Suppose that there is a size class of firms that outperforms another size class on virtually every indicator of economic and social performance, including job creation, wages, worker benefits and safety, environmental protection, productivity, workforce diversity, unionization, tax compliance, and business social responsibility. You might expect this size class to be embraced and favored by most people across the political spectrum. You would be wrong, because it is large firms that outperform small firms.
Any claim that small is beautiful and big is ugly should be based on facts, not ideology, self-interest, or emotion. And the facts are eminently clear that on virtually every measure, big business is superior to small. As Todd L. Idson and Walter Y. Oi wrote in in their review of the relationship between firm size and economic factors:
A worker who holds a job in a large firm is paid a higher wage, receives more generous fringe benefits, gets more training, is provided with a cleaner, safer, and generally more pleasant work environment. She has access to newer technologies and superior equipment. … The cost of finding a job with a small firm is lower. The personal relation between employee and employer may be closer, but layoff and firm failure rates are higher, resulting in less job security.1
This pattern is clear in every industrial economy. Another scholar, Joachim Wagner, who looked at small firms in Germany, concluded the following:
Wages are lower, non-wage incomes (fringes) are lower, job security is lower, work organisation is less rigid, institutionalized possibilities for workers’ participation in decision making are weaker, and opportunities for skill enhancement are worse in small firms compared to large firms. The weight of evidence, therefore, indicates that, on average, small firms offer worse jobs than large firms.2
Still another study looking at US small businesses found that “most surviving small businesses do not grow by any significant margin. Most firms start small and stay small throughout their entire lifecycle. Also, most surviving small firms do not innovate along any observable margin.”3
A World Bank study of developing nations concludes that while:
MSMEs [micro, small and medium sized enterprises] tend to have higher rates of job growth in developing countries, larger companies provide more sustainable jobs, are typically more productive, offer higher wages and more training, and support a big multiple of the direct jobs they provide through their supply chains and distribution networks (which in particular provide opportunities for the poor).4
The report goes on to note that on net job creation MSMEs don’t outperform large firms because more MSMEs “exit the market.”
In short, on virtually every measure, large businesses perform better than small. This is not meant to denigrate small “Main Street” businesses. Most small business owners take risks, work hard, and contribute to their communities. But we should not let sentiment get in the way of reality. Economic prosperity will be determined principally by large firms, not by small firms, and least of all by the vast majority of small firms whose owners do not intend them to grow beyond a few employees.
For most working-age people, labor income (wages or salary) is the major source of income. And virtually every study shows that big firms pay more than small firms. Even Walmart, the retail giant that progressives love to hate,5 pays its retail workers on average 25 percent more than the industry average.6 One study found that “working in a store with 500+ employees pays 26 percent more for high-school educated and 36 percent more for those with some college education, relative to working in a store with fewer than ten employees.7 So if you are advising your children where to work—in a big corporation or a small company—advise them to go big if they want to maximize lifetime earnings.
