1

David Williams

Why And How Do Policy-Makers And Practitioners Intervene To Encourage New Firm
Formation And Development?

The creation of new enterprising firms within an economy is key to ensuring economic
growth and development (Baumol, 1968). Small enterprises and the continued development
of new firms have many economic and non-economic benefits, which is why policy makers
seek after their formation. However the formation and development of small firms is
impeded by barriers, and it is for this reason that intervention and support is required.
Small enterprises have a number of economic benefits and these have been reviewed by
Westhead et al., (2011). Birch (1979) argues that small firms play a major role in the creation
of jobs irrespective of the economic cycle, and especially when large firms are downsizing.
The DTI Government Action Plan for Small Business (2004, p.14-15) states that small
businesses accounted for employing 56% of people and job creation from 1995-99 showed
that 85% were in small businesses. This high level of job generation keeps unemployment
low and reduces poverty within the country (Storey, 1982). Small enterprises are also
stimulators of competition as the entry of small firms into a market can reduce the monopoly
power of incumbent firms limiting the dominant firms ability to raise prices and therefore
benefits the consumer through lower prices and the provision of better quality products and
services.
The creation and growth of new businesses contributes to the beneficial process
of productive churn by which more efficient and innovative businesses replace
less efficient ones. (DTI, 2004, p.28)
These more efficient firms encourage the use of innovative practices (Storey, 1994). Radical
innovation is highly desirable, and is usually brought about by the exploitation of scientific
or technological knowledge, leading to the creation of new industries, the promotion of
economic development and give the country new competitive advantages in global markets.
However this will be at the expense of old industries, and is described as creative
destruction (Schumpeter 1934) and due to 40% of firms ceasing to trade within three years,
policy makers need to encourage efficient, highly productive, knowledge based firms that
will ensure a high level of productive churn. Entrepreneurial firms are also essential in
ensuring that larger corporations stay competitive, profitable and contribute to economic
development as they support the infrastructural needs of these larger firms. The development

David Williams

of new firms may have a substantial impact on the local economy. If an owner-manager lives
locally, he will employ local people, using local suppliers to service the local market. This
will have multiplier effects, increasing demand and creating opportunities for other
businesses. This will ultimately lead to wealth creation and job generation. Other economic
benefits include: a reduction in the dependency culture on large firms and the government,
improvements to the balance of payment position, the nurturing of potential entrepreneurs
and the re-investment of taxation that is received from firms and entrepreneurs.
There are also a number of noneconomic benefits that new firm formation and development
can introduce. They empower the owners, increasing independence, control and satisfaction,
and a recent study has shown around half of new business owners said their decision to start
a new firm was to become their own boss and live a more flexible and family orientated life
(The Economist, Issue 8754, p. 76). New firms have many social benefits, including a
reduction in discrimination as people from under-represented groups, such as ethnic
minorities and the disabled, can follow a career in enterprise and they can reduce regional
inequality as jobs are distributed more widely (Bridge et al., 2003, p.348). The working
environment provided by small firms is said to be more comfortable and nurturing, with
reduced bureaucracy due to direct contact with the owner-manager. Small firms can also
reduce the power of trade unions within an industry, and reduce the need for government
provision of services. A final reason that policy makers support entrepreneurs is that small
firms that benefit from government support are likely to vote in favour of the respective
party.
Policy makers intervene to encourage enterprise due to the associated benefits, and as Bridge
et al., (2003, p.349) argue, intervention will help correct the failures that are causing barriers
to enterprise development. When firms are set up they face many attitudinal barriers, such as
owner-managers wanting to keep their firms small. Surveys show that three-quarters of new
business owners want to keep their firm small with no more than ten employees, and an
average of 3-4 employees (The Economist, Issue 8754, p. 76). People face financial fear
when setting up a new business, an SBS Household Survey showed that 66% of people are
scared of getting into debt (DTI, 2004, p.23). The owners are also reluctant to raise finance
through selling equity and are unwilling to pay for expert advice. Small firms face many
resource barriers such as; access to finance, poor inflows of human capital providing new
knowledge and skills, and asymmetric information. Furthermore they face regulatory
barriers that are impeding growth. A report by the Small Business Research Trust in 2004

David Williams

showed that taxation, National Insurance and employment regulations are the key barriers
to growth. Firms face operational barriers including the inability to afford the technology
that large firms utilise or to carry stock and bulk buy. They face strategic barriers, which
include a lack of planning and a reactive approach to business (Westhead et al., 2011, p16).
Intervention used to overcome these barriers is summarised below in Fig. 1.
Micro Policies
Hard Support
Support
UK Examples
Soft Money Business expansion and small firms loan
guarantee schemes, Venture capital fund
(Grants, loans, soft
equity, in kind)
Equipment
Premises
Science park set ups
Soft Support
Provision of
High growth start-up programme
Information Services
Counselling
Mentoring
Consultancy initiative
Education
Training

Macro Policies
Interest rates
Low Tax Regime
Public Spending
Control of Inflation
Immigration Policy
Welfare Payments
Competition Policy
Business Regulation

Fig. 1
Policy makers are keen to encourage new firm formation and development due to the vast
array of benefits that they contribute both economically and socially. They want to increase
the quantity of small firms but also the number of quality, knowledge and technology based
firms. However, there are few enterprises that are flyers and create substantially economic
development and job generation. It is therefore argued that policy makers should not provide
blanket support, but provide targeted support to winners so that the maximum benefit can
be received from the policy investments (Storey, 1994). It is also important that the
intervention provided does not just benefit the receiving firm, but that it has wider benefits
for the entire economy. If the right support is provided to the right firms, intervention can
increase the productivity and profitability of small firms and this can have economic benefits
in the local and national economy.

David Williams