June 1999 Vol 5, No. 1


June 1999 Vol 5, No. 1




ANOTHER LOOK AT SMALL BUSINESS

Job Creation Numbers Tell Only Part of the Story
* * *
Small business is a Threat to Productivity, Incomes, and Job-Quality

Canada’s small business sector enjoys an enviable degree of public and political support and credibility. The neighborhood business operators who symbolize capitalism’s "little guy" are almost universally respected for their hard work, long hours, frugality, and self-reliance. Politicians of all stripes have granted generous tax breaks and other subsidies to small companies.

Small firms account for a majority of all new jobs created in Canada’s economy, and this is often interpreted as proving that small business is now the main engine of economic growth. In practice, however, most small companies still depend on the investment, purchasing, and employment decisions of larger firms and government agencies for most of their business. Small business has become so important not because of its own vitality, but more by default–simply because larger companies and governments have performed so poorly this decade.

In reality, the growth of small business in Canada this decade is a symptom of our economic weakness, not one of our economic strengths. Many small businesses consist of marginally viable operations undertaken by individuals with few other economic opportunities in the lean-and-mean economy of the 1990s. We should focus less on subsidizing these lower-paid, less productive positions, and more on stimulating desirable jobs with larger firms and agencies. The freedom and independence of "being one’s own boss" may personally motivate many smaller entrepreneurs–but it’s hardly a sound basis for a whole country’s economic development.

The Issue: Small Business, Job-Creation, and Productivity
  • The small business sector is Canada’s largest creator of jobs–but it is also Canada’s largest destroyer of jobs, too. Ongoing turmoil resulting from the circular creation and bankruptcy of small businesses contributes significantly to the job insecurity of Canadian workers–not to mention to the cost of running our UI program.
  • The quality of employment is typically poor in small firms. Wages are barely half as high in small firms as in larger ones, basic employment benefits are much less common, and unions are weaker. The poor productivity of small businesses, largely the result of their less intensive use of capital equipment, has dragged down the productivity performance of the whole economy.
  • Pro-growth policies at the macroeconomic level (including lower interest rates, improved spending on public services, and pro-active policies to stimulate key industrial sectors) would encourage larger companies and government agencies to create more jobs, while at the same time helping small companies to create better jobs.

Respect is One Thing, Prosperity is Another

Who do Canadians most respect? According to a 1998 Angus Reid public opinion poll, no group is held in higher regard by their fellow Canadians than the overworked, underpaid neighbourhood small business operator. The poll found that lawyers are reviled–no surprise there. Politicians are distrusted–we all knew that. Journalists, corporate executives, and–yes–even trade union leaders all have an image problem. But not the corner dry-cleaner, the private-practice accountant, or the door-to-door Amway salesperson.

The poll put small business owners right at the top of the heap of Canadian professions, as far as the level of respect their work elicited from the population at large. A full 67 percent of respondents replied they had a "great deal of respect" for small business owners, putting them miles ahead of any other profession–even priests, doctors, and police officers. Another 30 percent of respondents had a "fair amount" of respect. Like Rodney Dangerfield in reverse, virtually no-one in Canada holds any disrespect for these self-made entrepreneurs. The long hours, spirit of self-reliance, and generally modest habits of most small business operators have clearly touched a sympathetic nerve with most Canadians.

If Canadians knew more about how hard small business operators work, however, and how little they typically get paid for it, a little bit of the lustre might chip off this rugged, individualist dream. Public respect may be one thing–but bottom-line success, it seems, is quite another. Many small entrepreneurs, no doubt, would happily trade in some of their public esteem for a little more money. In general, small business is a surprisingly unproductive, poorly compensated undertaking. Indeed, the low productivity and low incomes of the rapidly-growing small business sector have helped to drag down overall productivity and income growth in Canada. And the lower salaries and benefits paid by small businesses have contributed significantly to the stagnation of Canadian living standards.