This difference is not new. As far back as 1890, when the US Census Bureau first started collecting the data, large manufacturers paid their workers more than small ones.8 This pattern has held over time and across nations. Indeed, it is as consistent a finding as anything in economics. One review of the literature concluded, “Our bottom line is that the size-wage differential appears to be both sizeable and omnipresent.”9
A study from the early 2000s showed that firms with more than 500 workers in the US pay 28 percent more than small firms. In 2015 workers employed by large firms earned on average 54 percent more than workers in companies with fewer than 100 workers.10 And this is true across sectors. For example, workers employed at large US hog farms earn 38 percent more than workers at average-sized hog farms.11 Similarly, as a 2014 study from researchers at Stanford and the University of Michigan found, large chain retailers like Walmart “pay considerably more than small mom-and-pop establishments. Moreover, large firms and large establishments give access to managerial ranks and hierarchy.”12 And large firms give bigger increases to their workers: “Staying an additional year in a large firm brings an estimated average of 3.4% increase in salary in large firms but only 2.6% in small firms.”13 This pattern is repeated around the world. In Germany, average wages in firms with one to nine employees are about half those in large firms.14 Even after controlling for industry to reflect the fact that some industries with larger firms pay more and for differences in level of education of workers between firms, big firms still paid 14 percent more in the United States and 8 percent more in Canada.15
Small firms are also much more likely to employ low-wage workers. A 2007 study by The Urban Institute found that “Low-income workers are disproportionately likely to work in smaller firms. Although 20 percent of all workers are employed in firms with fewer than 10 workers, such firms employ 42 percent of low-wage workers and 35 percent of low-wage workers in low-income families with children.” Large firms with over 500 workers employ just 28 percent of low wage workers, but 44 percent of all workers.16
The wage gap is even larger in many developing nations. Indian firms with five to forty-nine workers paid their workers just 22 percent of what firms with more than 200 workers paid. Indonesian workers at small firms made 32 percent of the salaries of workers in large firms, in the Philippines 35 percent, in South Korea 50 percent, in China 60 percent, and in Thailand 72 percent.17 As a World Bank study concludes, “Large firms offer more stable employment, higher wages and more non-wage benefits than small firms in developed and developing countries, even after controlling for differences in education, experience and industry.”18 So for developing nations in particular, boosting living standards requires boosting firm size.
Is age the determining factor rather than size? Do new firms pay better than older firms? No. The average new firm paid its workers 72 percent of the average wage in the firm’s first year, and even four years later their wages were still below the average.19
The data lead to a clear if controversial conclusion: if policy makers want to improve wages, they should focus their efforts on helping both existing large firms and the minority of small firms that are capable of significant growth.
In the United States, workers in large companies receive 85 percent more supplemental pay (e.g., overtime and bonuses), 2.5 times more in the value of paid leave and insurance (e.g., health insurance), and 3.9 times more in retirement benefits (and more than 5 times more in defined benefit plan contributions) than workers in firms with fewer than 100 workers.20 For example, few small retailers match their employee’s 401k contributions, if they even provide plans. But Walmart provides a 6 percent company match after one year on the job.21 Large firms (100 or more employees) are almost twice as likely to offer paid life insurance and disability insurance as smaller firms.22
In 2011, before the passage of the Affordable Care Act, more than 97 percent of firms with more than 200 employees offered health insurance to their workers, compared to fewer than 50 percent of businesses with three to nine workers. This is why 36 percent of workers employed in firms with fewer than ten workers were uninsured, in contrast to fewer than 15 percent of workers employed by large firms.23 In the case of benefits, new businesses and startups are not more generous than old ones. On the contrary, as Scott Shane points out, “Studies show that older businesses are more likely to offer a pension plan or health insurance coverage to their employees.”24
Small firms are far less likely to give their workers time off when they or their partners have a baby. In 1997, 95 percent of medium-sized and large establishments provided their workers maternity and paternity leave coverage, but only half of small establishments did the same. As a Bureau of Labor Statistics study concluded, “The contrast was stark, with larger establishments offering a full range of formal leave plans designed to provide time off for vacations, sickness, funerals, and other personal commitments and smaller establishments providing time off only for holidays, or … basing time-off policies on individual performance.”25 In fact, the average number of paid vacation days at large firms is between 20 to 40 percent higher than at small firms.26
Large firms are also more likely to provide wellness benefits than small firms. Fifty-three percent of firms with more than 5,000 workers offered weight loss programs such as Weight Watchers versus 16 percent of small firms, and 57 percent of large firms offered health coaching versus 24 percent of small firms. Large firms are significantly more likely to offer free health risk assessments, on-site exercise facilities, smoking cessation programs, and weight loss programs.27
This may be why the share of workers who voluntarily quite a job at a large establishment (one with more than 5,000 employees) is about 40 percent the rate at small establishments.28
Some critics of big business argue that the reason big firms pay their workers more is that they have market power and use that to charge higher prices, at least some of which they pass on to their workers in the form of higher wages while the rest is funneled to shareholders.
