Economics of Small Business

Economics of Small Business Drexel University Spring Quarter 2014 Tenth Week

Government Policy and Small Business

An Inventory of U.S. Government Policies in Support of Small Business (Follows Veronique de Rugy)

SBA • For the Small Business Administration, programs are of two types: • Lending and Loan Guarantee • Non-lending

Non-Lending Programs 1 • “Office of Advocacy dedicated to protect small businesses’ interests • “HUBZones encourages economic development in historically underutilized business zones • “Drug free workplace programs • “SBDCs grants to assist small businesses in setting up drug-free workplace programs • “Small Business Development Centers provide management and technical- assistance services to small businesses and potential entrepreneurs.

Non-Lending Programs 2 • “Business Counseling & Training • “Assistance to Native American • “Assistance to Women • “Assistance to Veterans • “Assistance to exporters • “Assistance for Small & Disadvantaged Businesses” • (These two slides quote Veronique de Rugy.) • In addition there is a small business disaster recovery program.

Other benefits • Small businesses are exempt from many regulations, though the upper limit varies from 15 to 50 employees. (MSEs do not seem to get this sort of benefit. • In some cases penalties for violations are reduced for small businesses. • Small businesses are given some preference in awarding Federal contracts. • Subsidies for research and technology transfer. • It is argued that some tax rules, though applicable in general, are relatively favorable to small business.

Lending 1 • A major form of support via the SBE is a loan guarantee program, the 7(a) loan program • The loans are made by commercial lenders (mostly banks) on terms approved by the SBA. • Only part of the loan amount is guaranteed. • This is meant to be financed by SBA fees, with “zero subsidy.”

Lending 2 • Some programs rely instead on nonprofit lenders. • The CDC/504 administers loans through Certified (Community) Development Corporations. These are largely brick-and-mortar investments. • A “microloan” program also acts through certain kinds of nonprofits. • Disaster assistance also takes the form of low-interest (subsidized) loans.

Agriculture • All of these pertain to non-agricultural small business. • Agriculture, which comprises mostly small businesses, has its own set of supports, both at the Federal and State level.

The SBA Resource Guide

Counseling • The SBA itself emphasizes counseling – • That is, advice and information to make it easier to start a small business and improve the management skills of small businessmen.

Network • In addition to the SBA itself, a number of “Resource partners,” generally local offices and nonprofits, offer information and technical and management supports for small business on a local level. • Specific organizations and offices support businesses set up by women, veterans and specific minority groups. • The SBA often justifies these activities on the grounds that they promote “job creation.” • Perhaps – but to the extent that they target small business in general they are not targeting high-impact businesses.

Agriculture, Again • Here again there is a longstanding parallel in agriculture – the network of County Agricultural Agents operated by state governments under the Federal Land Grant education program. • Agriculture is not a job creator! • However: these programs have been beneficial on net (according to our best data) because they accelerated the growth in agricultural productivity. • The productivity impacts of SBA programs does not seem to have been studied.

Productivity Conjecture • Here is my conjecture – that is, my “educated guess.” • Probably the technical and management support operations do enhance labor productivity in many of the small businesses they help. • From what we know about high-impact firms, that probably increases employment growth somewhat. • As in agriculture, it probably also benefits the customers of the businesses through lower prices.

Loans 1 • “The 7(a) Loan program is the SBA’s primary business loan program.” • “The business loans that SBA guarantees do not come directly from the agency, but rather from banks and other approved lenders.” • For this purpose, eligibility as a small business is determined by assets, not employment scale, in some cases.

Loans 2 • “The SBA guaranty reduces the lender’s risk of borrower non-payment by providing a guaranty on a percentage of the total loan. If the borrower defaults, the lender can request the SBA to pay the lender that percentage of the outstanding balance the agency guaranteed.” • “…the lender must certify that it would not provide this loan under the proposed terms and conditions without an SBA guaranty.”

Loans 3 • The proportion guaranteed is substantial – 75-85%. • Moreover, the limit means that the banks have an incentive (though less than 100%) to examine the business plans carefully. • Rates are also subject to some regulation. • A fee is charged and ideally, the program is self-financing.

