Academic journal article Journal of Small Business Management

Small Business Policy: Subsidization, Neutrality, or Discrimination

Academic journal article Journal of Small Business Management

Small Business Policy: Subsidization, Neutrality, or Discrimination

Article excerpt


The starting point for this article is the question: "Is it a valid policy goal for a government agency, like the U.S. Small Business Administration, to provide loan guarantees, direct loans, or in other ways to subsidize the activities of small business?" Or, more specifically, if it is shown that there are significant shortages, gaps in the market, or problems in financing smaller businesses, should the government develop a new set of programs? Should the government be indifferent to the struggles between small and large businesses in our "free market" economy?

Preliminary evidence indicates that very small businesses are being crowded out of the economy by the largest businesses, because of the economy's competitive nature. In fact, there is a growing body of evidence to suggest that the impact of government policy is not neutral, but discriminatory against smaller firms.

A strong case can be made for government to provide special programs to support smaller business in their competition with larger businesses. However, if we had truly competitive markets or ease of entry into existing markets, a neutral government policy would make sense.

Basic Assumptions and Hypotheses

The answer to the question of whether small business, or any subset of firms in the business community, warrants special consideration by government depends on one's assumptions about the nature of the economy in which we live.

If we lived in the perfectly competitive world of microeconomics textbook,

* There would be many buyers and sellers;

* Firms would operate on the low point of their long-run average cost curves, and prices would just equal the cost of producing the last unit of output;

* Freedom of entry would prevent the development of excessive profits, except for brief periods of time when new innovations were introduced; and

* Prefect knowledge would exist about supply and demand schedules, products and processes; so that

* Information and transaction costs would be zero.

In such a world, the answer to the question of whether government should subsidize one group of firms relative to all firms would be no. The invisible hand of Adam Smith would be operating most efficiently--the economy would maximize welfare, and minimize the costs of production, as well as the price of every product.

A basic exception to this perfectly competitive model is the lack of perfect knowledge about one's competitors and the most efficient production processes. Thus, the more competitors there are, the greater the risk and higher the information cost this lack of knowledge creates.

Because of the higher information and transaction costs involved when dealing with the many small firms which want relatively small loans, commercial banks prefer to deal with larger businesses. Thus, large firms tend to face much more competitive capital markets. Small firms face a restricted set of markets and options. Very few small firms can tap the equity, bond, or Euro-dollar markets, or pension and trust fund source for their capital needs.

Not only is the small firm faced with basically the same non-price competitive struggles as the large firm (with labor, government, foreign competitors, market share, return on investment, etc.), it also competes with many more firms, but has restricted capital markets and fewer buyers because it serves more local markets. Nor does the small firm have the market power or the political power that the large firm has. Consequently, the basic competitive struggle is quite different for small and large firms.

The economic paradigm which best describes the U.S. domestic economy is not the perfectly competitive model, but a two-sector model, a competitive sector and a relatively less competitive sector. The more competitive sector is the world of small business, with many buyers and sellers. …

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