Small firms act faster in recovery

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The Independent Online
Why is the recovery different? We have mostly stopped worrying about the robustness of the recovery, for it seems to have steamed through the tax increases with barely a shiver. But if the quantity of recovery is fine, what about the quality?

Most analysis about the recovery has focused on demand: whether the main impetus for growth is coming from consumption, exports or investment. This is certainly the usual way economists have thought about the economic cycle, and has underpinned their forecasts. But during this cycle in particular, supply is perhaps more interesting. The fact that supply is coming from different corners of the economy than in previous growth phases may, in part, explain why economists were so slow in picking up the strength of the recovery.

Much of the growth in supply seems to be coming from smaller companies, rather than the large ones that tend to be in the headlines. And it seems to have been coming from the service sector, rather than manufacturing.

Intuitively, both these points would make sense. The first is obvious in the labour market.

There are stories almost daily that such-and-such a company is declaring many redundancies, yet total employment is probably still creeping up. (One has to say 'probably' because, though employment rose rather surprisingly in the early stages of recovery, the most recent figures suggest that this rise may have tailed off.)

But even stable employment against a background of continuing redundancies by large firms means that small firms must be increasing their workforce.

As for the balance between services and manufacturing, the published employment figures also show that the new jobs are in services. One would certainly expect this, for manufacturing is in long- term secular decline in all the Group of Seven countries, both in terms of employment and contribution to gross domestic product, and has been for a decade.

This would explain a lot. It is much harder for the statistics to pick up what is happening in small firms than in large companies. And it is much harder for them to identify changes in service output than in manufacturing.

We know how many cars are being made, but we do not know how many meals restaurants are serving. As a result it has taken a while for the statistics to catch up with the scale of economic growth.

But this large/small distinction is evident also in manufacturing, as a study by Kleinwort Benson Securities shows. It has tracked changes in manufacturing output since 1976 and shown that, for the first time since then, the output of large firms has lagged behind that of manufacturing as a whole. It argues that, since order books and delivery trends are similar, this suggests that large companies have been slower than small in recognising that recovery has started.

Thus large firms report lower business confidence than small, their expected output over the next four months is lower, and they are more likely to think that they have adequate stocks. They also have much lower investment intentions, in plant and machinery and in buildings.

Finally, as might be expected because this squares with what is actually happening, they have much lower employment intentions: small firms still expect to shed jobs, but large ones expect to shed them even faster.

We should be grateful to Kleinwort for digging out the figures, but is it really credible that large companies are less well-informed about demand, or less responsive to market trends, or simply less optimistic, than small ones? And if so, why are they behaving differently in this cycle than in previous ones?

There is no obvious answer in the figures. What would be most interesting to know is what is happening to the very small firms.

Kleinwort used Confederation of British Industry data, and took 'large' as having more than 5,000 employees; the smallest grouping was companies with fewer than 200 employees. But companies towards the top end of that segment are already quite large.

Perhaps the most interesting thing to know would be what is happening to the tiny companies, for example the firms with fewer than five employees (the only category of UK business increasing employment) or with turnover of less than pounds 100,000 a year.

These tiny companies, in aggregate, are very important: the Central Statistical Office's Size Analysis of UK Business last year showed that 41 per cent of manufacturing production comes from companies with a turnover of less than pounds 100,000.

A lot is made of the fact that Germany has proportionally more medium-sized firms than the UK, but we should be grateful that we do have a large and presumably growing army of these tiny firms. If the main message of the CBI is that small companies are more responsive to the market than large ones, then this is good news indeed.