A well-oiled lobby machine has effectively translated the almost universal high regard for capitalism’s "little guy" into formidable political clout with governments of all political stripes. Small business representatives are among the loudest, and typically most conservative, of the lobbyists pressing hands on Parliament Hill and in the provincial capitals. And the most powerful ammunition in their campaign for small-business-friendly policies is the evidence that small businesses have been the most important source of job-creation in Canada’s economy. This would seem to suggest that measures to help small business would result in a stronger labour market and lower unemployment, and many policy-makers have accepted this argument.

A deeper look at the economic evidence, however, suggests a different conclusion. Perhaps the growing importance of small business in Canada is more a symptom of economic weakness, rather than evidence of a growing, vital, entrepreneurial spirit among Canadians. Small businesses have become the most important source of new jobs largely by default, simply because larger companies and governments–which offer better-paid, more productive, and more secure jobs–have not been hiring, or worse yet are downsizing. Bluntly put, many small business undertakings are marginal, low-productivity undertakings that would not be carried out if their proprietors had access to more productive and well-paid work in a "real" job.

Part of the policy response to the growth of small business employment will require acting to improve productivity and income levels within those small businesses. But part will also involve taking measures to rejuvenate employment opportunities in larger, more productive firms and public agencies.

Job-Creation and Job-Destruction

Small companies have indeed produced a disproportionate share of new jobs in Canada. Large employers are still the most important source of paid work in the private-sector. Firms with more than 500 employees make up a tiny fraction–just 0.2 percent–of all companies in Canada, yet they provide 40 percent of all private sector work. [Large employers are even more important in the public sector.] But the importance of large companies has been declining, due both to their own sluggish hiring and to the faster growth of small business employment.

Firms with fewer than 50 employees accounted for about 60 percent of all net job creation in Canada during the 1980s and 1990s, and now employ about 35 percent of all private-sector workers. Medium-sized companies, with between 50 and 500 employees, accounted for 20 percent of job growth during the same period, and now make up another one-quarter of all private-sector employment. The importance of larger firms in job-creation has picked up somewhat as Canada’s economic recovery gathered steam later in the 1990s. During 1997, for example, workplaces with over 500 employees accounted for over 25 percent of all job growth, more than in previous years.

The generally positive job-creation record of small firms, however, hides a lot of churning and turmoil under the surface. In addition to being the largest creators of jobs in the modern labour market, small businesses are also the largest destroyers of jobs. Rapid job turnover, frequent bankruptcy of small firms, and other sources of instability all undermine the employment security of workers at small companies.

The gross job-creation rate is extremely high in the small-business sector. The smallest companies typically create almost one "new" job each year for every four jobs currently in existence–a phenomenal rate of job-creation. Unfortunately, however, almost as many jobs (over one in five each year) simultaneously disappear from small businesses thanks to lay-offs and bankruptcies. Thus the net job creation of small businesses is much more modest: about one new job for every 35 workers per year. Even on a net basis, however, small firms have still been the most important source of new employment.

One consequence of this ongoing job turmoil is that smaller firms are by far the heaviest "users" of the UI program. Workers at companies with less than 20 employees are four times more likely to lose their jobs in a given year, than employees of firms with over 500 workers. As a result, the small business sector draws far more out of the UI system (in the form of benefits for workers who have lost their jobs at small companies) than it contributes in premiums. It is especially ironic that small businesses remain the most vocal critics of UI premiums, when their own failure to create stable jobs has added so significantly to the cost of Canada’s unemployment insurance system.

Wages, Benefits, and Job Quality

Jobs with small companies tend to offer poor compensation relative to jobs with larger firms–both in wages and salaries, as well as fringe benefits (see Table 1). Wages and salaries for employees in large workplaces (those with over 500 workers) are between 60 and 70 percent higher than for those working at sites with fewer than 20 employees. Part-time employees of small businesses fare even worse: average earnings for part-time workers at large firms are twice as high as for those in the smallest workplaces. Due to low wages, the contribution of small business to the purchasing power of Canadian workers is much smaller than the job-creation numbers suggest: the smallest firms have accounted for 60 percent of job growth in recent years, but only about 40 percent of all income growth.

