Free-Markets 101: Small Businesses Key to America’s Innovation Future

Free-Markets 101: Small Businesses Key to America’s Innovation Future

Our politics are full of paeans to small business. Regardless of one’s policy preferences or party affiliation, everyone appears rhetorically to be on the side of small business.

As an entrepreneur and small business owner, I am reminded daily of the struggles and virtues of owning a small business. But far too many politicians have little to no experience running a business, creating jobs, or being an entrepreneur. For this reason, it is valuable to review the evidence on the importance of small businesses, particularly as the fiscal position of our nation becomes more precarious and the trillions of dollars in wealth created by small businesses begins to look like a piggy bank to be raided by government.

Let’s start with the basics; what exactly is a small business? According to the small business administration (SBA), a small business is “independently owned and operated, exerts little influence in its industry, and … has fewer than five hundred employees.” There are nearly twenty-nine million small businesses in the U.S., making up 99.7% of all businesses in the U.S. These businesses generate roughly 50% of our annual GDP and employ tens of millions of Americans, but these numbers actually understate their importance to our nation.

One of the defining features that sets our economy apart from many of our economic competitors is its incredible dynamism, known as “creative destruction” in economic circles. A telling statistic demonstrating this phenomenon can be seen comparing the list of Fortune 500 companies in 1955 and today. In the intervening six decades, nearly 90% of the largest 500 companies in 1955 have fallen off of the list due to a combination of bankruptcy, mergers, and declining revenues. What does this number tell us?

When some hear this number, they may use this as an excuse for government intervention, this is precisely the wrong way to view it.

The real story here is that another 90% of businesses were created to replace the old, static, failing ones. These now large, formerly small businesses grew by providing people with a better product at a better price. Despite what some may think, we cannot create a kind of utopian combination of high levels of innovation and stable, lifetime employment within single companies.

With only a handful of exceptions, real paradigm-shifting economic disruption does not happen through existing firms transforming themselves. It relies instead on the displacement and replacement of existing companies with fresh new upstarts, who compete ferociously among themselves to become the new kings of the hill, at least for a while. Case in point: fifty years ago, the life expectancy of a Fortune 500 firm was nearly seventy-five years, while today it is less than fifteen years and may continue to fall.

Even if we wanted to somehow stop or slow this process of creative destruction, it’s simply a way of life in today’s global economy. Yes, government could step in to shut down the pipeline of new and growing businesses currently disrupting large established firms, but that would be long-term economic suicide as their market share gobbled up by foreign competitors rather than home-grown start-ups. Government cannot control consumer’s ever-changing demand for new products and services. The marketplace can only influence whether their demand is satiated by workers at home or by businesses abroad.

So, how do we go about supporting America’s small businesses? First, we must identify their unique strengths in our economy.

Small businesses in America do three things really well: job creation, innovation, and promoting financial independence. Consider that small businesses hire much more frequently than large businesses and create employment opportunities for majority of workers entering the work force.

Given the importance of on-the-job learning as a part of the total human capital of our nation, I would argue that small businesses are quite literally the pathway for tens of millions of Americans to alter their future economic trajectories. We must not disrupt this pathway to prosperity by putting a false floor on wages, essentially illegalizing employment for those whose skills cannot justify the politically-determined compensation.

On innovation, the competition between large and small businesses is really no competition at all. According to the SBA, the average number of patents per worker in small businesses is 26.5 per 100 employees, compared to only 1.7 per 100 in large businesses. Advocates of market-driven innovation simply cannot ignore the dominant role played by small businesses. We must reject those with the loudest voices in Congress trying to pick economic winners and losers – the advocates of those large, established firms trying to put up barriers to their future competitor’s growth.

Finally, I want to discuss the economic freedom that small businesses have provided to millions of Americans, myself included. I have shared my own story on these pages before of how entrepreneurship has ended a legacy of poverty in my family and replaced it with one of upward mobility for myself and future generations, and I am not alone. According to Census data, the past two decades have seen a large increase in the number of women (~12 million total) and minority-owned (~8 million total) businesses. which is cause for great celebration as millions of citizens are now invested in enriching their communities.

We must continue to support policies to promote innovation and entrepreneurship more broadly. This will ensure that the upward cycle of economic growth and opportunity continues in perpetuity, as a growing share of entrepreneurs continue to support policies promoting further small business creation and development, with all of us reaping the rewards.

Damon Dunn writes the bi-monthly “Free-Markets 101” column for Right by the Bay.  He is a fellow in business and economics at the Pacific Research Institute.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.