In fact, large firms pay more because they are on average more productive. One 1978 study of US manufacturing firms sought to determine whether large firms were more productive than smaller firms and, if so, whether that was the reason they were more profitable. The study found that on average, the four largest firms in any industry had profits 57 percent higher than the other firms in the industry.29 But these higher profits did not come from squeezing their suppliers, charging higher prices, or paying lower wages. Rather, the four largest firms in any industry enjoyed labor productivity rates on average 37 percent higher than the remainder of the industry. They passed on at least some of the gains to their workers, with average wages 15 percent higher than in the rest of the industry. And this advantage was experienced at all levels of workers, not just top managers. In fact, production workers in the largest four firms made on average 17.2 percent more than production workers in the rest of the industry.30
Why are big firms more productive? One reason is that they use more capital equipment to drive efficiency. Capital intensity is positively related to productivity and firm size.31 A 1988 national survey of 10,000 manufacturers found that technology use is positively correlated with plant size.32 Likewise, larger banks were significantly more likely to adopt ATMs when they were first developed in the early 1980s.33
But the willingness of large firms to spend money on equipment and software to drive productivity is just one factor. Even when this factor is controlled for by measuring total factor productivity, larger firms are still 16.6 percent more productive than smaller firms.34 This may be because of more economies of scale in production or because larger firms are simply better managed and operated.
Many small business advocates like to claim that small business deserves a privileged position because it does more to support local communities. The American Independent Business Alliance urges consumers to “Shop Small” and shift 10 percent of their spending to local independent firms because “community-serving businesses are the backbone of local economies, civic life, local charities, and wealth creation for millions of citizens, as well as a training ground for future generations of entrepreneurs.”35
At one level they are right. One study found that local retailers returned 52 percent of their revenue to the local economy, compared with 14 percent for national retailers. Local restaurants spent 79 percent of revenue in the local economy, compared with 30 percent for franchises and national chains.36
But this is zero-sum thinking. If one region gets to keeps more of its spending in its region by preferring small, locally owned firms, by definition that means other regions will get less. But if all other regions do the same, it will mean less spending for the first region. The very reason why regions, like nations, trade is because it leads to higher productivity and incomes, thanks to specialization or increasing returns to scale.
These communitarian small business advocates are actually advocates for their local community at the expense of the broader national community. Moreover, they don’t even advocate for the local community. As one study of buy-local movements found, the focus was on local business owners, not on the well-being of low-income individuals in the community.37 And buy-local policies are not even associated with more local growth. As one study found, “In downturns, single-establishment firms reduce employment more than non–locally owned companies.”38
When it comes to jobs, it also turns out that the dominant narrative is largely wrong, as we demonstrate in chapter 5. The main reason that small businesses create more jobs is that they also destroy more jobs. When we look at net job creation, we find that big business is at least on par with small businesses and that over the last two decades large companies have created more net jobs than small businesses.
Small business advocates tout the claim that small firms rather than large are the innovators. Indeed, they often argue that small firms make up for lower productivity with more innovation. As David Audretsch writes, small business defenders argue that “the dynamic contributions made by small firms far offset any static efficiency losses.”39 If this were true, it might compensate for small businesses’ sub-par performance on wages and productivity. But as we discuss in chapter 6, this is not the case. A couple of data points for now: while small firms account for 49 percent of US employment, they account for just 16 percent of business spending on R&D, while firms of more than 25,000 workers account for 36 percent.40 Likewise, small firms account for 18.8 percent of patents issued, while the largest firms account for 37.4 percent of patents.41
Exports enable a nation to afford needed imports. Nations with anemic export strength suffer either through high trade deficits or a weaker currency or both, in the case of the United States. Large firms export more than small firms. A review of studies on the relationship between firm size and export intensity found that the lion’s share found a positive relationship.42 A study of German firms found that the share of output going to exports increased with firm size.43 A study of South Carolina firms showed that “the larger the firm, the higher the likelihood that it will choose to engage in exporting.” In the United States, small firms (fewer than 500 employees) employ 49 percent of workers but account for just 34 percent of exports.44 Moreover, from 1997 to 2007 exports by small firms grew 3 percent more slowly than exports from large firms.45
Even if big business’s economic benefits to consumers and workers eclipse those of small business, it might still be the case that small business outperforms big business on social factors, such as business social responsibility and environmental protection. In fact, big business outperforms small business on almost all social factors.