Large employers also offer far more extensive packages of important non-wage benefits–such as health insurance and pension coverage–which may ultimately be even more important to the economic and social well-being of their employees. Workers at the largest firms are between two and six times more likely to receive these non-wage benefits as part of their total compensation.

Lower union activity in small companies is an important factor explaining the lower compensation that is paid there, especially the absence of standard employment benefits. Unionization in firms with less than 20 employees was just 8 percent in 1996, compared to over 50 percent in the largest companies. The growing importance of smaller workplaces is clearly undermining the prospects for improving the quality and democracy of worklife.

Table 1
Earnings and Benefits by Firm Size

Size of Company

Gap: Largest versus Smallest

Under
20 Workers

20-100

100-500

Over
500

Wages and Salaries (1997):
Average hourly wage

$12.27

$15.35

$17.69

$20.59

$7.82 (+61%)

Average weekly earnings

$453

$568

$665

$771

$318 (+70%)

Non-Wage Employment Benefit Coverage (1995):
Supp. health insurance

23.1%

56.9%

69.5%

79.5%

56.4 points

Dental plan

19.7%

50.9%

63.8%

78.0%

58.3 points

Paid sick leave

27.7%

46.9%

61.7%

71.2%

43.5 points

Pension plan

9.8%

29.1%

45.8%

65.7%

55.9 points

Unionization (1996):
Workers rep’d by a union

7.8%

14.7%

32.5%

52.6%

44.8 points

Investment, Productivity, and Profitability

Small companies tend to utilize much less capital equipment–such as machinery, computers, and other equipment–in their day-to-day business. The average value of capital equipment used by each worker in Canada’s retail industry, for example, is just one-fifth as large as in the manufacturing sector. This trend is partly because small businesses generate consistently lower profits than bigger firms, and hence have few financial resources to reinvest. They can’t finance new investments from internal profits, but they often can’t borrow the money either (because banks and other lenders tend to view small businesses as a poor credit risk).

One key result of this underinvestment is a very poor average level of productivity in the small business sector. In fact, the growing importance of small business is an important factor behind the apparent slowdown in Canada’s productivity growth that has generated so much public attention in recent months.

The sorts of industries which are dominated by small business–retail and wholesale trade, food and beverage services, personal and business services–are those which use the least capital equipment in their operations, and which consequently demonstrate both the lowest productivity and the slowest productivity growth (see Table 2). Put simply, if an industry does not require much capital investment to get started, then that is an industry which will be dominated by smaller companies.

Productivity growth in many labour-intensive sectors such as business and hospitality services–precisely the industries dominated by smaller firms–has actually been negative in recent years. Small companies are born and die, they use little capital equipment, and they offer low-wage, often part-time or temporary employment. Not surprisingly, their productivity is poor.

The harsh competition faced by most small businesses, and their weak investment in productivity-enhancing capital equipment, means that they tend to be consistently less profitable than larger firms. Larger companies, on average, have been about 60 percent more profitable than small ones during the 1990s. Ironically, the poor profitability of small businesses tends to reinforce the low productivity and labour-intensity of their operations, which in turn is a fundamental underlying cause of their poor profitability.

Strangely, the small business lobbyists stridently blame their financial underperformance on onerous government taxation. Given the range of lucrative tax subsidies which are provided to small business (and which are summarized on the back page), this claim is laughable.

