Small Firms and Efficiency

Abstract

Two disparate views about the impact of small firms on economic efficiency have emerged in the economics literature. On the one hand is the traditional view in the field of industrial organization that views small firms as imposing excess costs on the economy as a result of a scale of production that is too small to be efficient. According to this traditional view, the inefficient scale of operations results in lower levels of productivity for small firms and lower wages for their workers. The shift in economic activity that has taken place over the previous two decades away from large corporations and toward new and small firms is interpreted as causing a decrease in the standard of living of Americans. Shifting employment out of high-productivity and high-wage firms and into lower-productivity and lower-wage (small) firms reduces the well-being of the American population. According to this traditional view of small firms, any policies that shift economic activity out of small firms and back into large corporations should be encouraged, since they will increase the American standard of living.