Many advocates decry big corporations for their impact on the environment, seeing them as rampant polluters. We see the tragic pictures from Bohpal in India when a Union Carbide plant sustained a chemical gas leak that killed thousands of local residents. We were horrified by the Exon Valdez oil spill in Prince William Sound, Alaska, and Americans watched for months as oil spewed into the Gulf of Mexico from the BP oil rig. There is no doubt that some large companies have put profits before environmental stewardship. And there is no doubt that in many more polluting industries, such as chemical production, big firms account for most production. But that’s not the point. The point is that within any particular industry, does big business pollute more than small business per unit of output? And on this point, the research shows they pollute less.
A wide array of studies finds that large firms invest significantly more in pollution control than small firms, in part because they are subject to more stringent regulations and enforcement. Not only do some environmental regulations exempt small firms but regulators are more likely to enforce environmental regulations at large, multiplant firms than at small firms.46 This makes sense, as regulatory budgets are fixed and it can take nearly the same time to inspect a large firm as a small one. Moreover, large corporations are more likely to be in the public eye when it comes to their environmental behavior and to suffer reputational harm if they do something bad.
This is why one study noted that “environmental expenditure is more feasible to large companies due to a combination of greater economies of scale in the provision of the services and the greater likelihood of both image benefits and regulation enforcement on large firms.”47 And it is why a study of compliance with the US Clean Air Act found that factories belonging to multi-unit firms (e.g., large corporations) spent $185 and $477 more on pollution control capital expenditures and operating costs than smaller firms, for every $10,000 more of value added.48 The largest plants spent approximately four times more on air pollution control per unit of output than the smaller plants. One reason is that large firms have environmental compliance departments staffed with experts whose job it is to keep their company from getting hauled into court or being on the front page of the New York Times for a violation. One study found that larger firms in the agricultural chemical sector are better able to address strict regulatory requirements.49 Indeed, many small businesses don’t even think about the environment. As a study of UK small firms concluded, “The typical SME is ill-informed and unwilling to take action unless threatened by strong external forces such as prosecution or customer demands. Worse still, many foresee no threats or advantages to their companies from the environment.”50
With all the attention regarding cybersecurity and hacking, with high profile breaches and attacks at large corporations such as Target, surely large firms have worse cybersecurity than small firms. In fact, small firms that are online (only 54 percent had a website in 2015)51 are less secure with regard to the Internet.52 This makes sense as larger firms can devote the internal and external resources to ensure that their computer and Internet systems are secure. Two-thirds of small firms with websites manage their sites solely with internal resources, with 40 percent of owners doing it themselves. Forty-two percent report cybersecurity as one of the biggest IT challenges they face, 44 percent report being the victim of a cyberattack, but just 21 percent report that they have a high understanding of the issue.53
Enron. Tyco. Sophisticated corporate tax avoidance schemes with exotic names like double Dutch Irish. Certainty compared with smaller firms, corporations must cheat more on their taxes. But before considering this, it’s important to recognize the distinction between tax evasion, which is illegal, and tax avoidance, which is legal. To be sure, many large corporations are rich enough to be able to hire the best accounting talent to help them engage in complex tax avoidance schemes, the lion’s share of which are legal and pass muster with the IRS. In these cases, it is incumbent on government to close the loopholes it believes are a problem.