Table 2
Investment and Productivity by Sector
Canada, 1994

Sector

Capital per Worker

Prod’y per Worker

Prod’y Growth 1994-97

"Small Business" Industries
Business services

$4,250

$52,600

-2.0%

Retail trade

$7,500

$28,700

5.7%

Wholesale trade

$9,300

$56,200

-1.6%

Accommodation & food services

$11,000

$22,600

-3.4%

"Big Business" Industries
Manufacturing

$38,000

$65,000

4.0%

Transportation

$52,000

$62,900

6.3%

Communication & utilities

$228,000

$111,000

12.7%

Oil & gas

$790,000

$430,000

7.8%

Self-Employment: The Smallest Businesses of All

Self-employment in Canada has been the most rapidly growing form of small business employment. It grew by one-third between 1990 and 1997, accounting for over three-quarters of all new jobs during this time. Almost one in five of all jobs is now a self-employed position.

Indeed, self-employment now exceeds employment in the public sector of the economy for the first time in Canada’s postwar history. This symbolizes the extent to which Canadians, in the wake of the government downsizing and stagnant labour markets which dominated the economy during the 1990s, have truly become a nation of ruggedly self-reliant entrepreneurs. But is this a good thing?

Surveys of the incomes and working conditions of the self-employed paint a worrisome picture of this most rapidly-expanding form of small business activity:

  • 90 percent of the growth in total self-employment during the 1990s consisted of "own account" self-employment, in which the self-employed individual has no additional employees.
  • By 1997 these "own account" workers accounted for 60 percent of total self-employment.
  • On average, self-employed workers earn less than paid employees. Average earnings for the "own account" self-employed were just $22,900 in 1995–two-thirds as much as for paid employees.
  • Incomes among the self-employed are more polarized than in society as a whole. At the top, 5 percent of the self-employed earned over $100,000 in 1995, versus just 1 percent of paid employees. At the bottom, over 35 percent of the self-employed earned less than $15,000 the same year, compared to just 17 percent of paid workers.
  • Self-employed individuals worked an average of 42 hours per week in 1996, about six hours more than paid employees. One-third of all self-employed individuals work over 50 hours per week.

To put it bluntly, much or even most self-employment consists of marginal, low-productivity undertakings that would not be carried out if their proprietors had access to more productive and well-paid work in a "real" job. Far from representing an entrepreneurial renaissance, the rise of self-employment is more a reflection of desperate attempts at economic survival by hundreds of thousands of Canadians who have been excluded from the productive "core" of the labour market by cutbacks and downsizing.

Conclusion

The harsh economic constraints facing most small businesses make any additional business cost–no matter how socially or morally justifiable it may be–a very bitter pill to swallow. Thus small business resistance is fierce to taxes, unions, minimum wages, and government regulation governing anything from consumer protection to worker rights to environmental guidelines.

Larger businesses, too, tend to hate these things. But thanks to their superior productivity and flexibility, they can usually adjust their operations accordingly. That’s why larger, more productive companies have been more fruitful targets for policies aimed at improving the social and environmental conditions of employment and production. Unions have been far more successful organizing and bargaining with large companies, than with small ones. Government regulations are typically more effective with larger companies which possess discretionary resources to invest in safer, cleaner workplaces–and whose compliance can be monitored and enforced more effectively.

Increasing the minimum wage by fifteen cents would not likely elicit a peep from most large companies, which employ few minimum wage workers–yet it sparks a near-rebellion from legions of low-productivity retailers, restaurants and other small businesses which depend on ultra-low wages for their very existence. For small businesses scrambling desperately to stay afloat, every new intrusion by governments or unions to improve social and economic conditions for workers and communities is seen as potentially the last straw.

Thus it is not surprising that the small business sector tends to be one of the most entrenched and conservative constituencies in the whole economy. This stems at least as much from the marginal, hyper-competitive economic conditions that most small businesses face, as it does from the personal views of small business owners–many of whom, of course, are enlightened and compassionate people. In this light it is somewhat odd that the small business sector’s strong public image is often endorsed by progressives who would otherwise be critical of business, and who support the types of social and economic interventions that are invariably denounced by small business.

