discussion papers
FS IV 90 - 13
Small Firms and Entrepreneurship:
A Comparison between West and East Countries
Zoltan J. Acs*
David B. Audretsch**
*University of Baltimore
**Wissenschaftszentrum Berlin für Sozialforschung
August 1990
ISSN Nr. 0722 - 6748
Forschungsschwerpunkt Marktprozeß und Unter
nehmensentwicklung (IIMV) Research Unit
Market Processes and
Corporate Development (IIM)
ABSTRACT
Small Firms and Entrepreneurship: A Comparison between West and East Countries1
In July, 1990, Research Unit "Market Processes and Corporate
Development" hosted an international conference, "Small Firms and Entrepreneurship in West and East Countries: An International
Comparison". A selection of the papers from the conference will be published by Cambridge University Press in 1991. This paper is the introductory chapter of that volume. The purpose of the paper is to explain why small firms and entrepreneurial activity have played a key role in industrial restructuring, and how this
experience has differed between Eastern and Western nations. Four fundamental questions are addressed: (1) To what extent has a
shift in economic activity away from large firms and towards small firms occurred, and to what extent is this a similar phenomenon across countries? (2) Is th role of small firms and entrepreneur- ship the same for all countries, or is this a country-specific phenomenon? (3) What explanation or hypotheses can account for the increased role of small firms? and (4) How have government
policies shaped the industrial restructuring which has taken place?
Nine distinct stylized facts are derived based on the most reliable and solidly substantiated findings which have been
validated in empirical studies. These stylized facts should serve as the core of knowledge about what is currently known regarding the economic and social role of small firms and entrepreneurial activity.
To be published in Small Firms and Entrepreneurship: A Global Perspective, Z.J. Acs and D.B. Audretsch, eds., Cambridge:
Cambridge University Press, 1991.
1
ZUSAMMENFASSUNG
Kleinbetriebe und Unternehmertum: ein West-Ost-Ländervergleich Im Juli 1990 veranstaltete der Forschungsschwerpunkt '’Marktprozeß und Unternehmensentwicklung" eine internationale Konferenz zum Thema "Kleinbetriebe und Unternehmertum in West- und Ostländern:
ein internationaler Vergleich". Eine Auswahl der Beiträge dieser Konferenz erscheint 1991 bei der Cambridge University Press. In dem vorliegenden Beitrag, der in die Thematik einführt, geht es um die Frage, warum Kleinbetriebe und unternehmerische Aktivitäten eine Schlüsselrolle im industriellen Strukturwandel gespielt haben und ob sich Unterschiede zwischen östlichen und westlichen Volks
wirtschaften erkennen lassen. Vier zentrale Fragen werden behan
delt: (1) In welchem Ausmaß haben sich Wirtschaftsaktivitäten von Großunternehmen auf Kleinbetriebe verlagert? Ist dieses Phänomen in den betrachteten Ländern ähnlich? (2) Spielen Kleinbetriebe und Unternehmertum in allen Ländern die gleiche Rolle oder ist dies ein länderspezifisches Phänomen? (3) Welche Ansätze oder Hypothe
sen können zur Erklärung der gesteigerten Rolle von kleinen Unter
nehmen herangezogen werden? Und (4) inwiefern haben staatliche Maßnahmen die wechselseitigen Rollen von großen und kleinen Unter
nehmen im industriellen Strukturwandel beeinflußt?
Auf der Grundlage von empirischen Forschungsergebnissen werden neun verschiedene "stilisierte Fakten" abgeleitet. Diese
stilisierten Fakten widerspiegeln unser Basiswissen über das, was uns derzeit über die ökonomische und soziale Funktion von
Kleinbetrieben und unternehmerischen Aktivitäten bekannt ist.
I . Introduction
Nearly one decade ago David Birch revealed the startling findings from his long-term study of U.S. job generation. De
spite the prevailing conventional wisdom at that time, Birch (1981, p. 8) reported that, "...whatever else they are doing large firms are no longer the major providers of new jobs for Americans." Rather, Birch discovered that most new jobs emana
ted from small firms.
Birch's findings met resistance for at least three
reasons. First, certainly at that time the preoccupation of the literature in industrial economics, the field most directly associated with studying markets, was with identifying the extent of concentration in markets and its effects on economic performance. Given the existing state of knowledge about the source of economic activity, this preoccupation was not surpri
sing. The long-term trend had been clearly identified by the early 1970s as an increased concentration in economic activity both at the aggregate as well as at the market level. For
example, Figure 1 shows that the percentage of total U.S.
manufacturing assets accounted for by the largest one hundred corporations increased from about 36 percent in 1924 and 39 percent after the second World War to over fifty percent by the end of the 1960s, causing F. M. Scherer to conclude in the 1970
(p. 44) edition of Industrial Market Structure and Economic Performance, "Despite the (statistical) uncertainties, one thing is clear. The increasing domestic dominance of the 100 largest manufacturing firms since 1947 is not a statistical illusion. "Thus, it was not readily apparent how to reconcile
FIGURE 1: Estimated Changes in the Concentration of
Manufacturing Corporation Asset Control: 1924 to 1967
peicentage 65 of Total
Manufacturing Corporation Assets ,
Controlled by 50 the Largest 100 Firms
45
40
35
tsj
1924 29 31 33 47 50 55 60 .65 67
Year
5
- V
3
Birch's claim that eighty percent of new jobs were created in small firms with the stylized facts which emerged in the in
dustrial economics literature pointing towards an ever in
creasing tendency towards concentrated economic activity, both in individual markets as well as the overall economy.
A second point of contention was raised regarding the exact methodology and application of the underlying data
(Armington and Odle, 1982; Storey and Johnson, 1987; and FitzRoy, 1989). As Evans points out, reconciliation between discrepencies in the enterprise (firm) and establishment
(plant) records in the underlying Dun and Bradstreet data files leads to substantially different results than those reached by Birch. As Evans also emphasizes, both the publication of and reaction to Employers Large and Small by Brown, Hamilton and Medoff (1990) serve as a barometer of the ongoing debate that still rages over the statistical validity of Birch's claims.
