Small innovators are less productive overall

Productivity should be the focus, and small firms are often less productive than large firms. Indeed, recent evidence has suggested that some economies that have favoured small firms, such as India, have in fact performed worse. Hsieh and Klenow (2009), for example, suggest that 40-60 per cent of the total factor productivity (TFP) difference between India and the United States is due to misallocation of output to too many small and low-productivity SMEs in India. As most small start-up firms fail, or are incapable of growing beyond the stage of having a sole owner-operator, targeting assistance to them through grants, soft loans or tax breaks will necessarily involve a high degree of waste. While this waste is a necessary gamble in the innovation process (Janeway 2012), it is important to at least guide the funding process with what we know about 'high growth' innovative firms rather than some folkloristic notion of the value of SMEs as an aggregate category— which actually means very little.

Bloom and Van Reenen (2006) argue that small firms are less productive than large ones because they are less well managed and subject to provincial family favouritism. Furthermore, small firms have lower average wages, fewer skilled workers, less training, fewer fringe benefits and higher instances of bankruptcy. They argue that the UK has many family firms and a poor record of management in comparison with other countries such as the US and Germany (2006). Among other reasons, this is related to the fact that the tax system is distorted by giving inheritance tax breaks to family firms.

Some have interpreted as a result that it is high growth rather than size that matters, and that the best that government can do is to provide the conditions for growth through policies that foster innovation. Bloom and Van Reenen (2006) argue that instead of having tax breaks and benefits target SMEs, the best way to support small firms is to 'ensure a level playing field by removing barriers to entry and growth, among firms of all sizes, enforcing competition policy and strongly resisting the lobbying efforts of larger firms and their agents'. But as we will see in Chapters 3 and 5, often the most innovative firms are precisely those that have benefitted the most from direct public investments of different types, making the association between size and growth much more complex.

The policy implication is that rather than giving handouts to small companies in the hope that they will grow, it is better to give contracts to young companies that have already demonstrated ambition. It is more effective to commission the technologies that require innovation than to hand out subsidies in the hope that innovation will follow. In sum, in an era in which so much emphasis is placed on reducing public budget deficits, it makes even less sense to hand out subsidies and benefits to companies just because of their size, with so little evidence on the impact (Schmidt 2012).