Monday, July 18, 2011

Should we encourage business ownership?

Politicians claim left and right that small business owners are critical to the success of an economy. They woo them with various tax credits and by turning a blind eye to their opportunities to hide income from taxation. Yet, politicians also rewards large companies with generous tax abatements, especially when the relocate or just promise not to move away. So, in the end, who should be encouraged. the small business owner or the big conglomerate? In part, this is a question about whether it is better to have many self-employed workers or many employed workers.

Mirjam van Praag and André van Stel address this question by trying to determine the optimal business ownership from a sample of 19 OECD countries over 26 years. They proceed by estimating a Cobb-Douglas production function augmented with a business ownership rate, its square, tertiary education, as well as interactions of the latter with the formers. This is not a production function that has an interpretation for factor shares, it is rather a test of some relationships in the data. And by the implied non-linearity, it allows to computed from the regression coefficients what the optimal business ownership rate would be. On average, it is 12.5%, which is definitely not high, and it declines over time.

Furthermore, van Praag and van Stel find that countries with a higher proportion of workers with tertiary education enjoy a lower optimal business ownership rate, converging towards 11% when everyone has a university education (no gravediggers?). The interpretation they offer is that better educated people run larger firms. As business owners are a minority in a developed economy anyway and only the top business owners really matter for economic performance, I am not quite convinced by this argument, but it is apparently supported by microeconomic evidence. I would have rather thought that a more educated workforce is more specialized, and under such circumstances it is more difficult to be a business owner. The only exception are start-ups, which then either fails or are gobbled up by a larger firm.

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