The third major challenge raised against Birch's finding is the relevance in examining the numbers of newly created jobs. As Brown et al. (1990) point out, many of these newly generated jobs subsequently disappear. That is, without consideration of the number of job disappearances, focusing solely on the amount of job generation emanating from small firms is misleading and leads to an overstatement of the amount of economic activity actually stemming from small firms
(Storey, 1990).
Despite these well-founded challenges to Birch's claims, a number of independent studies based on different statistical methodologies have converged,towards a singular conclusion —
4
namely, between the mid-1970s and beginning of the last decade of this century, a substantial shift has occurred in American economic activity. Small firms are apparently playing a rela
tively more important role in the economy. For example, Brock and Evans (1989) report that the number of new-firm start ups in the U.S. has increased drastically over time. While 376,000 new firms were established in 1976, 703,000 new businesses were registered in the U.S. in 1986. This 87 percent increase in the number of new-firm start-ups was more than twice as great as the 39 percent increase in real gross national product which occurred over the same period. Equally striking is the reversal in the steady increase in average firm size that had taken
place throughout the post-war period. While the average real GNP-per-firm rose by nearly two-thirds between 1947 and 1980, from $150,000 to $250,000, it subsequently declined by about 14 percent during the subsequent six years to $210,000.
This shift in U.S. economic activity away from large firms and towards smaller firms has not escaped the attention of the popular pressl. For example, The Economist reports, "Despite ever-larger and noisier mergers, the biggest change coming over the world of business is that firms are getting smaller. The trend of a century is being reversed. Until the mid-1970s, the size of firms everywhere grew; the numbers of self-employed fell. Ford and General Motors replaced the carriage-maker's atelier; McDonald's, Safeway and W.H. Smith supplanted the cor
ner shop. No longer. Now it is the big firms that are shrinking and small ones that are on the rise. The trend is unmistakable 1 See David B. Audretsch, "America's Challenge to Europe",
The Wall Street Journal. July 31, 1989, p.6.
5
— and businessmen and policy-makere will ignore it at their peril.
Of course, as Evans (forthcoming) and Tom Gray
(forthcoming) both point out, there is a temptation to attri
bute this relative increase in the number of small firms and in small-firm employment to the obvious long-term transition of employment into the service sector and out of manufacturing.
Between 1960 and 1990 the employment share of manufacturing fell from 40 percent to about one-quarter. However, as Table 1 shows, a substantial shift in the share of manufacturing sales accounted for by small firms occurred between 1976 and 1986.
While firms with fewer than 500 employees accounted for about 19 percent of manufacturing in 1976, the small-firm sales share had risen to over one-quarter by 1986.
Several hypotheses have been proposed to explain at least some of the forces underlying this shift in economic activity away from large firms and towards small firms, but most of these have been speculations which have not been subjected to rigorous systematic analysis. The purpose of this papere is to address the following questions which arise from the American experience:
(1) To what extent have similar shifts in the firm-size distribution occurred in other countries? Has this shift been similar among the most developed nations as well as the develo
ping countries?
"The Rise and Rise of America's Small Firms," The Economist, January 21, 1989, pp. 73-74.
2
6
(2) Is the role of small firms and entrepeneurship the same for all countries, or is this a country-specific phenome
non?
(3) What explanations or hypotheses can account for the increased role of small firms? and
(4) How have government policies influenced the relative roles of large and small firms?
In the second section of this paper we present the
stylized facts on the economic role of small firms in market economies. These facts should serve as "guidelines" to
countries restructuring their economies. The third section examines the larger socio-economic "picture" for the shift toward small firms and plants, while in the fourth section the impending industrial restructuring in eastern Europe and the Soviet Union is examined. In the final section we conclude that the planned eoconomies must completely abandon the
administrative system and reinstitute a technologically progressive small firm sector.
7
Table I : Percentage of Sales Contributed by Small Manufacturing Firms, 1976-1986
Small Firms with Fewer than 100 Employees
Small Firms with Fewer than 500 Employees
1976 11.6 20.4
1978 10.2 18.7
1980 12.3 21.8
1982 12.1 21.4
1984 14.0 24.5
1986 14.8 25.8
Source: U.S. Establishment and Enterprise Microdata File,
April 1988, Small Business Adminsitration, Washington, D.C.
8
II. The Economic Role of Small Firms: The Stylized Facts While the small-firm sector has remained an enigma for years, a series of empirical studies have recently enabled researchers to assemble a far better understanding of the economic role of small firms:
Stylized Fact 1. A shift in the size distribution of firms has occurred away from larger firms and towards smaller ones.
The shift in the firm size distribution shown in Table 1 for the U.S. can be found in other industrialized countries at both the enterprise and establishment level (Loveman and
Sengenberger, 1991). In general, the increase has been at the expense of large enterprises and establishments. While the magnitude of the increase varies considerably from country to country and across sectors, its significance rests primarily on the fact that it signals the reversal of a substantial downward trend in the employment shares of small firms that had
prevailed for many decades. For example, as Table II shows, the small- and medium-firm share of employment in Japanese
manufacturing industries declined from 83 percent in 1935 to 63 percent in 1972 and has since increased to 67 percent in 1983.1 A similar trend can be observed in the other developed
countries, while in the socialist countries no such trend can be observed. Roy Thurik (forthcoming) attributes the shift in the size-distribution of Dutch manufacturing firms towards a reduction in scale economies.