But even with regard to these legal schemes, publicly traded firms are less likely to engage in sophisticated tax avoidance schemes than nontraded firms, and the former are on average larger than the latter.54 One reason is that the 1,500 or so largest Subchapter C corporations that are subject to the corporate income tax are for the most part subject to annual and even continual audits, which clearly serves to limit aggressive tax avoidance, not to mention tax evasion.55 This is why larger firms disclose more information on risks to investors than do smaller firms.56
Contrast that with the many small businesses that operate in substantial part on a cash basis, where the level of underreporting income can be quite high. As one study of business tax evasion notes, “Many self-employed people deliberately choose this organizational form over working as dependent employees, in order that they can evade taxes.”57 In Italy, unincorporated companies pay only about 45 percent of the tax they are legally required to pay.58 In the United States, individuals underpay tax on business income by around $345 billion a year.59 According to Jane Gravelle, a tax policy expert for the Congressional Research Service, the underreporting rate for proprietorship income is 57 percent, contrasted with a rate of less than 20 percent for large and medium-sized corporate businesses.60 In other words, small businesses report only 43 percent of their actual income, compared to the 80 percent reported by medium-sized and big business. And 61 percent of small businesses understate their income; that is, they lie.
One study of small business tax avoiders found that many rationalized it on the grounds that tax evasion by small firms is a subsidy “that equates to direct subsidies to farmers or bail-outs to various international businesses.” They believed they deserved such a subsidy because “a small business person is key to a healthy economy.”61 Others said that if they didn’t cheat, they might have to go out of business. Exactly! Cheating lets low-productivity, “zombie” businesses stay in business, hurting the rest of us. On top of this, the fact that small business tax scofflaws seldom have to pay significant penalties if by some slim chance they are audited (about a one in 200 chance) has made tax avoidance part of the culture for many small businesses.62 In this they are enabled by shady small accounting firms that know that if they don’t at least turn a blind eye to evasion, they will lose the business.63
Surely, given all the press about rapacious CEOs with nicknames like “Chainsaw Al” Dunlap and “Neutron Jack” Welch, big corporations must be more likely to lay off workers to pad their profits. But this is not the case. In fact, small firms show less loyalty to their workers. One study found that both the quit rate and the dismissal rate of workers in German companies declined as firm size increased.64 Workers employed by larger Austrian firms had a lower risk of being laid off than those employed by small firms.65 Likewise, Canadian firms with fewer than twenty employees were almost five times as likely to lay off their workers as companies with 500 or more employees.66
It is no different in the United States. When 50 percent of jobs created by new firms, which are mostly small, disappear in five years, the odds of losing one’s job are quite high.67 As one study concluded, “Small-firm jobs are less stable. Workers in these jobs have shorter tenures, are more likely to quit or to be fired, and are more likely to experience a future spell of unemployment.”68 Another study using data from between 1978 and 1984 found that firms with fewer than 100 workers were almost three times more likely to permanently separate their workers than firms with more than 2,000 employees.69 More recent data show that every year between 2000 and 2012, establishments with more than 250 workers had a lower share of layoffs and discharges than smaller firms. In 2015, small establishments with 1 to 249 employees had a four times higher rate of employee discharge than establishments with 5,000 or more employees.70 Small establishments pay 20 percent more in federally required unemployment insurance taxes because they lay their workers off more and must pay higher experience-rated unemployment taxes.71 If unemployment insurance taxes were fully experience-rated, instead of capped, small firms would pay even higher unemployment taxes. So “Chainsaw Al” is actually much more likely to be a small mom-and-pop employer.
