A CONTENTIOUS issue that encompasses economics and politics is that firms of what size (large or small) are the engines of macroeconomic growth.

Insight into this issue is essential from a policy perspective, since it will enable better utilisation of scare resources with growth-orientated government policies. This is especially relevant for a developing nation like Pakistan, which has seen stagnant and slower growth during the last few years.

Politicians and economists, on both sides of the spectrum, passionately take partisan positions on this issue.

In this article, I will argue, by surveying academic research, that large firms are the main source of growth in an economy. Building on this premise, I will present targeted policy recommendations that encourage the growth of large firms, and, hence, the macroeconomy.

So how do we know that large firms are the real drivers of macroeconomic growth?

First, large firms, by their very nature, are able to undertake economic activities that would elude smaller firms. In a 2007 article, author Kelly Edminston showed that large firms have inherent credit worthiness that allows them to tap large pools of investment capital. This allows large projects to be developed that might otherwise not see fruition.

Large firms are also able to undertake riskier and more innovative projects. Such projects require large sunk costs in research and development and sales and marketing. These costs can only be recovered through large sales volumes, which also facilitate the division of labour, resulting in benefits associated with the economies of scale.

Large firms are able to undertake riskier and more innovative projects, which require large sunk costs in research and development, sales and marketing

Second, most small firms do not want to grow or innovate. In a paper published in 2011, authors Erik Hurst and Benjamin Pugsley showed that few small businesses intended to grow or innovate. Most want to provide existing services to an existing customer base. And few small businesses intend to purposely bring new ideas to the market or to add new employees.

This shows that since small firms do not intend to grow or innovate, their contribution to macroeconomic growth will be less than those by large firms, most of which want to grow and innovate.

Third, large firms utilise resources more efficiently than smaller firms. Numerous studies have found that large firms have superior management and logistical knowledge, along with specialised training and education. In contrast, small firms usually depend on a small number of individuals who are responsible for a multitude of disconnected tasks.

This results in inefficiencies based on a lack of specialisation. This problem is conspicuous in family enterprises, where heritability triumphs merit, business acumen and cognition.

Last, large firms are better employers. Kelly Edminston found that jobs at large firms are more stable, pay a significantly higher wage per hour and are twice as likely to offer health and retirement benefits than smaller firms.

This evidence is corroborated by authors Todd Idson and Walter Oi, who showed in an article published in 1999 that workers are more productive at their jobs at large firms compared to small firms. These can be attributed to frequent training and skill-building which occurs at large firms.

Hence, large firms provide better employment opportunities, more skill-building and produce more productive labour compared to small firms, all of which drives higher macroeconomic growth in the long run.

The question arises: in light of the evidence presented, how can policy enable maximum growth? Here are some precise policy proposals that might be food for thought.

• Allow large firms to deduct a percentage of investments from profits for tax purposes, until a threshold is reached

• Allow all research and development expenditure by all firms to be deducted for tax purposes, including technology-related expenditure

• Allow large firms to deduct all training and education-related expenses of employees from profits

• Allow tax holidays to entering large firms by specifying initial investments undertaken as a criteria for qualifying for the tax holiday

• Standardise the above proposals to apply equally to all, rather on a case-by-case basis

This article shows by quoting academic economics literature that large firms are the prime drivers of macroeconomic growth. This is in contrast to the view that the government should primarily support small enterprises for economic growth. Better knowledge of how the economy progresses can guide policies that maximise growth, leading to a better standard of living for the citizenry.

The writer holds a PhD in economics from the University of Minnesota. The views expressed in the article are solely his own.

barl0047@umn.edu

Published in Dawn, Economic & Business, April 20th , 2015

On a mobile phone? Get the Dawn Mobile App: Apple Store | Google Play