1 For more recent evidence on Japan see Sato (1989) and Yokokara (1988).
Table II
Employment- S h a r e s by E n t e r p r i s e S i z e Tim e S e r i e s f o r M a n u f a c t u r in g
1919 19 3 5 194 9 1955 1972*3 1975*3 1979*3 1980*3 1982*3 1983
Japan
Sm al 1 45*1
78*
48*1
83* 5 1 *2
77*
57*1 43 45 49 49 47 47
S m a ll and medium 85* 63 65 68 68 6 7 67
1958 1963 1967 1972 1977 1982
United States
S m a ll 2 0 .6 1 9 .1 16 . 3 1 6 .2 1 6 .2 1 7 .6
S m a ll and medium 3 7 .1 3 4 .5 3 0 .4 2 8 .9 2 9 .0 3 0 .3
1971 1979
Prance
S m a ll 2 6 .4 2 8 .6
S m a ll and medium 4 9 .5 5 0 .6
1963 1970 1976 1 977 1980 1983 1984
FRG 4
S m a ll 1 4 .0 1 2 .5 1 3 .1 1 5 .9 1 5 .4 1 6 .0 1 6 .2
S m a ll and medium 3 9 .6 3 7 .3 3 8 .0 4 0 .4 3 9 .9 4 0 .8 4 1 .1
* 5 1971 1973 1975 1976 1978 1979 1980 1981 1982 1983
United Kingdom
S m a ll 1 5 .5 1 5 .3 1 6 .6 1 7 .0 1 7 .3 1 7 .5 1 8 .8 2 0 .3 2 1 .1 2 2 .0
1965 1985
Switzerland
S m a ll *6 3 4 .8 2 9 .7
S m a ll and medium 7 1 .0 6 9 .4
* 7 1951 1961 1971 1981
Italy
S m a ll 5 0 .5 5 3 .2 5 0 .5 5 5 .3
S m a ll and medium 6 7 .4 7 2 .0 6 9 .2 7 3 .9
Table II (cont.)
1938 1959 1964
Hungary
a ) S t a t e 8 7 .1 2 .1 0 .7
Sm al 1 9 7 .2 2 2 .0 1 0 .0
S m a ll and medium b) S m a ll f i r m s * *10
c ) I n d u s t n a l C o o p e r a t i v e s A v e r a g e s i z e *12
*11
1 1 4 .5 1 9 8 .5 Sm al 1
S m a ll and medium d) S m a ll c o o p e r a t i v e s
e J P r i v a t e s m a ll s c a l e 1 0 0 .5 5 9 .2 i n d u s t r y *14
1982 1983 1984
f ) S m a l l - s c a l e u n d e r
t a k i n g s *17 5593 15176 27070
1 . P r i v a t e b u s i n e s s -
work p a r t n e r s h i p s 2431 4741 7450
2 . I n d u s t r i a l and s e r v i c e p a r t n e r s h i p s
i n s i d e c o o p e r a t i v e s 477 1243 2200 3 . E n t e r p r i s e b u s i n e s s
work p a r t n e r s h i p s 2775 9192 17420
1956 1976 1985
Czechoslovakia *18
Sm al 1 1 3 .0 1 .8 1 .2
1985 31787 7742
3420 20625
1969 1979 1981 1982 1983 1984 19 85
o . 4 0 .2 o . 2 0 .2 0 .2 0 .2 2 .2
7 . 5 5 .4 5 .5 5 .5 5 .7 5 .8 1 6 .9
2 3 .0 204 285
1 9 .0 3 .1 3 .7 2 .9 2 .8 3 .0 3 .0
8 6 .4 6 3 .7 6 7 .1 6 8 .3 6 9 .5 6 8 .0 6 8 .0
* 1 £ 145 255 368
1 0 1 .9 4 3 .9 1 1 2 .0 1 2 1 .4 1 3 1 .5 1 3 9 .0 1 4 3.
*1 5 -9 9 e m p lo y e e s
*2 5 -9 9 9 e m p lo y e e s
*3 fro m OECD ( 1 9 8 5 ) , C h a r t 13
*4 6 3 -7 6 d a t a a r e n o t c o m p a r a b le w it h 7 7 -8 3 d a t a due t o i n c l u s i o n o f th e handw ek s e c t o r o n ly in th e l a t t e r p e r i o d . A l s o d a t a c o v e r s o n ly e n t e r p r i s e s w it h 20+ e m p lo y e e s
*5 D a ta fro m S t o r e y an d J o h n s o n , T a b le 4
*6 1 -4 9 e m p lo y e e s
*7 E x c lu d e s NACE d i v i s i o n s 21 and 23
*8 D a ta r e f e r t o em p lo ym en t s h a r e s . By 1987 th e t o t a l o f t h e s m a ll f ir m s e c t o r had i n c r e a s e d t o 34 p e r c e n t
Table II (cont.)
*9 1 0 1-1 0 0 0 e m p lo y e e s
*10 Number o f "new s m a ll o r g a n i s a t i o n s " , a new s t a t i s t i c a l c a t e g o r y in t r o d u c e d t o a c c o u n t f o r new in d e p e n d e n t fo rm s r e s u l t i n g from b r e a k - u p s o f l a r g e r f i r m s . I n c l u d e s s u b s i d i a r y c o m p a n ie s
*11 D a ta th r o u g h 1964 a r e a v e r a g e em p loym en t p e r c o o p . S u b s e q u e n t d a t a a r e em p lo ym en t s h a r e s
*12 A v e r a g e number o f e m p lo y e e s p e r c o o p e r a t i v e
*13 Same a s * 8 , e x c e p t f o r c o o p e r a t i v e s
*14 T o t a l e m p lo y m e n t, in th o u s a n d s
*15 1948 d a t a
*16 1978 d a t a
*17 Number o f u n d e r t a k i n g s , o r u n i t s
*18 l e s s th a n 500 e m p lo y e e s : From S t a t i s t i c k ä r o c e n k a C S S R . 1989 fro m F e d e r a l O f f i c e o f S t a t i s t i c s
12
Stylized Fact 2: The firm growth rate decreases with firm size and firm age.
Recent studies have considerably expanded the state of knowledge about the relationship between firm size and growth.
