> Posted by Katherine Knotts, Freelance Writer and Editor

Rarely has a discussion on small business within the EU been had without wheeling out the stock phrase “engine of growth”. I’ve done it; you’ve done it. We’ve all done it. Policymakers do it too. Based on the commonly-held view that small businesses are both 1) job-creation powerhouses, and 2) centres of innovation, EU policymakers have designed national and regional strategies to tackle persistently high unemployment through supporting and expanding small businesses. A major part of this policy package is access to finance for small businesses, following the logic that addressing credit bottlenecks will unleash their potential. Here, “small business” is defined based on the size of the enterprise. However, mounting evidence points to a troubling conclusion: small may be beautiful, but it also may be the wrong policy medicine for the economic malaise in question. This has serious implications, especially when it comes to those financial service providers across Europe rushing to deliver ever-increasing amounts of credit to small businesses.

Consider the following home truths: most new businesses actually start small, remain small and die small, without ever realising their “job creation” potential. Half of the jobs created by micro, small and medium enterprises (MSME) in the EU are thanks to less than 5 percent of those firms (predominantly medium enterprises). In terms of growth potential, it’s far easier to “graduate” from a small to a medium enterprise than it is for micro enterprises to achieve “small enterprise” status. When you apply these trends to real-life scenarios – namely the number of firms that would need to be created to bring unemployment down to reasonable levels – the maths begin to look impossible. In some countries, the number of micro and small enterprises would actually need to double to generate a sufficient number of jobs. Given all of this, a more nuanced policy approach towards leveraging the MSME sector for job creation is clearly overdue.

For a start, it’s high time we dispensed with a few unhelpful habits. Firstly, let’s stop using “job creation” as our indicator of choice. Only by considering net job creation can we appropriately acknowledge the effect of job losses driven by small business failure (statistically the most likely outcome for a small enterprise). Secondly, let’s stop using “small firm” and “new firm” as interchangeable terms. We do know that most jobs are created by “growth-orientated firms”, which are typically small – and new data points to firm’s age (read: ability to survive and thrive in the market) as that which drives that job creation. Finally – let’s stop treating “self-employed” and “entrepreneurial” as synonymous, as the latter implies a degree of innovation that is not by definition always found in the former. Sometimes, people (such as migrants) start businesses because they can’t find anyone who will actually give them a job. Complicating matters further is the rise of the “new self-employed” class of workers who neither fully control nor bear the risks for their work, and are often just labouring under a different legal arrangement for the same type of work they have always done as employees. (If you’re confused about this distinction, order an Uber taxi for your next journey across town.)

Definitions aside, however, the biggest problem with small enterprise policy is that it is focused on small enterprises. That is: support is targeted at firms based on firm size alone – a shortcoming that is clearest when you compare MSME employment in Germany and Greece. If the old “engine of growth” label were true – then the latter nation should be the tiger, and the former the laggard. To wit: 19 percent of Germans work in MSMEs (with an average of 12 workers per firm), whilst 59 percent of Greeks work in MSMEs (averaging 3 workers per firm). Yet pro-small business policies persist as the default, despite big blind spots in our understanding of their role in the overall economy. This is even more worrying if you consider that the data shows a positive correlation between the percentage of employment in MSMEs to overall unemployment, and a negative correlation to overall GDP level. Further research on MSMEs should also take into account not just the quantity of employment but the quality – in terms of wage levels, social benefits, and safe working conditions.

Most people (outside of Hollywood) will tell you that age doesn’t matter. Yet when it comes to employment creation, it’s clear that policymakers should very much be paying attention to firm age – not just size. The vast majority (averaging around 85 percent) of employment in the MSME sector is thanks to firms that have already marked their fifth birthday. Start-ups (before they have one candle on the cake) only account for an average of 3 percent of workers – with firms between 1 and 4 years mopping up the remaining 12 percent. However, it’s the new firms that are creating (and potentially destroying) the greatest number of jobs. Surely we can find a better balance between creative destruction and job creation?

By no means should EU policymakers and financial service providers abandon their focus on the small business sector. On the contrary: those with the power and capital to support them should be unflagging, and part of that support should be to unshackle them from unreasonable expectations vis-à-vis their role in restoring the European economy to health. In doing so, we’ll finally be able to take a more nuanced approach to the MSME sector. In terms of our financial inclusion priorities, we need to target support to those who create businesses not because it’s their only option, but because they are innovators and market disruptors. Here additional business training and access to credit will help genuine entrepreneurs overcome obstacles they face in vaulting from the small to medium enterprise category. For those that are “involuntary entrepreneurs”, social programs for poverty alleviation are far more appropriate. For firms that choose not to grow: credit isn’t always what they need to survive, but cutting red tape can go a long way to smoothing the bumps in the road. Finally, entrepreneurs might be stars, but they do not exist in a vacuum. Any policy to support entrepreneurs to innovate and create value needs to consider the big picture: value chains, horizontal and vertical intra-firm linkages, and the spatial concentration of businesses within an economic zone. Then, and only then, will our engine of economic growth be running at full throttle.

This article draws on the findings from a recent MFC policy paper. Read more here.

Katherine Knotts is a freelance writer and editor in the social and economic justice sphere. Her recent book, The Business of Doing Good, delivers six insights around what it takes to make a social business work for customers, staff, and in the marketplace. (@katherineknotts)

Image credit: David Gee

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