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