Little and large
Tim Congdon No one has yet suggested that Gulliver's Travels is a manual on political economy. Whatever else Swift intended, it was not his purpose to show that a country run by little people had a higher growth rate and better productivity than a country run by big people. But an idea scarcely more credible than Gulliver's adventures in Laputa and Luggnagg_ seems to lie behind a number of 'schemes' recently set up by the Government. It is that an economy based on small companies will be more dynamic than an economy based on large companies. If any thought has been given to the pertinent question of how or why small companies should confer this benefit, it is hard to detect in a great mass of ministerial speeches. Phrases about 'potential entrepreneurs', 'changing attitudes', 'the balance of risk and reward', 'the importance of initiative' and so on have been puffed out on many occasions, but a coherent account of the thinking behind the verbiage has never been presented. When the miscellaneous bits of small companies legislation are examined in detail, the official silence is easy to understand. Nearly all the schemes suffer from two defects which are inevitable with most forms of state intervention and are illustrated particularly well in this case. The first is that intervention involves drawing a dividing-line between activities which are to be helped and those which are not, but the dividing line is arbitrary and lacks any justification; the second is that the gains of favoured groups are at the expense of other groups who are artifically penalised, giving rise to an illogical and damaging distortion. Take, for example, the Loan Guarantee Scheme, described by John MacGregor, the junior minister responsible for introducing it, as 'opening the door to a new range of opportunities for those willing to take business risks and to build a success story large or small'. Under the scheme, the Department of Industry guarantees 80 per cent of new term loans, satisfying certain conditions, up to a maximum of £75,000. The scheme is 'initially designed to last for three years and will be reviewed in the light of experience'. The difficulty here is trying to find out why a figure of £75,000 was chosen. To say that a loan of £74,999 is virtuous and one of £75,001 wicked cannot be advanced as a persuasive proposition in economic theory. If any sense can be attached to it all, it is a dubious moral judgment about a serious practical subject. As it happens, budding entrepreneurs do not have to be particularly ingenious to remain among the Small and the Good. Suppose that a businessman wants to borrow £300,000 and still exploit the scheme. Obviously, he must not have one loan of £300,000, but four loans of £75,000. By subdivision, any company can ensure that it remains appropriately sized and suitably blessed.
The small business lobby will no doubt protest that only genuine applicants will be accepted. But this presupposes criteria for genuineness and someone to decide whether the criteria are satisfied. What is a 'genuine' small loan? Who should be entitled to say whether it is or not? Clearly there is no rationale for the £75,000 figure. It has no more merit, and no less, than £25,000, £50,000, or £100,000 or even £75,001. The dividing line is wholly at the minister's discretion. It might just as well be chosen by lucky dip.
The problem of the dividing line also afflicts the Business Start-up Scheme, welcomed by Sir Geoffrey Howe because 'investors and their professional advisers will see that we are putting on to the statute book a tax incentive unparalleled in any major Western country'. The essence of this scheme is that a subscription to the equity of a new business (or, rather, a 'genuinely new' business) is tax-deductible up to a limit of £10,000. An individual with a top tax rate of 75 per cent can therefore make an investment worth £10,000 at a cost of £2,500. But why stop at £10,000? If a tax-deductible capital injection of £10,000 has such advantages, why not double them by allowing injections of £20,000?
However, the true objection to the Business Start-up Scheme is not the arbitrariness of its scope, but the second general weakness mentioned earlier. It is intended to cause — and will cause — . a shift of resources from large to small companies. This shift will be from a part of the economy where the resources could have been efficiently used to another part where they will probably be wasted. It requires only a grasp of elementary arithmetic to see why this is so. If a taxpayer can invest £10,000 at a cost of £2,500 he does not need a positive return to make the project worthwhile. Indeed, the project could be a hopeless flop and he would still be usefully in pocket. For example, it could be liquidated to pay its shareholders only 30p in the £ , but the top rate taxpayer would have made a return of 20 per cent. (He has £3,000 back after 'putting in' £2,500). By contrast, a well-established company has to earn a positive return to keep it shareholders happy. What the Business Start-up Scheme does is to encourage activities where, as far as the investors are concerned, they can lose half or more of their capital. Sir Geoffrey Howe is quite correct that the 'incentive' is 'unparalleled in any major Western country'. No other major Western country has thought that the tax system, whatever other peculiarities it may have, should induce deliberate bankruptcy. The assumption behind other countries' approach is quite logical; it is that labour and capital are better employed from society's viewpoint if they operate in profitable companies rather than unprofitable. Sir Geoffrey is free to argue that the distinction between profitable and unprofitable companies is irrelevant and that what really matters is the distinction between large and small. It is possible that small companies make people feel more content, relaxed and involved. But this charming notion has no connection with growth rates, productivity per man and other banausic items which form the typical subject-matter of the Chancellor's speeches.
Perhaps small company programmes could be concocted which would not cause such blatant distortions as the Business Start-up Scheme. But, as long as they discriminate between large and small businesses, they will interfere with the free working of those market forces to which Sir Geoffrey Howe and Mrs Thatcher so frequently pay homage. Adam Smith put the point with admirable lucidity in The Wealth of Nations over two hundred years ago. 'Every system which endeavours, by extraordinary encouragements to draw towards a particular species of industry a greater share of the capital of the society than would naturally go to it, is in reality subversive of the great purpose which it means to promote. It retards, instead of accelerating, the progress of the society towards real wealth and greatness; and diminishes, instead of increasing, the real value of the annual produce of its land and labour.'
Why do politicians accept propaganda as silly as that put forward by the small companies lobby? Why do they invent such obvious follies as the Loan Guarantee Scheme and the Business Start-up Scheme? The aim may be partly to please a pressuregroup and earn its support. But there is a more insistent motive. Politicians want to show the electorate that they have achieved results; they think, understandably enough, that the only way they can obtain results is by some sort of action; and the urge to 'do something' is therefore compelling. A noninterventionist politician is a contradiction in terms. A politician is in politics to change things and, as soon as he has the opportunity, he will change them. The expectation that he will respect existing institutions and arrangements is naïve, even if he is a member of the 'Conservative' Party and a self-proclaimed believer in 'less government interference'.
Fashions in interventionism, particularly industrial interventionism, come and go. Ten years ago large companies were being promoted because it was thought that only they could stand up to foreign competition. Today small companies have official blessing. Ten years from now large companies may be back in favour. Perhaps we may then be able to contrast the performances of two competing Enterprise Zones, one called Lilliput and the other Brobdingnag.
Previous page
