bring a new idea to market. Instead, most intend to provide an existing service to an existing customer base. Further, using the same data, we find that most small businesses have little desire to grow big or to innovate in any observable way. We show that such behavior is consistent with the industry characteristics of the majority of small businesses, which are concentrated among skilled craftsmen, lawyers, real estate agents, doctors, small shopkeepers, and restaurateurs. Lastly, we show non pecuniary benefits (being one’s own boss, having flexibility of hours, etc.) play a first-order role in the business formation decision.

In other words, most small businesses are just that – small businesses. Essential to the economy, but not engines of growth. Small business owners don’t generally have some better way of doing some old thing, they don’t usually plan to grow, and they aren’t motivated for the most part by a desire to work harder and reap more of the reward, but simply by the desire to work at their own pace.

The undercurrent here (these are University of Chicago economists after all) is that there is no market failure which small business subsidies actually address. Their point is that small businesses are a terrible proxy for innovative firms, labour-intensive production and services, and growth industries. Thus, small business benefits are market distorting, not market correcting.

The first problem with the conclusion is one of research design: they don’t have a negative case. They are studying the intentions and outcomes in a US small business sector which already benefits from a network of subsidies and tax benefits. The relevant question isn’t: given existing subsidies, what portion of the small business sector is innovative? It’s: without these subsidies, would the economy as a whole see lower employment growth, and less innovation? I don’t think they’ve provided relevant data to answer that question.

The other problem I have with their conclusions turns on their narrow definition of market failure. Now, for the most part they are responding to a certain set of arguments, so this isn’t a failing of the paper so much as of the entire discussion. Because the discussion seems to discount the overall social benefit of a rich ecology of small businesses. One of the market failures which small business subsidies can provide is that the market doesn’t necessarily make a city liveable, because there are obvious collective action problems in getting citizens to pay for ‘liveability.’

Now, does the P.A. benefit from small business subsidies? Maybe not – it does have another branch in another part of town. But there is no doubt that without these subsidies, my neighbourhood Starbucks may have priced out some of the local cafés, and the McDonald’s two blocks away would have found it easier to compete with local restaurants, rather than shutting down for lack of profitability three years ago. Now I don’t know about you, but that’s market distortion I can live with.

[h/t David Lizoain]

Smarter ducks

Over on the New York Times economix blog, an argument for high taxation and robust government spending using data from, of all places, the Republican-supporting Heritage Foundation in response to those who think that those who pay low taxes are ‘lucky duckies.’ As an example of the cute analysis:

Equatorial Guinea: According to the Republican-leaning Heritage Foundation, those who live in this small country in sub-Saharan Africa are lucky duckies indeed. Because of recently discovered oil deposits, the citizens of Equatorial Guinea pay less than 1 percent of the gross domestic product in taxes. The comparable figure for the United States is 26.9 percent of G.D.P., according to Heritage.

However, Equatorial Guinea doesn’t seem to be a very pleasant place to live. The people are poor and have little freedom. Heritage says that “persistent institutional weaknesses impede creation of a more vibrant private sector” and “the rule of law is weak.” This sounds suspiciously as if government is too small to do its job properly. But I’m sure that the citizens of Equatorial Guinea don’t mind having a dysfunctional government; after all, they’re lucky duckies.

Perhaps the most interesting part of this short piece – one of the clearest, quickest arguments for the idea that working markets requires a strong, effective government – is that it comes from Bruce Bartlett, a former policy advisor to Reagan, Bush Sr., and Ron Paul. It demonstrates that even someone who has worked with a headstrong libertarian type sees the need for effective government presence in any good society.

The conclusion of his article demonstrates another point however. Bartlett believes that high taxes and low regulation (like Denmark) are preferable to lower taxes and less ‘business freedom.’ So it’s worth keeping mind that, even convincing people that government is important and necessary to a functioning economy doesn’t mean they’ll be convinced that it should be on the side of a functioning society. Still, if you can lead a duck to water…