Loans 4 • To the extent that these conditions really apply (and no system is perfect) this is a highly targeted program, going to just those firms that cannot get loans because they lack sufficient collateral. • Even if the program is self-financing, the government carries some risk of net cost, a contingent liability. This is a taxpayer cost – though a very difficult one to assess and which doesn’t show in the government deficit. • Substantial losses were taken after the crash of 2007-8, for example.

Loans 5 • There are a number of special programs under 7(a) that support exports or import competition, veterans, etc. • Some have more generous guarantees. • Another program, the 504 loans, work through nonprofit community development corporations and are directed to small-business projects that do expand employment or advance other public policy goals.

Loans 6 • For the microloan program, SBA lends funds to nonprofit intermediary lenders who in turn make loans up to $50,000 to small businesses in their communities. • SBA also guarantees, regulates and certifies some for-profit lenders that invest in small businesses, the SBIC’s (Small Business Investment Companies.)

Loans: Interim Conclusion • This is a complex and often political array of loan and loan support programs. • The key element in most cases seems to be guarantees that reduce the riskiness of lending to or investing in small businesses. • If capital markets are inefficient due to “liquidity constraints” that affect many small businesses, as the evidence suggests, then this may well improve efficiency overall, even if it does not “create jobs.”

Research Grants • Public policy also requires federal agencies that make research grants to reserve 2.5% of their grants for researchers employed in small businesses. • There are also funds reserved for research by “partnerships” between small businesses and nonprofits. (Universities are probably the most common instance of nonprofits.) • In these cases the limits are 500 employees.

Contracts • Public policy also requires federal agencies to award some proportion of their contracts for supply of goods and services, building, etc. to small businesses. • The target is 23%. • Businesses headed by women, historically disadvantaged minorities, disabled veterans or in designated distressed neighborhoods (HUBZones) have their own targets. • Generally 51% ownership by an American citizen or resident alien of the appropriate category will be required.

Abuse 1 • These preferred contracting programs are vulnerable to abuse. • A common pattern is that large firms headed by businessmen who would not qualify use more or less fictitious “front” firms to channel the contracts to themselves. • Since 2010 there has been something of a crackdown. • SEPTA and PennDOT were prominently scammed; the fraudulent contractors were convicted in 2012.

Abuse 2 • “…the American Small Business League, a nonprofit group ... estimates large companies received more than $16 billion from the federal government’s top 100 small-business contracts in fiscal 2001.” • In a case under investigation IBM may have received 98% of the revenues from contracts awarded to a firm headed by a “disabled veteran” whose disability stemmed from an injury received in military prep school. (It should be stressed that these are allegations!)

Assessment • These are complex programs, and any complex program under political pressures will be subject to some abuse. • However, these may be good reasons to find other, less complex means to promote good ends, if possible. • Contracting usually begins by inviting bids or negotiations. Policies that assure that some proportion of the invitations are sent to small and policy-supported businesses probably do no harm, may promote competition, and cost little. • Beyond that, the case is much less clear.

Disaster Assistance • The SBA also makes disaster recovery loans, which are direct loans and may be made to individuals and nonprofits as well as small businesses. • It has done so since its inception in 1953, when it replaced the discontinued Reconstruction Finance Corporation, and took over that activity from the RFC. • I will skip over this.

Criticism • The SBA document, of course, is not unbiased and is not meant to be. It is a sales pitch, essentially. • The SBA has been a subject of criticism and political opposition from the start. • In the 1970s it was sometimes called the “Small Scandal Administration.” • Proposals to cancel it have been brought forward by several presidents. In 2012, President Obama proposed to merge it with two other agencies. • Yet it lives on! Perhaps because it is doing something right?

Summary Assessment • We do have evidence that small businesses may have reduced access to finance and to managerial expertise. • Programs that assist them to overcome those limits may well be beneficial on net, though different economic theories (and theorists) may differ on that. • These should not be thought of as employment creation programs but should be assessed on their costs and benefits more broadly.

Economics of Small Business