Is It Possible To Have Too Many Small Businesses? Yes—It’s a Key Reason Italy and Greece Are a Mess.

How to start and grow companies.
July 6 2012 3:15 PM

Southern Europe’s Small-Business Problem

Why corruption and poor regulation cause Greece, Italy, and Spain to have way too many workers at small firms.

A restrictive system of licenses in an Italian pharmacy such as this one essentially prohibits market competition.
A restrictive system of licenses in an Italian pharmacy such as this one essentially prohibits market competition.

Photo by Gabriel Bouys/AFP/Getty Images.

Politicians often tout the virtues of small firms as a way of signaling support for dynamism and entrepreneurial spirit while distancing themselves from the cruelties of global capitalism and the mega-riches of big-time CEOs. But it turns out that some of the most troubled economies of Europe are precisely the ones that are most dominated by small businesses. And this is no coincidence. An economy where a huge share of the population works at small businesses is not one that is friendly to entrepreneurs, but rather one that has widespread corruption and poor regulation. The key to prosperity is not to coddle small firms, but to give people the tools they need to start one and the firms that exist the ability to thrive and compete.  

John Schmitt, an economist at the Center for Economic Policy Research in Washington, D.C., pulled together some striking data last fall from an Organization on Economic Cooperation and Development report on entrepreneurship showing that the United States has a strikingly low percentage of its workforce employed by small businesses. The countries at the other end of the spectrum, however, aren’t dynamos—they’re basket cases. If you look at share of the workforce employed by firms with fewer than 10 workers, the leaders among OECD members are Greece, Italy, Portugal, Mexico, and Spain. Only 11 percent of employed Americans work at firms with fewer than 10 employees while 58 percent of Greeks do. Expand it to look at the share of the workforce employed by firms with 50 or fewer workers, and you get Greece, Italy, Portugal, Spain, and Hungary. About one-third of employed Americans work at firms with fewer than 50 employees while 75 percent of employed Greeks do.     

What went wrong?          

One issue is trust and corruption. One of the most difficult aspects of modern social life is that the world is a big place and cooperating with strangers is difficult. After all, they might rip you off. You could appeal to the authorities, but the authorities are likely to be strangers, too. In societies with poorly functioning institutions, high levels of corruption, and low levels of social trust, it makes sense to try to stick with smaller-scale entities. Business relationships are driven by family and personal ties rather than contracts, and a small scale is used to solve the difficulties of impersonal administration.            

It’s not a coincidence that if you look at Transparency International’s Corruption Perceptions Index, the four worst-performing eurozone members are our old friends Greece, Italy, Portugal, and Spain. The converse is that large-firm employment is most common in English-speaking and Nordic countries that have the least corruption.          

Keeping economic units small is a perfectly reasonable response to a less-than-ideal situation, but it’s very economically limiting. Economies of scale can make larger firms more productive and let medium-skilled workers specialize more and earn higher wages. A bigger issue is that great ideas deserve to start small, prove themselves, and then grow. Not every business owner wants to build a Fortune 500 company, but sticking forever with a staff of fewer than 10 people is very limiting.          

And corruption is often reinforced by bad regulation. In the United States, for example, the landscape of independently owned pharmacies was disrupted by larger chains, such as CVS, Rite Aid, and Walgreens, that were able to exploit economies of scale and reduce prices. In Italy, by contrast, pharmacies are essentially prohibited from competing against each other. The mechanism is a restrictive system of licenses that prohibits the creation of large chains and ensures that to start up a new pharmacy, you must first acquire a license from an existing pharmacist. It’s a convenient system if you happen to be the not particularly hard-working son of an elderly pharmacist. Dad will pass the license down to you, and though you’ll never get rich running a single shop, you don’t need to worry that you’ll be put out of business by some entrepreneur with more hustle or better business sense.          

This is crippling for the hardest-working, most-skilled pharmacy owners in Italy. It’s also bad on the whole for pharmacy workers. It ought to be the case that the worst-managed shops close and the best-managed shops branch out and prosper. That way more people would end up working for managers who know what they’re doing, rather than managers who happen to have inherited a license. Such competition-stifling rules are not unheard of in the United States. An idiosyncratic regulatory framework explains why you've traditionally had to buy a car from a locally owned car dealership rather than from a national retail chain or directly from a manufacturer. But the fact that most Americans work at companies with more than 250 employees while almost 70 percent of Italians work at firms with fewer than 50 highlights the scale of the difference. The strength of the Nordic and Anglophone models, from an entrepreneurial perspective, is that these are the places where it’s easiest to start a business and also the places where it’s easiest for one to grow.          

These issues don’t explain all the eurozone’s problems. In business regulation terms, Ireland looks much more like the United States or Denmark than it does like its fellow PIIGS. In the short term, issues about financial inflows, land-price bubbles, bank bailouts, and inflexible monetary policy dominate business regulation. But Greece, Italy, Spain, and Portugal were Europe’s economic laggards before the acute crisis hit.          

Italian Prime Minister Mario Monti is trying to improve pharmacy regulations, and Silvio Berlusconi’s center-left predecessor Romano Prodi also attempted to bring more competition to Italian markets. But while improvement is possible, the corruption data is telling. Building effective institutions of governance that give people confidence in their dealings is much more complicated than simply passing a law or two. And yet to create a framework in which it’s possible for small businesses to not only exist but thrive does seem crucial to long-term prosperity.

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