Could micro-businesses be the answer to the UK’s productivity puzzle?

Solving the UK’s productivity puzzle is the next big challenge for the UK’s economic policymakers – and they should consider turning to the UK’s booming micro-business community for answers, according the latest report from the independent RSA think-tank.

Published today with the support of Etsy, the online marketplace, The Second Age of Small concludes that it’s time to ditch outdated views that the small business community is dominated by lightweight and inefficient firms that drag down the UK’s productivity.

RSA researchers discovered that microbusinesses are in fact outgunning larger competitors in 12 of the UK's 19 fastest growing sectors – enjoying higher productivity in areas such as health, education and social work.

The report concluded that the ‘revolving door’ phenomenon, whereby some micro businesses start and close within a short period, makes the community as a whole appear unproductive. Were we to concentrate on long-standing firms that have found their footing, the economic impact of the micro business population would look considerably better.

There are other reasons why the productivity of small firms may be underestimated, the report concluded, including that official data-sets do a poor job of calculating the revenue of micro businesses. The government can only approximate the turnover of many small firms, and these estimations are based on the finances of businesses registered for VAT, which often complete inaccurate returns.

Today’s report argues that with the number of micro businesses (firms with 0-9 employees) swelling by 50 per cent over the last fifteen years, the UK has returned to a ‘golden age of small firms’.  Rather than being in ‘terminal decline’, as was claimed many years ago in the government’s 1971 Bolton Report, small businesses are set to take a larger slice of the UK economy, a situation last seen prior to the industrial revolution, the report said.

Micro-businesses are also faring much better on innovation than previously thought, the report argues. Whilst it’s true that just 13 per cent of small businesses have engaged in internal R&D, when you look more closely at the data, small businesses appear to be more efficient at innovation, making greater use of ‘open innovation’ and outperforming large firms when ‘sweating’ the value of new products and services.

The report also says that small firms are more likely to develop game changing innovations that initially have markets too weak for large businesses to be interested in.

Similarly, when it comes to matters of employment, whilst microbusinesses often pay less than larger firms, offering fewer benefits and in-house training opportunities, they score notably higher on several measures of employee satisfaction, including job control, job security, supportive management, and involvement in decision-making and general enthusiasm for their work.

The report said that economists such as Simon Kuznets, who argued that high rates of self-employment and large small business operations are characteristic features of poor countries, are being proven incorrect. Analysis of OECD data shows that while the rate of self-employment is on average high in poor countries – many rich nations also exhibit high ratios, including New Zealand and Holland – not just the UK. Indeed, when you look at the fastest growing economies in the OECD, many of these have actually seen their self-employment rates rise, contrary to what Kuznets would have predicted.

The RSA said that rather than worry about the number of microbusinesses in the economy, policy makers should pay more attention to the rise of oligopolies (markets where a handful of firms dominate), which have emerged not just in banking and supermarkets but also in search engines, cinema screens and video games. Since 1980, the GDP share of the 1,000 largest firms in the OECD has risen from 31 to 72 per cent. There is a risk that concentrated markets are stifling innovation and economic competitiveness, often charging their customers more and making less money available for R&D, the report concluded.

Commenting on the report, Benedict Dellot said:

“Few people now disagree that our economy is entering what we might call the ‘second age of small’ with a flourishing micro-business community. The question we need to ask is whether this is a desirable development for the UK. Often people question the value that small firms bring to the economy – do they have the resources to innovate? Do they only create poor quality jobs? Our research has shown that microbusinesses can thrive under the right conditions and provide far greater value to the UK economy than previously thought. We should not fear the second age of small – rather we should celebrate its coming.”

The report identified five structural trends behind the UK’s second age of small including:

• People: Many people now view entrepreneurship in a positive light. According to the Global Entrepreneurship Monitor, 80% of people think entrepreneurs have a high level of respect in society, while 55% believe most people see starting a business as a good career choice. More highly educated people are moving into self-employment – including many over 65s and new parents aiming to boost their income and enjoy the benefits of flexible working.

• Government: Since the 1970s, successive governments have championed the cause of small businesses and sought to make their life easier – most notably by paring back red tape. Recently, the government promised to scrap 3,000 regulations and keep down the rate of corporation tax (21%), as well as introducing the new Employment Allowance - effectively writing off the first £2000 that employers have to pay in National Insurance for their workers.

• Technology: Whereas 20 years ago it may have been necessary to have a bricks and mortar shop to stock and sell goods, today all that is required by many people is a laptop, basic computing skills and an internet connection. Small manufacturers are also benefiting from new machines that allow for smaller batch runs (for example, in shoe making, clothing and ceramics). And technology has changed the world of transport making it cheap for a small firm to ship raw materials and distribute their products.

• Consumers: The focus of the UK economy has shifted from manufacturing to services – which many small firms are arguably better able to deliver. Microbusinesses are able to forge close bonds with their customers by offering them unique experiences and providing them with niche products that satisfy specific tastes.

• Corporations: Large corporations are frequently struggling to retain their grip on market power. They are faced with fiercer competition, in part because lower barriers to entry has led to an influx of smaller rivals but also because globalisation has opened up domestic markets to large international contenders. Customers have also become less loyal, which in turn has led to shortened product life cycles. In response to diminishing returns and market volatility, some corporations have sought to cut costs by outsourcing work to smaller contractors.

Notes to editors

1. For more information contact RSA Head of Media Luke Robinson on 020 7451 6893 or 07799 737 970 or luke.robinson@rsa.org.uk
2. Micro-businesses now account for 35 per cent of private sector employment
3. UK workers produce less per hour than our main economic rivals: 30% less per hour than workers in Germany, the US and France – and 10% less than the average Italian.