From the archives: the small business myth

This is a piece I wrote years ago for the mostly right-wing Canadian paper The National Post. Though more than a decade old, it’s still mostly true and relevant. Sorry—no links to sources and such.

National Post (Canada)—September 23, 2000

SMALL IS NOT BEAUTIFUL Forget the romantic view of small business: for employees, big firms are less nasty places to work Doug Henwood

Everybody loves small business. Well, maybe Fortune 500 CEOs and the investment bankers who serve them don’t, but practically everyone else does. Across the political spectrum, it’s celebrated for its authenticity, pluck, and copious powers of job creation. On the right, the needs of small business are used to counter proposed regulations or minimum wage increases, as if the virtues of small business were self-evident. On parts of the left, small business is positioned as local and human-scaled, in contrast with globe-striding behemoths.

This is a mass infatuation badly in need of some fact-checking.

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, and does more physical damage to nature and workers than the big guys.

You often hear it said that small business creates most new jobs. That’s a half-truth. Most people work for firms employing under 500 workers, the semi-official definition of a small business, so it’s not surprising that such firms should be responsible for the bulk of job growth. The real question is whether small business creates more than its share of new jobs. And there the answer is no.

Firms employing fewer than 500 people accounted for 78% of U.S. workers in 1980, 80% in 1990 and 80% in 1996 — in other words, the share was essentially unchanged over nearly two decades.

Some people might think that businesses with hundreds of employees aren’t so small, but the numbers for really small operations are quite underwhelming: firms employing fewer than 20 people accounted for 26% of workers in 1980, 26% in 1990 and 26% in 1996 (that repetition is no typo). If small firms, no matter how defined, were really the prodigious job machines they’re supposed to be (and if big firms were as relentlessly downsizing as the headlines would lead you to believe), then their share of total employment should have increased dramatically over the course of 16 years.

That underwhelming performance of really small business is worth a bit more attention because, despite these numbers, it’s still often claimed that that’s where all the real job action is. The claim is ultimately traceable to 1980s work by the consultant David Birch, who once famously said that 88% of the new U.S. jobs created in the first half of the 1980s were in firms employing fewer than 20 workers. That factoid was repeated by pundits and politicians, and has since made its way around the world. But it’s not true.

Mr. Birch came up with this nugget by playing with some computer tapes from the credit rating and business information firm Dun & Bradstreet. 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. Firms were classed as being born and dying when they merely changed hands. And Mr. Birch’s methodology was pretty idiosyncratic, to put it kindly.

For example, firms that started in the very small category — fewer than 20 workers — were categorized for all time as staying there, even if they’d grown beyond the small category. Or, more wackily, if a firm with 600 employees had a bad year and canned 200 of them, this would show up as a gain of 400 jobs for the small business sector. Not that Mr. Birch ever fully disclosed his techniques, like most serious researchers would; he did, however, tell the Wall Street Journal in 1988 that his figures were “silly,” and that “I can change that number at will by changing the starting point or the interval. Anybody can make it come out any way they want.” Despite that confession, Mr. Birch is still taken seriously by the U.S. press.

More rigorous work than Mr. Birch’s shows that the job creation story is far from simple. For example, a detailed study of 40,000 U.S. manufacturing firms between 1972 and 1988 by Steven Davis, John Haltiwanger and Scott Schuh found that “large, mature plants and firms account for most newly created (and newly destroyed) jobs.”

Smaller employers generated plenty of jobs, but they also destroyed them in great quantities; new jobs were more likely to persist at larger employers than smaller. They concluded that “in a nutshell, net job creation…exhibits no strong or simple relationship to employer size.”

What about job quality? Let’s start with pay. A study by the U.S. Bureau of Labor Statistics (BLS) for 1995 showed little variation in pay for professionals and managers by establishment size, with small operations (those with fewer than 500 workers) paying 1% below the national average, and larger ones (1,000 workers or more) paying 2 to 3% above average.

