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Small Business and the Macro Economy:
Some Observations
Clifford G. Gaddy
The Brookings Institution
The general economic environment is critical for understanding the
prospects of small business in any country, including Russia. In
this presentation I will discuss the recent evolution of the
Russian economy and comment on how it might be expected to develop
in the years ahead. But before doing that, I will make a couple of
observations about the nature and role of small business in market
economies.
SMALL BUSINESS IN THE ECONOMY
Observation 1: Although the small business sector is
undeniably a vital part of a modern market economy, it is not
the core of such an economy. More importantly, small businesses
cannot and should not be expected to “save the
economy,” not even a local economy, much less a national
economy.
The United States has perhaps the largest small business sector
of the Western advanced economies. There, in the 1990s, small
business accounted for approximately half of total
private-sector employment and output. Yet, even in the United
States, small businesses play an auxiliary role. Or, more
correctly, they play multiple auxiliary roles, as they do in all
countries. Those roles differ depending on the state of
evolution of the economy and its overall health.
In a thriving economy, small businesses represent the most
dynamic, innovative, and risk-taking sector. In a declining
economy, or simply one that has low living standards, small
businesses are a survival, or coping, mechanism. These are not
mutually exclusive roles; the two types of small
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business will be observed in all economies. But the relative shares of
the two types differ.
One feature that both the innovative and the survival-oriented small
businesses share is that they are highly mobile. Small businesses are
easier to establish than large businesses, and they are easier to shut
down. (In economists' jargon, “entry” and
“exit” are easier for small businesses.) They can more
easily shift their orientation in terms of the market they target or
the products and services they produce.
Because of this flexibility, small businesses allow individuals (the
entrepreneurs) to take advantage of better opportunities as well as to
cope with a risky, unpredictable environment. In the United States in
the prosperous decade of the 1990s, small businesses accounted for 75
percent of net new jobs—a share that is larger than their share
of total employment. In a recession, we can expect small business to
account for a disproportionate share of job losses. The message is:
Small businesses are more volatile. They grow faster, but they also
die faster.
Every year in the 1990s, about 10 percent of U.S. small businesses
went out of existence. (This represented about half a million firms
each year.) But only about 10 percent of the firms that shut down
business actually went bankrupt. The other 90 percent were voluntary
shutdowns. Moreover, when asked about the reasons for closing the
business, the majority of firm owners responded that their businesses
were successful at the time they shut them down. Why, then, did they
close? The answer has to do with the economist's notion of
“opportunity cost”: the owners judged that the resources
that were being used in the old business, even when it was successful,
could be used even more profitably somewhere else.
Small businesses do not determine the state of the economy as much as
they reflect it. They are, in particular, very dependent on the
institutions of a modern market economy. For instance, 75 percent of
American small businesses obtained credit from outside. In other
words, their health depended on the health of the financial system.
Small businesses in the United States also depend on a healthy
government budget, since they are part of the federal contracting and
procurement system. No less than 28 percent of federal contracts went
to small businesses. While this is less than their share of the
private sector (which, recall, is about 50 percent), it underscores
the way in which small businesses are integrated into and dependent
upon the overall economy.
Observation 2: While small business cannot save the entire
economy, there are specific tasks the small business sector can help
solve. Policy towards small business should not be based on
exaggerated expectations but rather on clearly defined and realistic
goals.
As stated above, the roles that small business plays in an economy are
varied. They range from helping citizens to cope under conditions of
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economic hardship, at one extreme, to the development of high-tech
world-class industries, at the other extreme. Depending on a
country's situation, those roles can both be important and
deserving of support. Different policies will be necessary to help
them fulfill those different roles.
It is important to have a strategic view of the country's economic
development in order to decide on specific policies towards small
businesses. Knowing the prospects for the general economic climate is
critical. Policies to promote small businesses to solve any economic
task beyond using them as mere survival mechanisms will be costly, in
the short and middle term. The availability of resources depends on
the overall economy. Let us now then turn to the picture of
Russia's economy now and what might be expected in the months
ahead.
A BRIEF REVIEW
The Russian economy has seen extraordinary changes in the past
three years. After the government's default on its domestic
debt in August 1998 and the subsequent paralysis of its payments
system, output plunged to the lowest levels ever in a disastrous
decade. But by the beginning of 1999, a strong rebound had begun.
For one full year, the economy showed not just steady, but
accelerating growth. Gross domestic project (GDP) growth rates
reached a peak of 10–12 percent on an annualized basis in
late 1999.
Since then, the economy's performance has become more moderate.
Although it is natural that the economic rebound would gradually
attenuate, and although the balance is still positive, there are
some worrisome signs. This year, some major sectors of industry
have even begun to show declines in output, in profits, and in
investment. It is a good time to pause and ask what is it that has
happened to the Russian economy after 1998. And what can be
expected over the longer term?
Figures 1 through 3 give a snapshot of the economy from early 1998
through mid-2001. They use a few selected official Russian
government statistical series to illustrate the production side as
well as the welfare side. The figures are based on monthly
statistics for year-to-year growth or decline. To smooth out
temporary fluctuations and better show the trends, they are
presented in the form of six-month rolling averages. In other
words, each data point is the mean of the values for the preceding
six months. For instance, the data point for June 1998 represents
the average values for January through June, July's value is
the average of February through July, and so on. (Smoothing the
data in this way not only permits us to discern actual trends more
clearly; it also helps minimize the measurement and reporting
errors that plague Russian statistics.)
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~ enlarge ~
FIGURE 1 Industry and transport.
Figure 1 focuses on the production side. The two curves show industrial output and freight transport—both measured in physical units. Although the industrial output measure is more volatile, the two data series show the same general pattern: They were negative in 1998 (even before the August financial collapse); they rebounded strongly in 1999; and finally, they tapered off in 2000 and 2001, while still so far remaining positive.
Figure 2 shows some of the follow-on effects of the trends in the production sphere. It looks at household incomes and capital investment.
~ enlarge ~
FIGURE 2 Investment and incomes.
~ enlarge ~
FIGURE 3 Comprehensive presentation of economic indicators.
ACCOUNTING FOR GROWTH
There are two principal explanations for the patterns shown by
these curves. The first is the increase in world oil prices. The
second is the depreciation of the Russian ruble relative to the
dollar and other major currencies.
Oil Prices
It is hard to avoid the importance of the world price of oil for
the Russian economy. Russia exports such large quantities of
crude oil and various oil products that every dollar's
increase in the price of a barrel of petroleum translates into
roughly $1.5–$2.0 billion of additional yearly export
revenues. The world oil price rose from barely $10 a barrel in
February 1999 to more than $27 a barrel a year later, continuing
eventu