Hall (1987) identified a four percentage point difference in the annual growth rates between firms in the 25th and 75th
percentiles. Smaller firms were found to grow faster than their larger counterparts. She argued that differences in investment and R&D outlays explained the truly superior job creation
performance by small firms. Building on the work of Jovanovic (1982), Evans (1987a and 1987b) also cast considerable doubt on Gibrat's Law. In his 1987a paper, Evans selected 100 four-digit Standard Industrial Classification industries and calculated individual firm growth rates between 1976 and 1980. He found that Gibrat's Law did not hold in 89 percent of the industries.
In both papers Evans reached the same conclusion. The firm growth rate is found to decrease with both firm size and firm age. These results have been confirmed for Italy (Contini and Revelli, 1990).
Stylized Fact 3: Small firms are at least as innovative as large firms on a per employee basis and generally have the innovative advantage in high technology industries.
The most convincing evidence in support of the innovative advantage of small firms (Scherer, forthcoming; Cohen and
Klepper, forthcoming) comes from the U.S. Small Business
13
Innovation Data Base, and is analyzed in our 1987 and 1988 papers and 1990 book. We found that in 1982, large firms in manufacturing introduced 2,608 innovations. Small firms
contributed 1,923 innovations. However, small-firm employment was only about one-half as great as large-firm employment, so that the mean small-firm innovation rate was 322 innovations per million employees. By contrast the large firm innovation rate was 225 innovations per million employees. The small-firm innovation rate is relatively higher in the high-technology industries, for example: instruments, chemicals, non-electrical machinery and computers.
Similar results have been found in the United Kingdom using the Science Policy Research Unit (SPRU) innovation data base (Pavitt et al., 1987). The SPRU data also revealed that the relatively high innovative activity of small firms is a new phenomenon that did not emerge until around 1970.1
Stylized Fact 4: Small firms face binding liquidity con
straints .
It has long been suspected that small firms face liquidity constraints because of imperfect capital markets. Recently
Evans and Jovanovic (1989) concluded that imperfect credit mar
kets do indeed constrain entrepeneurs. They based their judge
ment on econometric tests in which wealthier people are shown to be more likely, ceteris paribus, to switch from paid employ
ment into self employment. Fazzari, Hubbard and Petersen (1988) 1 For a further examination of the data see Rothwell (1989).
14
found that for a sample of publicly traded companies, financing was more difficult for small firms than for large firms.
Finally, Blanchflower and Oswald (1990), using data on a British birth cohort, found that the probability of self-
employment depends upon whether the individual ever received a gift or inheritance. Those who were given or inherited 5,000 pounds, for example, were approximately twice as likely, ceteris paribus, to establish a business. These results are consistent with the U.S. results stressing the importance of capital and liquidity constraints.
Stylized Fact 5: The small-firm share of employment is growing faster in the goods producing sectors than for the economy as a whole.
In the U.S. the small firm sector share of employment declined in every major sector between 1958 and 1977. However, between 1976 - 1986 the small-firm share of employment
increased in the goods producing sectors and decreased in the non-goods producing sectors. Small firm employment increased by 7.8 percent in mining, 3.5 percent in construction, and 1.8 percent in manfacturing. During the same period, it decreased by 0.8 percent in wholesale trade, 7.5 percent retail trade and by 3.2 percent in services. (Brown, et a l ., 1990, p. 26). A similar trend can be found in other OECD countries. That is even after taking into account sectoral shifts the small-firm share of employment in manufacturing has increased (Lovemann and Sengenberger, 1991).
15
Stylized Fact 6: Firm survival is positively related to firm size and firm age.
New firm start-ups, as well as new plants tend to have a lower rate of survival than established firms. These results were substantiated with different data sets in the U.S. by Dunn et al. (1989), Evans (1987a and 1987b), and Hall (1987).
Industries experiencing substantial entry in the form of
entrepeneurial start-ups are more likely to also experience a high rate of firm failure. Such industries can be characterized by a high degree of what Invernizzi and Revelli (forthcoming) term as "turbulence1’ — or the simultaneous entry of new firms and exit of incumbents.
While it is well known that new firms fail at a higher rate than established firms, exactly how many firms survive for a "long" time, and therefore make a meaningful contribution to the economy is unclear. Recently Phillips and Kirchhoff (1989), using the U.S. Small Business Database, developed an estimate for the whole economy between the years 1976-1986. They found that 39.8 percent of the new entrants survived at least six years. Even more striking was the finding that the survival rate was highest in manufacturing, 46.9 percent, and the lowest in construction, 35.3 percent.
Evans and Leighton (1988), using the U.S. current population survey, show that about three-fifths of those
entering self employment are still in business after 10 years.
Moreover, Evans and Leighton (1990) also found that the failure
16
rate for those entering self employment from unemployment is twice as high as for those that were not previously unemployed.
These issues are further examined by David Storey (forthcoming) for the U.K. and Michael Fritsch (forthcoming), who points out in his chapter that new-firm start-ups in West Germany face a lower rate of survival than do established firms.
Stylized Fact 7: Most New Plants and Firms Enter on a Small Scale.
The increase in the number of U.S. establishments over a six-year period by 32,000 — from 448,000 in 1980 to 480,000 in 1986 — does not suggest a particularly important role for
entry. On average, there was an increase of just slightly more than one percentage point in the number of establishments each year. However, when the amount of gross entry rather then net is examined, a considerably different picture emerges. In fact, 205,000 new manufacturing establishments entered between 1980 and 1986, representing a gross entry rate of 45.8 percent. At the same time, 173,000 manufacturing establishments exited from manufacturing, resulting in an exit rate of 38.6 percent (Acs and Audretsch, 1990). Using a different data set over a longer period, these results were confirmed by Dunne, Roberts and Samuelson (1989). They found that in each census year, plants with fewer than five employees accounted for 36 percent of the total number of plants.
Data on entry and exit for European industry have been compiled by Geroski (1990). He concluded that gross entry rates
17
of around 5 percent seem to be something of a norm in
manufacturing with a shift toward smaller plants during the 1970s and 80s. In comparing entry and exit of new plants with Yugoslavia, the entry and exit process that we observe in the west is nonexistent (Estrin and Petrin, 1990).
