On Jan 25, 2010, at 12:47 PM, Joseph Catron wrote:
> Speaking of which, Doug, I've been meaning to ask: Can you, or
> someone else,
> recommend any resources those of us who don't know our economic
> trivia can
> use to refute such lunacy when it arises? Surely some informed
> person has
> composed a systemic argument against the weird fetishization of the
> petit
> bourgeoisie across the entire political spectrum.
Actually I don't know of such a thing. I've done some of it myself here and there, but nothing systematic.
Here's a piece I wrote for Canada's National Post back in September 2000.
Doug
----
Size matters
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 (even though McDonald’s suffers more from the latter than Mom’s Burger Shack would), as if the virtues of small business were self-evident. On parts of the left, particularly among the unfortunately named antiglobalization movement — as if internationalizion were the enemy rather than the way it’s carried out — 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 factchecking. 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, probably does more physical damage to nature and workers that 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 it creates more than its share of new jobs. And there the answer is no.
Firms with fewer than 500 employees employed 78% of U.S. workers in 1980, 80% in 1990, and 80% in 1996. 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 with fewer than 20 employees employed 26% 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, then their share of total employment should have increased dramatically over the course of almost two decades.
That underwhelming performance of really small business is worth a bit more attention because it’s often claimed that that’s where the real job action is. The claim is ulimately traceable to late 1980s work by the consultant David Birch, who 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 subsequently found its way around the world. But it’s not true.
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 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.
More rigorous work than 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 conclude 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 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 2–3% 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 that for laborers was 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 American passion 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 (or even the threat of unionization. This is true whether workers are paid an hourly rate, a salary, or at a piece rate. 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.
Most of what I’ve cited so far is based on U.S. data, but studies of other countries come up with pretty much the same results. A 1998 study 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 f,rms pay 15–20% more than small ones, a relation that has persisted over time. Pension coverage is at least four times higher in large firms. Workers in small firms are more likely to work more than five days a week.
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 les 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).