Workers at smaller firms are more likely to be injured on the job. Firms with fewer than 100 employees pay 9 percent more in workers’ compensation insurance payments than bigger firms, reflecting their higher claims on the system.72 We see this in many industries, including coal mining73 and construction.74 The rate of work injury in small utilities is almost four times higher than in large firms. In cable and telecommunications firms the rate is almost three times higher, and in information technology firms it is twice as high. Small trucking firms have higher rates of accidents than large firms, including unsafe driving violations, hours of service compliance, vehicle maintenance violations and crashes.75 Overall, in goods-producing industries the rate of worker injury is 25 percent lower for firms with over 1,000 employees than for firms with ten to forty-nine employees.76
What about unionization rates? Aren’t large companies vociferously anti-union, able to afford expensive and sophisticated anti-union campaigns? To be sure, a growing share of US corporations has taken actions to avoid unions, but large companies are still more likely to be unionized. For example, in Canada, 50.2 percent of large firms are unionized compared to only 27.4 percent of small firms.77 One study of unionization rates in Pennsylvania found that rates ranged from 22 percent of manufacturers with over 1,000 employees to between 12 and 13 percent of manufacturers with fewer than 100 employees.78
Large firms also invest more in workforce training. In Germany, 60 percent of small firms had no connection to apprenticeship programs, while only 12 percent of large firms had no connection.79 Likewise, the probability that a firm pays for further training for its workers increases with firm size, from 24 percent in the smallest firms to 93 percent in the largest. In the United States, new employees received far more hours of both formal and informal training in establishments with more than 500 workers than in smaller ones.80 Across the OECD countries, large firms train on average 63 percent of their workers, compared to just 39 percent for small firms.81
With respect to racial and gender diversity, large businesses are more diverse than small, both because they have professional human resource departments that are more aware that employment bias can hurt firm performance and because they are more likely to be under scrutiny for their hiring practices. As one study concludes, “There are other reasons to expect establishment size to foster racial and gender heterogeneity: Organizational size is positively related to sophisticated personnel systems, formalization, and job differentiation, which contribute to diversity in firms.”82
One reason US larger firms are more diverse is because federal contractors with more than fifty employees are required to use affirmative action plans when hiring, but small firms are exempt.83 In addition, small firms with fourteen or fewer employees are exempt from Title VII of the 1964 Civil Rights Act, which prohibits employment discrimination based on race, color, religion, sex, and national origin, and companies with fewer than 100 employees are exempt from reporting requirements.84
Moreover, large corporations are more likely to be under public scrutiny for hiring practices. This is why Jonathan Glater and Martha Hamilton wrote in the Washington Post, “At many of the nation’s large corporations, affirmative action is woven into the fabric of the companies.”85 A study from the late 1990s by the labor economist Harry Holzer found that African Americans constituted 13.3 percent of the workforces of employers of more than 500 employees but only 7.9 percent of the workforces of companies with fewer than ten employees.86 In large part this was because most small businesses are owned by whites, who can be reluctant to hire nonwhites. Small firms did employ a larger share of Hispanics, but even accounting for this, large firms with more than 1,000 workers had a smaller share of white workers than small firms, by four percentage points.87
Large firms also employed a higher share of women than small firms, by approximately three percentage points (48 percent to 45 percent), and employed a higher share of veterans (8 percent more) than did small firms.88 And don’t look to “entrepreneurs” for gender parity: in the United States the rate of female business ownership is 60 percent that of the male rate, and it is even lower across other OECD nations.89 In sum, large corporations’ workforces are more diverse than small business’s workforces.
To listen to small-is-beautiful advocates, big corporations are interested only in profits and not in giving back to society, while small businesses are grounded in and committed to their local communities. In fact, the situation is more complicated than that.
One study found that both large firms and small firms have higher levels of charitable giving than middle-sized firms.90 The hypothesis is that small firms give because they are close to their community and local customers, while large firms give more because they are under more scrutiny than medium-sized firms.