Stylized Fact 8: Small firms generate at least a proportionate share of new jobs.
It is in the area of job generation where the most inter
national research has been done. These studies are summarized in Sengenberger, Loveman and Piore (1990), Storey and Johnson (1987), and OECD (1985). The results from these international studies broadly suggest that the trend observed in the U.S. by Birch has similar counterparts in other countries. However, there are two observations that must be kept in mind. First, in Europe substantial job losses by large firms dominated the
employment statistics and offset the employment gains of smaller firms. Second, the net new jobs result from a very dynamic process of expansion and contraction — births and deaths — within the small firm sector. As Alan Hughs points out, there has been an increase in the share of employment in the U.K. manufacturing sector; however, it has not been as large as previously suggested, and the trend started much earlier.
18 III. The Larger Socio-Economic Context
While there has been a shift in the size distibution of firms in most countries during the past two decades, Table III shows that the share of small- and medium-sized firms differs across countries. While the small and medium firm sector
accounted for almost 50 percent of employment in 1985 in
Norway, 70 percent in Switzerland, and 31 percent in the U.S., it accounted for only a lower share of employment in
Czechoslovakia and in East Germany. As Lovemann and Sengenberger (1991, p.5) point out, the actual size
distribution of firms at any particular point in time depends on the institutional or historical context: "(M)ajor criteria for structuring SME sectors are the legal status (such as in France), the ownership status (as in Hungary), the distinction between 'craft' and 'industrial' firms (as in the Federal
Republic of Germany), independent and subordinate firms (as in Japan), or small firms in small-firm industries vs. small firms
in industries where large enterprises dominate or where there is a mixed size composition.” In other words, while there ap
pears to be no predetermined optimal size distribution of firms, the shift toward a larger percentage of small firms in most countries is even more remarkable given that they started from such different points.
There are at least eight major factors hypothesized to underlye the shift in the firm size distribution (Acs and Audretsch, 1990; Brock and Evans, 1989; Loveman and
Sengenberger, 1991; Aiginger and Tichey, 1991). These are: (1)
1 9
The percentage share of employees in the small and small-and medium- sized enterprises in the manufacturing sector
Table III
Country Small Enterprises Small- (less than 100) (less
Italy (1981) 58,9 80,2
Japan (1980) 57.8 73.4 *,
Ireland (1980) 38.1 79.6
Portugal (1985) 43.8 77.5
Denmark (1982) 39.8 74.4
France (1980) 44.1 72.9
Spain (1978) 43.4 65.2
Austria (1976) 39.0 62.7
Netherlands (1980) 38.8 —
Belgium (1985) 32.8 58.7
Luxembourg (19-0) 19.2 45.0
Finland (1984) *b 25.5 43.8
F.R.G. (1983) *c (16.o) (40.8)
U.K. (1983) 22.0 36.4
U.S.A. (1986) 23.7 37.4
Hungary (1987) *d 23.0 34.0
Czechoslovakia(1985) . 5 0.7
DDR (1986) . 4 1.1
Switzerland (1985) 41.2 7o. 5
Sources: — - — - --
For EEC countries: Johnson, S. and Storey, D.J., Small and Medium Sized Enterprises and Employment Creation in the EEC Countries - Summary Report, 1988, p.7
Japan: Small Business Agency, Small Business in Japan 1984,MITI 1984, 92.
Austria: Aiginger, A. and Tichy, S., Die Größe der Kleinen, Siqnum Verlag, 1985, 43.
Finland: Statistik arsbok for Finland, 1987, p.195
U.S.A.: The State of Small Business. A Report of the President, Washington, DC, 1988, p.49.
*a: Enterprises wirh less than 300 employees, estimate for the 500 category: 78 percent
*b: Industry
*c: Only enterprises with more than 20 employees, estimate including these firms also: 22 percent and 47 percent, respectively
*d: State and Cooperate Sector
20
government deregulation in numerous markets; (2) a changing composition of the labour force; (3) the proliferation of consumer demand away from standardized mass-production goods;
(4) the increased globalization (and volatility) of markets;
(5) transitory shift from the business cycle, but no structural change; (6) statistical fallacy; (7) a sectoral shift in
demand; (8) the implementation of new flexible technologies.
While the evidence is still inconclusive, we believe that the most decisive factor contributing to the emergence of small firms and smaller establishments has been a fundamental shift in the underlying technology.
Throughout most of this century, industrial technology fa
vored mass production, or the application of special purpose machines to produce standardized products. Inherent in this technology was inflexibility and a bias towards large firms and plants over smaller ones. However, more recently manufacturing technology, "...has been revolutionized by the cost reduction of small-scale production relative to large-scale and the degree of flexibility offered by the technology" (Carlsson,
1984, p.91). Indeed, the new breed of "flexible" capital
equipment is considered to be especially well suited to a small firm strategy favoring small batch customized production (Dosi, 1988) .
The large scale units of production and employment, orga
nized by the dynamic center of the economy, the Kombinate or combine in the East and the vertically integrated corporation in the West, were themselves part of a more encompassing model of economic and social development. The key ingredients of this
model were: mass production of standardized goods, market ex
pansion to minimize costs, Keynesian-type demand management and income stabilization schemes to assure stable and continuous mass purchasing power, and a Taylorist-type of work organiza
tion built on an extensive division of labour. This coherent model of production, consumption and work organization has been termed '’Fordism1’ (for an elaborated discussion see Piore and Sable, 1984). This model of industrialization prevaded not only Western market economies, but had significant elements (most notably mass production and the centralization and integration of productive organizations) in Eastern European planned
economies as well. Certainly, not all structures and
institutions conformed to this concept, "(b)ut the exceptions and deviations were generally seen to play a residual role or were a left-over, bound to disappear as economic development proceeded” (Loveman and Sengenberger, 1991, p.2). Small firms in this model were supposed to wither away due to inferior organization, poor management, or backward technologies.