Perhaps it is a knee-jerk concern for the underdog that leads many left-wing commentators to express solidarity with small businesses, even as they denounce the power and influence of large corporations (which ironically tend to have much better records on subjects such as labour relations, social responsibility, and environmental protection). Even Canada’s federal New Democratic Party has tried to jump on the small business bandwagon; in 1998 several party leaders expressed a desire to shift the party’s policies to appeal to the small business community.

The political logic of this repositioning seems far-fetched, given the stated conservative views of most small business owners. But even more worrisome is the economic thinking underlying such an approach: if the goal is to generate a high-wage, productive, and egalitarian economy, then the growth of small business must be seen as a negative development, not something to be encouraged with even more favourable policies.

The problems raised by the growth of small business employment in Canada suggest two policy approaches. First, economic policies and labour laws must be aimed at improving productivity, incomes, and working conditions in the small business sector–through measures such as stronger minimum labour standards, sectoral bargaining structures, and incentives for capital spending by small businesses.

But second and more importantly, Canada’s economy must reduce its reliance on small business and self-employment for so much of its job-creation. Through better interest rate, budget, and trade policies, governments could help to revitalize growth and job-creation by the larger companies and government agencies which provide the best and most productive employment in the economy.

Small Business and Taxes: Rhetoric and Reality

"Get government off our backs," is the typical refrain of the Canadian Federation of Independent Business (CFIB) and other small business lobby groups. They fight for lower taxes, fewer regulations, weaker social programs, and tougher rules against unions. For example, a 1996 survey undertaken by the CFIB found that the following five policy measures were deemed most important by small business owners for improving the economic climate for their job-creation efforts (listed in order of their degree of support among survey respondents):

  • Reduce payroll taxes (like UI premiums)¤Cut taxes for consumers (like personal income taxes)
  • Cut government spending¤Reduce the employment "paperburden"
  • Cut social assistance payments

At the same time, however, not to let consistency stand in the way of a good lobby campaign, the small business sector has also been successful in winning a wide range of attractive government subsidies for smaller companies. Table 3 lists just some of the special tax breaks received by small businesses in Canada. Their total cost runs to several billion dollars in foregone revenue at both the federal and provincial levels each year.

In addition, small business also benefits from a range of other subsidy programs which involve the actual payment of hard money by governments–such as special job-creation grants, cash subsidies to self-employment through the UI program, federal guarantees for small business loans by commercial banks, and numerous other measures. Small businesses pay notably lower taxes, lower wages, and fewer benefits to their employees than do their mega-corporate counterparts. Despite this, however, they are consistently less profitable, to the point in many cases of being marginally viable.

Table 3
Small Business Tax Subsidies

Subsidy

Explanation

Estimated Annual Cost

Lower income tax rate: federal Small business taxed at 12 percent instead of 28 percent.

$3 billion

Lower income tax rate:

provincial

Provinces also charge lower corporate taxes for small businesses, with rate reductions of between 5.0 and 9.5 points.

$1 billion

Capital gains exemption for small business shares Investors receive a $500,000 lifetime capital gains exemption on small business investments.

$620 million

Enhanced R&D tax credit Rebate of 35 percent of R&D spending, instead of 20 percent for other companies.

$195 million

Labour-sponsored venture fund tax credit Rebates 30 percent of investments in labour-sponsored small business mutual funds.

$150 million

Small business GST exemption Exempts very small businesses from collecting & forwarding GST.

$130 million

Allowable business investment loss More generous treatment of capital losses incurred on small business investments.

$117 million

Home office expenses Allows home workers to deduct a portion of total household operation costs for businesses run partly or wholly from home.

Unknown

Exemption from WCB premiums Allows small businesses to avoid WCB premiums in many provinces.

Unknown

Other payroll tax exemptions Allows small businesses to avoid or pay lower rates for other employer-paid payroll taxes (such as public health insurance premiums) in many provinces.

Unknown


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