At finer levels of occupational classification, the differences were occasionally a bit wider, but not profoundly so. Differentials widen, though, as you move down the status hierarchy. Data entry clerks in small establishments earned 7% below the national average, while those in large firms earned 20% above. Gaps for janitors were wider, and those for labourers were wider still. (Though this is mainly a story about private business, similar patterns were visible among government workers; in small jurisdictions, workers in “protective services”—like cops and prison guards—earned 18% below the national average, while those in large ones pulled in 11% more. This sheds new light on the passion in the United States for small government.)

These are pretty broad-brush patterns, and there may be simple reasons why pay increases with employer size. Maybe big firms have “better” workers—more educated, more experienced—and are more likely to be unionized. But there is now a large literature in economics showing that worker “quality”—I keep putting these things in quotes because, while conventional economists use phrases like this, I find it offensive to talk about people as if they were consumer durables ranked in some kind of buyers’ guide—explains some of the pay differential, it hardly explains all. In a phrase, size matters, and quite a lot—and there’s good evidence that the advantage has been growing over time.

Though the relation was first noted as early as 1911, a classic modern study in the field is a 1989 paper in the Journal of Political Economy by Charles Brown and James Medoff. They crunch data from several different surveys, and all tell pretty much the same story: while bigger firms (and bigger plants or offices within firms) do have “better” workers, that accounts for roughly half their pay advantage. Larger outfits pay more for similar work done by similar workers than do smaller ones. Using standard statistical techniques, this fact of economic life persists regardless of occupation, industrial sector, education, experience, geographical location, union status. The disparities remain whether workers are paid an hourly rate, a piece rate or a salary. Workers who move from small employers to large and presumably carry with them the same set of skills they had on their old job, generally get a significant raise (roughly equivalent to going from a nonunion job to a union one)—and the reverse is true as well.

As with pay, so with benefits. As of the mid-1990s, just 62% of full-time workers in small independent establishments (what the U.S. BLS calls plants and offices with fewer than 100 employees not owned by a larger entity) were covered by health insurance, compared with 77% of those working in larger operations; 42% of those in the small shops had a retirement plan of any kind, compared with 80% of those in larger ones. And as with pay and benefits, so with worker safety.

In a recent report for the International Labour Organization, U.S. economist Peter Dorman wrote that “size and risk are inversely correlated at all levels of scale.”

Most of what I’ve cited so far is based on U.S. data, but studies of other countries, including Britain, Japan, Germany and Canada, come up with pretty much the same results.

A 1998 paper by two Statistics Canada economists, Marie Drolet and René Morissette, shows that even after controlling for the usual factors—like worker education and experience, industry, occupation, and union status—large firms pay 15 to 20% more than small ones, a relation that has persisted over time. Pension coverage is at least four times higher in large firms. Despite the disadvantage in pay, workers in small firms are more likely to work more than five days a week. Small doesn’t seem so beautiful after all.

Why does size matter? Here the answers are a bit harder to come by, though there’s no shortage of suggestions. It’s nicer to work for small firms—fewer rules, less hierarchy—so they can get away with paying less (though large firms have lower quit rates than smaller ones). Large firms are more vulnerable to unionization, so they pay more to keep workers happy and organizers away (though the fact that the size effect prevails even among union workers calls this one into question).

Small firms have less market power, so profit margins are thinner and they’re under greater pressure to keep down costs. It’s harder to supervise a large group of workers, so higher pay is an incentive for them to behave without the boss keeping an eye on them every minute of the workday (though the persistence of the size effect even for workers paid piece rates, where the wage is a direct function of productivity, calls this into question).

Collecting a large number of workers under one roof——literally, in the case of a big plant or office, or figuratively in the case of a big business with lots of locations—results in all kinds of organizational and intellectual synergies that elude small firms, making them more efficient, innovative and profitable. Smaller firms have less snazzy capital equipment, duller managers and less sophisticated work structures, making them less efficient, innovative and profitable.

Workers in large firms may have “subtler virtues” (in Brown and Medoff’s charming phrase) that can’t be measured or statistically modeled, which might be responsible for the pay differential. As plausible as these explanations appear, economists have been unable to decide for sure whether they’re accurate or not (and the parenthetical remarks cast serious doubt on some of them).