There are two versions, or interpretations, of what
transpired to undermine this model. They both direct attention to the larger socio-economic environment. The first attributes most of the change to exogenous factors - volatility of
markets, change in consumer tastes, changing technology - which shifted the advantage to smaller firms. A second line of
reasoning steps out of the narrow efficiency logic and
attributes a much more critical role to social or political organizations. The so-called Piore and Sable thesis (1984) suggests that how to organization of production, employment and
21
22
work ultimately depends on politics. As a consequence, the course of industrial development can produce rather different results in different societies, and it can also be redirected.
While in Eastern Europe - Czechoslovakia, GDR, and Hungary - small firms were being systematically eliminated, in Western Europe, and particularly in the U.S., small firms were being promoted. In 1953 congress passed the Small Business Act which established the U.S. Small Business Administration and in 1976 the Office of Advocacy. The agency was directed to help small businesses obtain government contracts and loans along with management technical assistance. Tom Gray outlines these
assistance programs in his forthcoming study. As a consequence of these policies and others, small firms in the U.S. employ 58 percent of the nonagricultural labor force (this includes 8 percent self-employed). Even in the crucial manufacturing sector, the U.S. maintained a quarter of employment in small firms. In fact these small manufacturing firms had survived precisely because of their flexibility in output and firm size
(Mills and Schumann, 1985). It can perhaps be argued quite convincingly that the small firm sector in general and small firms entry in particular acted as '’agents" of change in the restructuring process.
While the small firm sector could be "easily" expanded to accomodate new flexibility in larger firms, radical
reorganization was needed to create smaller, more
horizontically coordinated organizational units in which establishments within the corporation behave more like
independent small firms. This decentralization in terms of both
23
employment and production is a strategy for large firms to restructure large mass production enterprises by combining the dynanism of small entities with the labor standards,.
compensation, financial resources, and R&D of large
enterprises. Between 1972 and 1982 the mean establishment size in U.S. engineering industries declined by 12.7 percent, and the average plant size declined in 79 out of the 106 four-digit industries. The trend was verified for both the employment and value-of-shipments measures (Carlsson, 1989? Carlsson,
Audretsch and Acs, 1990; Audretsch and Acs, 1990).
Flexible specialization requires an institutional struc
ture that is radically different from that associated with mass production. We would like to argue that the existence of a
sizeable small firm sector in the industialized West gave it a critical advantage vis a vis their eastern European and Soviet counterparts. The most important institutional characteristics of flexible specialization are technological dynamism, the combination of extensive cooperation and vigorous competition, and location within a ’’community" or social structure.
Small high-tech firms in the U.S. provide an intuitive example of the new system. First, small firms derive their technological dynamism from their ability to innovate at least as much as large firms. Second, these firms have been able while competing vigorously in the market (some would claim too vigorously) to exhibit significant amounts of cooperation in R&D, marketing, and technology transfer. Third, these small high technology firms have survived by being closely linked to universities in the U.S. and forming production "networks" in
2 4
areas such as "Silicon Valley". These technological
agglomerations in the U.S. are the counterparts of the Japanese subcontracting system and the industrial districts in the third Italy, which have provided the social structure for small firms to survive and prosper in those countries. Several papers in this volume suggest that cooperatives in eastern Europe may provide the social structure for small scale entrepeneurship in the East. We shall return to this point below.
Several key studies have indeed found that innovative activity is a key mechanism by which new entrepreneurial start
ups attempt to enter an industry (Geroski, 1990; Acs and
Audretsch, 1989a and 1989b; Florida and Kenny, 1988; and Gort and Klepper, 1982). Brunner (forthcoming) shows that the role of small firms as "agents" of change — as represented by innovative entry — is not restricted only to the developed western nations. He finds that entrepreneurial start-ups
provided a significant share of the innovative activity in the Indian computer industry.
The extent to which new firms in an industry are able to serve as "agents" of change is implied to some extent by two quite different literatures. Winter (1984) and Gort and Klepper
(1982) argue that the technological conditions determine the relative ease with which firms outside of the industry are able to innovate and therefore enter. The models of "learning by doing" introduced by Jovanovic (1982) and Pakes and Ericson
(1987) suggest that firms may enter an industry at suboptimal scale in order to obtain the opportunity to learn and subse
quently expand if successful.
25
In fact, the technological regime characterizing the industry, along with the role which learning by doing plays, may explain a considerable amount of industry turbulence, or the extent of firm movement into, within, and out of an
industry (Audretsch and Acs, 1991). However, the virtual obliteration of small firms and entrepeneurship deprives eastern European countries of a key element to industrial
restructuring and technological progress. Therefore, a crucial ingredient of restructuring in the eastern European economies involves generating a vital base of entrepreneurial activity.
While the exact mechanism by which entrepreneurship in eastern Europe economies can be promoted is the topic of considerable debate, Me Dermott and Mejstrik (fothcoming), Loveman and
Johnson (forthcoming), and Grachev et al. (forthcoming),make clear the consequences of its absence.
IV. Industrial Restructuring in Eastern Europe
While western Europe has been restructuring its industries into smaller production units, the average establishment size for most countries in eastern Europe has increased
dramatically. As McDermott and Mejstrik (forthcoming) and Grachev et al. (forthcoming) emphasize, countries in Eastern Europe, as well as the Soviet Union, chose to push the mass production paradigm to its logical and perhaps fatal limits.1 1 It should take into consideration that the division of
labor is not as developed in the Soviet economy as in western countries. Firms are not specialized and produce almost everything they need because of shortages and
supply uncertainties. That is one of the reasons the USSR has mostly large firms. But in comparison with big western
26
Stylized Fact 9: Small firms in Eastern Europe were systematically eliminated.
