Small firms are bigger than you think

The world's biggest employer started here
The world’s biggest employer started here

Today’s post is by Chiara Criscuolo of the OECD’s Science Technology and Industry Directorate.

In September last year, Universum Global published a list of the world’s 50 most attractive employers in business and engineering, based on a survey of 200,000 students. Well-known multinationals top the list, since they seem to respond best to the students’ desire for market success, professional training and development, and secure employment. As Universum CEO Petter Nylander says, “This might come as a surprise as there is a view of Gen Y valuing more corporate social responsibility, a friendly work environment and flexible working conditions”.

Another surprise would be if they all got hired by their favourite firm. Google, Coca-Cola, Ernst & Young and the rest are certainly huge companies, but if you have a job, the chances are you work for a small or medium-sized enterprise (SME). SME’s employ 63% of the workforce in OECD countries and they are also the source of much turbulence: they contribute for three-quarters of total job destruction as well as job creation, according to new data from the OECD’s DynEmp (Dynamics of Employment) project.

With employment high on the agenda of governments everywhere, we looked at which firms were the ones creating those jobs to see what lessons we could learn from the successes and failures.

The full results are in a report we’ve just published, The Dynamics of Employment Growth: New Evidence from 18 Countries, but one of the most interesting trends to emerge is thatyoung SMEs (firms no more than five years old) have been the most dynamic job creators over most of the past decade and across the 18 countries we analysed. These firms only represent on average 17% of employment, but they contribute more than twice as much to job creation (42% of the total). Of course not all young firms survive and not all the jobs created are “permanent”. However, young SMEs account for only 22% of all job destruction, making them net job creators. This was the case even during the Great Recession, despite the fact that younger firms were hit harder than older ones.

Micro start-ups are particularly dynamic, and a small number of them far outperform all other firms in their category. While only 5% of micro start-ups overall grow to employ more than 10 workers after 3 years, this small minority accounts for 37% of all jobs created by micro start-ups.

Our findings on the importance of young firms are encouraging, but there is some bad news in the report too. While young SMEs “punch above their weight” as far as employment creation is concerned, the share of start-ups has been steadily decreasing over the past decade. This is in line with recent evidence from the United States that pointed to a significant decline in business dynamism over the past 30 years.

In a dynamic economy, the disproportionate contribution of young firms to job creation is a reflection of what’s sometimes called the “up-or-out” dynamics. Young firms either go “up”, resulting in higher than average growth rates after they get started, or they go “out”, with the entrepreneurs responsible perhaps re-emerging with a new start-up soon afterwards.

But this varies widely across countries, with some characterised more by “stay-and-stall” rather than “up-or-out”. For example, when you compare the situation internationally, the size of start-ups when they enter the market is much the same (although there are some differences of course). But after a few years, we begin to see a significant change, and it’s the change in the size of firms over time as they evolve from start-up to young firm to older business that explains the differences between countries. For example, an older manufacturing business in France is half the size of one in the US on average, even though start-ups in France are somewhat larger than in the United States.

Young firms are more likely to experiment with disruptive technologies and business models and this experimentation may be particularly important during periods of extensive technological change, when the success of new business models and applications may only become apparent through testing in the market. We used firm-level data from different countries to examine the extent to which innovative firms (firms seeking patents) attract the resources they need to implement new ideas and bring innovations to market. Despite concerns about the decline in business dynamism mentioned earlier, the extent to which capital flows to patenting firms in the United States is twice as large as in France and Germany, and four times as large as in Italy.

Government policy can play a role in encouraging start-ups to experiment and grow, but it can be hard to get the right balance between the interests of the various actors involved in creating and promoting young firms. For example, lenient bankruptcy regimes enable firms to experiment with risky technologies, but if creditors feel they are too exposed to risk they may not be willing to lend money. There can also be unintended consequences of what seems a good policy at first sight. The most striking example is generous fiscal incentives such as tax breaks to encourage R&D. You would think this would help boost dynamism, but in fact such incentives are correlated with less dynamism in R&D intensive sectors, suggesting that R&D fiscal incentives may protect incumbents and slow down the reallocation of resources towards more innovative entrants.

Practically all the companies that attracted students in Universum’s survey were SMEs and start-ups at one time, some only a few decades ago. In the next phases of our work, we’ll analyse in more detail how national policies and other factors affect entrepreneurship, experimentation and the growth of firms. We’ll also try to gain a better understanding of the link between employment dynamics and economic growth and productivity.

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