I said at the beginning of this piece that small business often serves an ideological purpose. On the right, it’s deployed to resist any political impulses to regulate business or push up wages. That implicitly concedes that smaller firms are nastier to work for, but it’s also a bit devious, since McDonald’s probably would suffer at least as much from a minimum wage increase as Mom’s Burger Shack would. Here, small business becomes a virtuous stand-in for business as a whole, since small business probably has a better public image than the big, no matter how ill-deserved. Even if this is a devious move, it’s not much of a surprise.

What I find more surprising, and disturbing, is the tendency of some folks on the left to embrace small business with some passion. This is particularly true in the unfortunately named anti-globalization movement—as if internationalization itself were the problem rather than the way it’s carried out. Their anti-globalism is connected to a desire to “relocalize” economies, and with them to reorient production on a much smaller scale. These aims seem more motivated by nostalgia—and, in many cases, by a nostalgia for something that never existed—than any serious analysis.

Larger firms are also far more productive than smaller ones. Small-is-beautiful advocates rarely tell us how tiny enterprises would produce locomotives, computers or telephones; maybe they’d prefer to do away with these things and revive a hunter–gatherer society. But if that’s what they intend to do they should tell us.

And people who presumably care about workers should also rethink their passion for tininess: the experience of actually existing small businesses show that they’re not great employers, with poor pay, cheesier benefits and more dangerous workplaces. Bigger firms are easier to regulate, more open to public scrutiny, friendlier to affirmative action programs and more vulnerable to union organizing.

A progressive case for bigness is rare and unpopular these days, but somebody has to make it.

Doug Henwood is editor of the Left Business Observer newsletter, and author of the book Wall Street.

13 Comments on “From the archives: the small business myth

  1. Doug wrote:

    “the mostly right-wing Canadian paper The National Post”


    Oy vey, Doug!

  2. As usual Doug, lots to chew on. And some to spit out, such as the characterization of small business having “duller” managers, which is a full 180 degrees out of sync with my 20 years experience consulting with outfits big and small. Middle management blessed neither with vision nor any particular competence proliferates far, far more at large firms than at small ones.

  3. I remember this essay! I commissioned it while I was working as an editor for the National Post. Looking back, I wish I had gotten Doug to write more for the paper, although back then the Canadian dollar was low so it was difficult to get Americans to write for us. (Bush’s wrecking of the US economy solved that problem — the Canadian dollar is now usually on par with the Yankee dough).
    The national Post is mostly right wing but they did allow me to write pieces arguing that Israel was created in an act of ethnic cleansing:

    and that Rupert Murdoch’s xenophobia is as bad as his phone tapping:

    I also did a piece for the Post arguing for the continuing relevance of Karl Marx, which alas isn’t available online.

  4. No arguments with the above. But I wonder how much of the “localization” fetish stems from food.

    Food production (and “production” is the right word) has concentrated, rationalized and globalized. Maybe Farmer Brown didn’t pay his help as much as Conagra, but you’d probably rather get your eggs from him.

  5. I would guess part of it is food, part of it the behaviour of behemoths like Wal-Mart and the final part being a growing frustration with the customer service of large, faceless, corporations.

    There is something to work with where, and while I’d agree with the analysis of small firms, I’m not sure that simply dismissing the sentiment entirely is the way to go.

  6. “There is something to work with where, and while I’d agree with the analysis of small firms, I’m not sure that simply dismissing the sentiment entirely is the way to go.”

    Yes. There’s an alienation angle that’s left out of Homo Economicus analysis.

  7. I can anecdotally add that small businesses have a tendency to be mean, vile places to work from the standpoint of management style and workplace relations. This is because small business owners tend to see themselves as masters of their domain, with all the capriciousness and arbitrariness one would then expect. There is no HR department looking over their shoulder, hoping to prevent legal exposure, because as often as not they themselves are also the direct supervisor’s of all work performed. Harassment of every kind is thus not only much more prevalent, but employees have little recourse to legal relief, especially considering the fiction of “at will” employment.

  8. The studies cited compare salaries in large and small firms but hasn’t adjusted for productivity. Smaller businesses are less productive and do not have the economies of scale that large business have. Consequently, they require more workers to do the same amount of work that a big company would. This means, though employees may generally be paid less, there are more of them employed.

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