For example, in his study of East Germany included in this volume, Hans-Gerd Banasch finds a drastic concentration of economic assets has taken place. While there were 11,523 establishments in East Germany in 1971, this number had been reduced through the Kombinate system to 349 by 1987. Similarly, the share of employment accounted for by small firms in
Czechoslovakian manufacturing fell from 13 percent in 1956 to 1.0 percent in 1986 (Table IV). The mean number of employees per establishment tripled from 1,121 in 1956, to 3,102 by 1988.
As Marius Hiricovsky pointed out at the conference, the current monopolistic situation in Czechoslovakian economy has no
historical precedent. This shift in the firm size distribution towards extreme concentration was a conscious policy decision that had more to do with ownership and political control by the party than economics.
Table V illustrates the fact that in 1948, 33.4 percent of the Czechoslovak economy was in the private sector and an addi
tional 1.1 percent was individually owned. By 1985 the share of firms in the private sector had decreased to 0.6 percent of the total economy. On the other hand, the socialist sector
accounted for 97.2 percent of output, with the state sectors accounting for 87.5 percent and the cooperatives accounting for
firms, many production units have not reachd the upper limits of effective mass production (the amount of cars produced in the USSR can be compared with that of a single Japanese corporation).
27 Table IV
Composition of the National Income (percentages’) in Czechoslovakia, 1948-1985
1948 1960 1970 1980 1985
National Income 100.0 100.0 100.0 100.0 100.0
From the socialistic sector 65.5 93.4 95.9 97.4 97.2
State owned firms 62.9 81.8 86.3 87.5 87.5
Cooperatives 2.6 11.6 9.7 9.9 9.7
From private (individual)
firms * 1.1 5.0 3.3 2.1 2.2
In the private sector 33.4 1.6 0.8 0.5 0.6
One person or one family firm
(Tschechoslowakei in Zahlen und Fakten. Presseagentur Orbis, Prague, 1988)
28
Size Distribution of Firms in Czechoslovak manufacturing Table V
Year
Employment Size Classes
less than 500
501- 1000
1001 2500
2500- 5000
500
and more
1956 13.0 19.7 35.9 15.5 15.9
1976 1.8 7.9 34.0 31.2 25.1
1985 1.2 7.4 33.1 32.5 25.8
1986 1.2 7.4 34.5 31.6 25.1
1988 1.0 8.0 35.0 30.0 25.0
1989 * 9.8 2.2 14.6 19.5 53.9
* - State enterprises as of April 1, 1989
Source: Statistickä rocenka CSSR (CSSR Statistical Abatract for the respective years)
1989,1990 the materials of Federal Office of Statistics
29
87.5 percent and the cooperatives accounting for 9.7 percent.
Similar trends can be observed in all of the eastern European economies, as well as in the Soviet Union.
During the same period the percentage of employment in enterprises employing more than 5,000 increased by 74 percent.
This trend towards industrial concentration appears to be
continuing. By 1989 the share of employment in the largest firm size category increased to 53 percent of total manufacturing employment.
Table VI illustrated the extent of the presence of large establishments in the manufacturing industries in the GDR, FRG and the U.S. The share of manufacturing establishments (plants) in the GDR with more than 500 employees was almost ten times as great as in the FRG. While only 10 percent of the plants in the U.S. have over 500 employees, in the GDR 40 percent of the
plants have over 500 employees. Similarly, while in the U.S.
and the FRG about 88 percent of the plants have less than 100 employees, only 18 percent do in the GDR. In terms of
employment the figures are even more revealing. While the U.S.
has 70 percent of employment in plants with more than 500
employees, the GDR has 80 percent, and the FRG only 50 percent.
In stark contrast to the U.S., where 27 percent of employees are in plants with fewer than 100 employees, there is an almost complete lack of employment in small firms in the GDR (1.1
percent).
A recent counterexample to this trend in eastern European industrial concentration can be found in Hungary. Between 1950 and 1980 the number of state-owned enterprises declined from
30
Table VI
The Small-Firm share of manufacturing establishments compared among the GDR, FRG, and US
share of establishment share of employment
GDR (1987)
FRG (1986)
US (1982)
GDR (1987)
FRG (1986)
US (1982)
Fewer than
500 Employees 60% 97% 90% 20% 50% 30%
Fewer than
100 Employees 18% 86% 88% 11% 20% 27%
Source: DDR, Statistisches Jahrbuch der D D R . 1988
FRG, Statistisches Bundesamt, Fachserie 4 Reihe 4.1.2.
USA, Census of Manufacturing, U.S.
Department of Census, Bureau of Census 1982
31
1,425 to 7 0 0 . Since then the number has increased by 50 percent. In 1 9 8 7 1 ,0 4 3 state-owned enterprises employed 1,258,000 workers and produced 80.3 percent of industrial
output. There are also 1,392 industrial cooperatives accounting for 6.1 percent of industrial output. The majority of their 3,973 establishments have less than 500 employees accounting for 95.7 percent of employment. Non-industrial organizations employ 218,000 workers and operate 16,667 establishments.
Although these organizations are only semi-autonomous, under the special Hungarian circumstances they function like small businesses. On the basis of these figures, 34 percent of
manufacturing employment can be considered as working in small establishments (Roman, 1990). However, this still puts the share of small establishments below countries like the United Kingdom and France.
In Poland as pointed out by Loveman in this volume, where reforms have been instituted during the 1980's, the presence of private manufacturing firms has increased significantly.
Between 1985 and 1988 the number of small manufacturing firms increased by 11 percent from 207,000 to 231,000. For the
economy as a whole in 1988 there were 1,287,000 new firms.
Entry and exit of small firms in Poland also exhibits a high rate of turbulence. In January of 1990, 22,321 new firms were established and 18,090 exited. In other words about 2.7 percent of the total number of firms are replaced each month (Gwiazda, 1990) .
