Friday, October 14, 2011

Why Small Business Always Loses in the US: A Two Stage Approach

I thought of what is perhaps a better way of explaining why small businesses are consistently betrayed by both parties in our political system.

Think of passing a bill as consisting of two stages.  Stage one is deciding whether or not we'll enact a policy and its overall cost.

Stage two is apportioning that cost, whether by linking it explicitly to taxes or by indirect factors such as compliance costs.

In stage one, there is a natural alliance among business interests, they want spending to be as low as possible because they know that costs will fall disproportionally on them, for the simple fact that the money is there.  Other welfare state beneficiaries will benefit more relative to the cost of an intervention than a business owner will so they are united in their opposition to spending.

In stage two however, big business has a number of advantages over small business.  Small business knows that historically they have consistently had more of the costs fall on them, they will try to force policy to stay at stage one as long as possible in hopes of lowering the total cost of welfare state policies.  There is also a substantial coordination problem in that small business is unlikely to be able to carve out specific exceptions for its interests, they're optimal outcome is evenly distributed costs.

Big business however is in a very different situation in stage two.  They know that they have consistently been able to shift costs away from them, once they know a welfare state policy will be instituted they have every incentive to accelerate its passage in return for shifting compliance costs away from themselves and onto either small business or consumers.  Having fewer individual corporations involved makes it easier to negotiate carve-outs with welfare state supporters.  They can consistently apportion costs to other actors, so they will always defect to side with welfare state supporters in stage two.

Our political institutions serve to create substantial opportunities for these behaviors.  Civilians tend to be quite committed at stage one, they'll write their Congressmen and tend to be moderately well informed about the basics of major legislation.  However, once a bill gets into committee and reconciliation between the two chambers we tend to see policy drift away from universal provisions, which would lower the relative costs for individuals and small businesses, in favor of more specific provisions that exempt certain favored entities though tax breaks or through moving away from general provisions such as a simple auction for cap and trade in favor of giving out limited numbers of permits to key industries.  At this stage the public is uninvolved and small business rarely is able to get away from calling for lower costs overall to instead shift to bargaining in favor of equal costs for all, resulting in small business getting nothing and bearing a disproportionate share of costs since big business got its carve outs.

For small business to become more competitive those that represent it in Washington will have to realize that they need to preempt big business by defecting first in favor of universal provision.  Small businesses don't have the political weight to seek business specific carve-outs, the best they can hope for is equal costs.  The incentives in favor of this are weaker on individual issues, however consistently losing in these bargains is very costly over time even if it is not in regards to specific policy losses.  This displays the limits of self-interest, however, since it is very difficult to act on long run systemic disadvantages when the relative gains/losses from individual interactions are so small.

But they add up.

[Edit: I realize this is very similar to a typical collective action problem.  The main difference I'm observing is that small business can overcome the collective action problem to oppose welfare state policies but it can't overcome the problem to negotiate welfare policies more favorable to their interests once the passage of these policies becomes inevitable.  Small business certainly does effectively organize itself to oppose laws such as the ACA and to pressure their legislators to oppose the passage of these bills, the government as a whole seems quite responsive to this particular income bracket and its interests.  However, once the horse-trading starts happening, costs are almost always shifted away from big business to fall most strongly on this group.  This corollary of the standard collective action problem is what I'm trying to tackle with these posts.]


  1. Tzi, I don't see this as a business problem separate from a wage-earner problem. Everyone with a job is paying for the benefits accruing to those who don't work and while it sounds right that big businesses pay for less of that than small businesses, workers probably pay the freight.

    There are, and I've been recruited by, lots of chambers of commerce and national trade associations which I didn't join because I don't trust other small business managers to support my positions or to put forward positions I support.

    It strikes me that your model is narrowing the real difference: That at big companies, decision-makers can marshall lots of resources behind their strategies while at small companies, we can't. That's much broader than just politics, although I can see how you apply it there, and that makes sense.

  2. Doug,

    A couple of short points in response. First, by welfare state policies I'm talking about the whole run of them, not just those that go to those that don't work. This tends to create something of a divide between most wage earners, who are in the lowest 4 quintiles and generally need welfare state interventions for economic and social security, and small business owners, who in the top quintile are usually well off enough to self-insure, if not feel wealthy. Small business owners more frequently, but by no means universally, feel they pay more than they get out of these policies.

    Second, I agree with you in a general sense that wage-earners and small business owners not infrequently have many interests in common. However, it has been the case historically in the US that small business owners tend to side with big business concerns against wage earners and not vice versa. This isn't true in many other states, I take no stance on why this might be different in different states, ascribe it to ideology, regulatory regime, culture, or whatever, just that it is. As a separate matter, this would be an interesting question to explore more fully.

    Since the US gives business such a large role, especially small business, I think it's worth considering why is it that despite this cultural belief in the virtue of small business our actual policies tend to discriminate against them. Health insurance is the big one, but our tendency to lean towards regulation rather than taxation (such as CAFE vs. gas tax among others) also point in this direction. Studies that look at political opinion and legislative action do find that legislators respond fairly well to the opinions of people at the top of the income distribution, and bodies such as the Chamber of Commerce do seem to be fairly influential legislatively. What I'm trying to explain, in part, is why small business seems to be fairly influential when its interests coincide with small business but that when this alliance isn't able to get its way the policy compromises made favor big business over small.

    I don't think this is something that can be explained solely by big business power, big business doesn't get its way everywhere and certainly didn't like the ACA. Japan jumps out as a state where small business is able to substantially protect itself from big business encroachment, at least in the retail sector (not that this is efficient). European legislation protecting small farmers vs. US policy favoring agribusiness also jumps out.

    In any case, I think there is something specific to be explained in how small business can successfully lobby alongside big business to oppose tax increases or regulatory programs generally but seems to be at the losing end of compromises when left wing polices are being passed. The Bush tax cuts for instance involved broad rate cuts rather than specific loopholes for big business, but these loopholes seem to just grow bigger when environmental or health policy is being passed. While I agree that your more general difference of big business having more resources is relevant, I think there is also a more narrowly strategic portion that needs to be explained separately as a special case. I also may be rambling.