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Why Should Government Support Small Firms?

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With the increasing importance of the small firm sector to national economies, there has been a progressive attempt by many governments to develop policies specifically targeted at supporting the development of small firms.

However, given that small firms are meant to operate within a free market economy, why should the government support small firms?

One of the primary arguments for the development of specific small firm policies is that they are disadvantaged in the market relative to larger firms. There are four major areas of market failure that might justify the development of policies to support and promote small scale enterprise.

The first is the existence of market failure due to monopoly practices provides a primary justification for state intervention. This is reflected in a wide range of policies, including the monopolies and mergers commission, competition policy and state regulations to ensure that potential competitors are not excluded from the market-place.

Secondly, and due to the fixed costs involved, small firms are at a disadvantage compared to large firms in the collection and analysis of information about market opportunities, sources of finance and government regulations.  This represents a major potential competitive disadvantage for the small firm sector that may constrain its development.

That is why business support mechanisms such as the Welsh Government’s Business Wales website have been created as a free service that provides impartial, independent support and advice to people starting, running and growing a business in Wales.

Thirdly, whilst small firms have been recognised to be highly innovative, they are less able to absorb the risk and uncertainty associated with activities such as innovation, new product development and new market development.  If government does not intervene, some of these activities may be lost to society as a whole.

As a result, there have been a range of different initiatives developed to stimulate greater innovation amongst small firms ranging from the SMARTCymru programme that offers financial support to Welsh businesses to help them develop, implement and commercialise new products, processes and services, to funding competitions promoted by the UK Government’s Innovate UK.

Finally, small firms can experience considerable difficulties in attracting finance in the capital markets, predominantly because of higher level of risk to the lender which can restrict small firms’ access to finance and increase the cost of external finance or because of  the economies of scale in finance, which means that the costs to the lender of making a loan to a new or small business is much higher than for a large business.

That is why we have seen a range of different initiatives – such as the British Business Bank, the Development Bank of Wales and the Scottish Angel Capital Association – established by the UK and devolved governments to support access to finance to small firms.

Therefore, whilst some entrepreneurs may think that the ten most feared words they will hear are “Hello, I’m from the government and I’m here to help”, the reality is that public bodies can provide tangible support to help small firms to grow and develop.

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