However, other studies find that big business outperforms small and middle-sized companies. As one study of business social responsibility concluded: “The first and most important conclusion we draw is that most small businesses do not recognize specific social responsibility issues. … [Most have] never thought about it.”91 Indeed, most studies on the topic find that small business focuses less on business social responsibility than does large business.92 This is in large part because “small business managers themselves argue that they have no time or resources to dedicate to social responsibility.”93 Another study of business managers found that the larger the corporation, the more the manager believed that business social responsibility in factors such as environmental protection and corporate philanthropy was important for the corporation’s sales and market share.94
Moreover, in line with the “follow the money” principle, large corporations are vastly more likely to be targeted for action by social activists, whether it’s boycotts, demonstrations, stock proxy efforts, or some other form of pressure. When was the last time a small mom-and-pop business was targeted for action by an organization like Common Dreams?95 Did the Guardian newspaper publish a list of small companies and their giving levels in the UK? No, it focused on large companies.96 And this pressure does lead large corporations to respond because for most of them, sales depend at least in part on their reputation and “visibility.” For example, as economist Kevin Cochrane writes, Walmart donated $1.6 billion to local charities and causes in 2016. To match this as a share of their sales, the typical small retailer would have to donate about $4,000 a year to local causes.97
It’s also easy for big business critics to forget that most of the assets held by charitable foundations in America came from corporate wealth. Carnegie, Ford, Rockefeller, Gates, Hewlett, Pew, Sloan, and Smith Richardson are just a few of the foundations endowed out of the profits of large corporations. In fact, of the largest 100 charitable foundations by assets in the United States, 78 were capitalized by individuals who owned or managed large corporations.98
Finally, what about inequality? Aren’t big corporations with their often extravagant CEO salaries and stock options the cause of much of the growth in income inequality? Thomas Piketty thinks so, writing that “the primary reason for increased income inequality in recent decades is the rise of the supermanager.”99 Likewise, former Obama administration economic officials Jason Furman and Peter Orszag argue that over the past two decades, large firms have gained market power, which allows them to pay even higher compensation to their top workers.100
A study of UK and US firms by Holger Mueller and coauthors found results that would seem to support the Piketty argument. In the UK, as firms get larger, inequality between the top three categories of occupations and the bottom increases.101 The authors of that study found, for example, that moving from the 25th to the 75th percentile of the firm-size distribution raised the wage associated with job level 9 (the highest level) by 280.1 percent relative to the wage associated with job level 1 (the lowest level).102 They also found that wages in high-skill occupations 6, 7, and 9 all increased with firm size increases.
However, several factors suggest we should be careful in how we interpret these findings. First, the Mueller study focused only on relatively large firms, not on the smallest. In fact, 60 percent of the firms in their sample were publicly traded, and the average firm size was over 10,000 workers. The vast majority of UK firms are small, so understanding trends in firm-based inequality requires looking at all size classes.
Second, it’s not clear how much of this has contributed to the growth of inequality. The authors point out that since 1986, employment in the largest 100 US firms has grown by 53 percent. But at the same time, total US employment has grown by 33 percent.103 So certainly some of the growth in top incomes in large firms has contributed to the growth, but not all.
Moreover, Jae Song and coauthors in another NBER study note that dispersion between high-wage and lower-wage firms appears to hold in all size classes; it’s not a matter of big versus little only.104 In other words, it’s not just big firms that are contributing to inequality. In fact, new research from the US Bureau of Labor Statistics finds exactly that: the ratio of compensation for the top 5 percent of earners compared to the bottom 10 percent was no different between small establishments (one to forty-nine workers) and large establishments (500 or more workers).105
Song and coauthors found that much the income inequality from work income can be explained not by highly paid managers getting more than lower-paid workers within the same firm but between firms.106 In other words, the ratio of pay between the highest-paid and lowest-paid employee within individual firms has remained more or less constant, but pay in some firms increased faster than pay at others, increasing the pay of those at the top. The authors write: “Although individuals in the top one percent in 2012 are paid much more than the top one percent in 1982, they are now paid less, relative to their firms’ mean incomes, than they were three decades ago. Instead of top incomes rising within firms, top paying firms are now paying even higher wages.”107 In other words, as some firms have grown in size, productivity, and sales, they have been able to pay all their workers more, including the ones at the top.