The Soviet Union may have one of the most concentrated economies in the world according to the Economist: "(m)any of
32
what are the most basic goods in any economy - polypopylene, stainless-steel pipes, concrete mixers - are produced entirely or almost entirely not merely by a single organization but by a single factory. Between 30 percent and 40 percent of the value of Soviet goods are produced on single sites.”1 However, with the economic reforms under Perestroika a new entrepreneurial sector, called cooperatives, has been introduced into the economy. According to Grachev et a l . in their contribution to this volume, in 1990 there were 250,000 cooperatives
registered, employing 5.5 million people (4 percent of the labour force), and producing 40 billion rubles of goods and services. On average these cooperatives are small firms with 23 employees and can be found in almost all sectors of the
economy, including the high tech sector.
The best example of high technology development is the DOKA-Center organized in May of 1987. The DOKA-Center is an '•independent” , self-supporting R&D facility. The Center has 32 full time employees and more than 2,500 skilled professionals from 17 cities working on a contract base. It is also a profit center with 52 percent of profits channeled back into R&D. The DOKA-Center is an attempt to create in Zolenograd (outside of Moscow) a technological agglomeration similar to that in
western countries. In the Spring of 1990, the Soviet Government had identified small business in high-technology development as an integral ingredient to shifting the firm size distribution.2 1 "The Best of all Monopoly Profits...," The Economist,
August 1990, p.63.
2 While in market economies, especially in the United
States, small firms have access to new technology, in the USSR small firms do not.
33
Given the fact the eastern European economies are in the process of changing the ownership structure and political ad
ministration of the economy, the floodgates are open to redi
rect the size distribution toward smaller firms. The
restructuring of these economies away from large firms toward smaller ones has two aspects. The first is to downsize the existing large-firms sector in order to facilitate smaller
establishments. The second is to create an economic environment that is conducive to entrepreneurial activity and to institute a network that will provide the infrastructure for promoting and financing new firm entry. As we have noticed in Poland, where the majority of political and administrative barriers hindering the development of small firms have been removed, new problems arise. These could have been predicted from the
experiences in the U.S. — liquidity constraints (stylized fact number 8), and a lack of consultants and other institutional support. Perhaps one of the most important lessons that we can learn from the anglo-saxon countries is that deregulation and wage cutting in the labor market alone will not lead to a healthy small firm sector.
The small firm sectors in eastern Europe face three choices. First, they can ask for support and protection from the state. Second, small firms can join with large firms as subcontractors (Kooij, 1991). Third, small firms can look for other small firms to build a joint support system. By forming communities or agglomerations, small firms can overcome the kind of deficiencies which they face as individual market agents acting entirely on their own. Again there is a wide
34
variety of historical and modern communal support systems, ranging from cooperatives to industrial districts, employee ownership, science parks, craft combines, and ad hoc co
operation. What makes this type of supportive institution
especially interesting is that they have been spreading in the west in recent years. Effective forms of communal organizations that exhibit strong forms of cooperation and competition can be found in the garment district in New York City. In these
support systems, while long run competition is intense, short run competition is replaced with cooperation.
The most promising form of small firm communal support systems in eastern Europe appears to be the cooperative.
Indeed, we have seen this form of support already working in Hungary (Roman, 1990) and the USSR (Grachev et al.,
forthcoming). This form of organization can accomodate both traditional small firms and high technology development.3 Moreover, the cooperatives are already an existing form of organization, and new systems are difficult to implement.
V. Conclusion
The industrial restructuring that has taken place in Japan and the U.S., the ongoing restructuring in western Europe, and the emerging restructuring in eastern Europe (Perestroika), suggests that nothing less than a fundamental shift in the social and political institutions supporting mass production in 3 In the USSR a new form of organization "Butec" (the
association of firms that are not under central control who have bought out their assetts from the state) is growing. We would like to thank Svetlana A. Smirnova for pointing this out.
35
this century is transpiring. While these changes were accommodated in the West at great cost, i.e. 30 million
unemployed in OECD countries for the better part of a decade (FitzRoy, 1990), the impact that restructuring will have in eastern Europe is unknown. The re-emergence of small units of production in general, and of small firms in particular, in the world economy has left eastern European economies with a new and as of yet untried, social experiment. We believe that only by completely abandoning the existing social and political structure will these economies be able to restructure. In fact this has been started with the elimination of the communist party monopoly in Czechoslovakia, Hungary and Poland, the
unification of the two Germanies, and Perestroika in the Soviet Union.
While the U.S., Japan, and western Europe faced a
difficult task of restructuring, the problems of eastern Europe are multiplied three fold. First, their economies must
regenerate a small firm sector. Second, they must create smaller establishments in their large firm sector by (1)
encouraging entrepreneurship (Puchev, 1990), and (2) breaking up the existing combines to create smaller units. Third, they must institute a system of private property. The problem is complicated by the fact that they lack both the entrepreneurial talent to create small firms and the managerial skills to
create decentralized large firms.
Thus, with the beginning of the elimination of interior barriers, new firm entry has begun to play an important role in the rejuvenation of markets in eastern Europe. It is worthwhile
36
noting that entrants need not be large or long-lived. And they need not unduly disrupt the position of those market leaders that adopt quickly to the changes initiated by such entrants.
What occurs in response to entry is a fundamental restructuring of product and production processes (Geroski, 1990). Our
conclusion, then, is that entry (de novo, diversified, self employment, foreign) is a highly specific tool of industrial restructuring.
Finally, one of the most striking findings from the U.S.
experience is that small-firm turbulence, or simultaneous entry and exit, is more than one-third greater under the
entrepreneurial regime than under mass production. While much attention has been directed in the popular press and by policy makers on both sides of the Atlantic about the desirability of fostering a vital sector of highly innovative small firms in new high technology industries, the stylized facts already established about small firms strongly suggest that associated with such markets is a high rate of turbulence. That is, any policy-maker advocating programs designed to encourage small entrepreneurial firms in new high-technology industries should also recognize the accompanying firm failure, and (at least temporary) job displacement and unemployment. The experience of the U.S. suggests that while such industries may be the engines
for generating innovative activity and perhaps ultimately employment growth, extensive turbulence is apparently
intricately entwined with industries under the entrepreneurial regime.
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