Robert Lucas and where have all the small entrepreneurs gone?

 

Robert Lucas predicted the decline in the number of small business people and small firms in 1978. The number of small firms will fall and the number of large firms will rise with increases in real wages (Lucas 1978; Poschke 2013; Gollin 2008; Eeckhout and Jovanovic 2012).

Lucas closed his 1978 discussion of the size distribution of firms, and how firms are getting larger an average over the course of the 20th century, with a discussion of a lovely restaurant he visited on the Canadian border. He predicted that in couple of decades time, these type of restaurants will be fewer.

Nations that are more productive  over time and have higher wages because they have accumulated more capital per worker.

One consequence of more capital per worker is real wages increase at a faster rate than profits (Gollin 2008; Eeckhout and Jovanovic 2012). For example, the rate of return on capital was stable over the 20th century while real wages increased many fold (Jones and Romer 2010). This relationship turns out  to be crucial in terms of occupational choice and the decision to become an entrepreneur – a small business owner

Higher wages reduces the supply of entrepreneurs and increases the average size of firms because entrepreneurship becomes a less attractive occupational choice (Lucas 1978; Gollin 2008; Eeckhout and Jovanovic 2012).

For example, in the mid-20th century, many graduates who were not teachers were self-employed professionals. With an expanding division of labour because of economic growth, many well-paid jobs and new occupations emerged for talented people in white-collar employment.

OECD countries richer than New Zealand should have less self-employment and more firms that are large because paid employment is an increasingly better-rewarded career option for their high skilled workers.

The U.S. had the second lowest share of self-employed workers (7 per cent) in the OECD in 2010 – the latest data – which is less than half the rate of New Zealand self-employment (16.5 per cent) in 2011 (OECD 2013). The Australian self-employment rate was 11.6 per cent in 2010 (OECD 2013).

A companion reason for larger average firm sizes in countries richer than New Zealand is more capital-intensive production can prosper in larger corporate hierarchies than can labour-intensive production (Lucas 1978; Becker and Murphy 1992; Poschke 2011; Eeckhout and Jovanovic 2012).

The more able entrepreneurs can run larger firms with bigger spans of control in richer countries because their employees can profitably use more capital per worker with less supervision. The diseconomies of scale to management and entrepreneurship should rise at a faster rate in less technological advanced countries such as New Zealand because they are more labour intensive economies (Lucas 1978; Becker and Murphy 1992; Poschke 2011; Eeckhout and Jovanovic 2012).

Importantly, the more able entrepreneurs benefit most from introducing frontier technologies because they can deal more easily with their increased complexity and more uncertain prospects (Poschke 2011; Lazear 2005; Shultz 1975; 1980). Growing technological complexity reduces the supply of entrepreneurs because it takes longer to acquire the necessary balance of skills and experience needed to lead a firm (Lazear 2005; Otani 1996).

The more marginal entrepreneurs will switch to be employees as technology advances so the average size of firms will increase. The entrepreneurs that remain in business will be the most able, more skilled and more experienced entrepreneurs and will be more capable of running larger firms that pioneer complex, frontier technologies (Poschke 2011; Lazear 2005, Otani 1996; Lucas 1978).

Countries more technologically advanced than New Zealand will have both larger firms and less self-employment because of growing technological complexity.

The greater is the exposure to foreign competition, the smaller is the fraction of self-employed and small firms in a country (Melitz 2003; Díez and Ozdagli 2012). More foreign competition increases wages because of lower prices, which makes self-employment less lucrative. More exporting favours larger firms both because of the fixed costs of entering export markets and because the stiffer competition will weed-out the lower ability entrepreneurs who run the smaller firms (Melitz 2003; Díez and Ozdagli 2012).

Other factors can countermand the effects that occupational choice, frontier technologies, exporting and capital intensity have to increase the average size of firms as real wages rise.

For example, tax and regulatory policies reduce the average size of firms in many EU member states to levels that are similar to New Zealand. The EU is less likely to have large firms in its labour intensive sectors. Employment protection laws, product market and land use regulation and in particular, high taxes stifled the growth of labour intensive services sectors in the continental EU (Bertrand and Kramatz 2002; Bassanini, Nunziata and Venn 2009; Rogerson 2008).

EU firms are are more capital intensive with fewer employees than otherwise because labour is so expensive to hire in the EU. Small and medium sized firms can struggle to grow in much of the EU because of regulatory burdens that phase in with firm size (Garicano, Lelarge and Van Reenen 2012; Hobijn and Sahin 2013; Rubini, Desmet, Piguillem and Crespo 2012). Average firm sizes are 40% smaller in Spain and Italy than in Germany. Obstacles to firm growth originate in product, labour, technology and financial and the binding constraints differ from one EU member state to another (Rubini, Desmet, Piguillem and Crespo 2012).

Average firm sizes in the USA and UK may be larger because of fewer tax and regulatory policies that limit business growth. Bartelsman, Scarpetta and Schivardi (2005) found that new entrants in the U.S. started on a smaller scale than in Europe but grew at a much higher rate. This willingness to experiment on a smaller scale was worth the risk because the payoff was much larger in terms of growth in the more flexible U.S. markets.

In summary, many factors drive the size distribution of firms countries including taxation and regulation. Underlying this, nonetheless, is Lucas’s point from 1978 that rising real wages makes starting a small business a less inviting occupation choice.

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1 Comment (+add yours?)

  1. Jim Rose
    Oct 23, 2015 @ 09:48:47

    Reblogged this on Utopia – you are standing in it! and commented:

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