In addition, large companies appear to pay their clerical and production workers more than small business, but their higher-paid professional workers tend to be paid the same, an outcome anyone concerned with helping the working and middle class should applaud. In 1995, according to the Bureau of Labor Statistics, establishments with 50 to 499 workers paid their professional and administrative workers 2 to 3 percent less than the largest establishments (2,500 or more workers), and their attorneys and engineers were even better paid. But small firms paid their clerical workers 6 percent less, their maintenance workers 27 percent less, and their material movement workers 42 percent less.108
While Mueller and coauthors found that larger firms pay their more skilled workers more than smaller firms, this appears to be a reflection of greater human capital and more skills. They write, “Our results support the notion that high pay disparities within firms are a reflection of better managerial talent.”109 They go on to note that “controlling for firm size, we find that higher pay disparities are associated with better operating performance, higher firm valuations, and higher equity returns.”110
Moreover, some research suggests that large corporations actually reduce income inequality. The University of Michigan business professors Gerald Davis and Adam Cobb found that between 1950 and 2006 there was a strong negative correlation (−0.8) between the annual change in the share of the US labor force employed by the top 100 largest US corporations and income inequality. In other words, when their share decreased, income inequality increased.111 They argue that these relationships are causal as large corporations tend to employ more middle-income workers, compared to either firms like investment banks at the top or small mom-and-pop companies at the bottom. As Gerald Davis writes, “Small is beautiful … if you love inequality.”112
Amid the adulation of small business owners, it is easy to forget that on average, they make considerably more than the average worker. Business-owning households make almost three times as much, on average, as non-business-owning households (one study showed $127,702 compared to $45,177).113 As Scott Shane writes, “The average net worth of a business-owning household was $984,307, as compared to $190,023 for the average non-business owning household.”114 A Federal Reserve Bank study on small business owners concluded, “More wealthy individuals are small business owners than poor individuals.115 According to the Tax Policy Center, the top 1 percent of pass-through businesses earned 50.8 percent of all such income, and the share going to the top 0.1 percent was 22.8. The bottom 60 percent received just 13.4 percent of such income.116
Furthermore, new research suggests that it is not managers of firms that constitute the largest share of the “one percenters” but professionals and financiers. Gallup economist Jonathan Rothwell finds that 6 percent of the one percenters (the top 1 percent of earners) are in the financial services industry, 7 percent are lawyers, 7 percent are doctors, 4 percent are dentists, and 7 percent work in hospitals.117 In fact, 21 percent of dentists are in the top 1 percent of earners, while 31 percent of physicians and surgeons are in the top 1 percent. Even 15 percent of college presidents are one percenters. In contrast, workers in the software, Internet publishing, data processing, hosting, computer systems design, scientific R&D, and computer and electronics manufacturing represent just 5 percent of workers in the top 1 percent of income earners. As Jonathan Rothwell writes, “There are five times as many top 1 percent workers in dental services as in software services.”118 And while there are no large dental corporations, there are plenty of large software corporations. Overall, Rothwell finds that managers in nonfinancial firms account for just 29 percent of the top 1 percent of earners, and a nontrivial portion do not work for large corporations.119
Steven N. Kaplan and Joshua Rauh come to similar conclusions. When looking at the top 0.01 percent of income (adjusted gross income) they find that in 2004, nonfinancial executives represented just 3.98 percent of the individuals in this income bracket, up slightly from 3.66 percent in 1994.120 They write, “In 2004, nine times as many Wall Street investors earned in excess of $100 million as public company CEOs. In fact, the 25 highest paid hedge fund managers combined earned more than all five hundred S&P 500 CEOs combined.”121 Moreover, there are more than three times the number of top earners from finance and law than from nonfinancial occupations, and the former earn five times more than the latter. So, if you want to find the biggest causes of income inequality, look to the successful hedge fund manager, not the typical CEO.
Even if all of the other advantages of big firms are conceded, the small-is-beautiful school can fall back on the familiar claim that small business is the engine of job creation. As we will see in the next chapter, under close examination the evidence for even this popular claim falls apart.