Government grants to small firms

I wrote yesterday about our research showing that government grants to smaller firms in economically disadvantaged areas of Great Britain can increase employment, but that grants to larger firms are wasted.

I confess to being surprised by this result. My starting position was that all this money was wasted because firms would have gone ahead and done the investment even if they hadn't received the money. Our results suggest that this is not the case, at least for smaller firms.

Does this mean the government should be providing much more support to smaller firms in disadvantaged areas? Personally, I don't think our results should be interpreted in that way. The programme that we studied, RSA, was targeted at firms that served national or international markets. I suspect that this is one of the reasons why we do not detect much displacement (where jobs at supported firms just replace jobs at nearby unsupported firms). However, many smaller firms serve local markets and I would expect support to those firms to mostly generate displacement. Findings from preliminary work on another government scheme (Local Enterprise Growth Initiative) support this assertion. Specifically, we are finding that support from LEGI, which mostly went to small firms serving the local economy, only generated displacement (and that over quite small distances). There appears to have been no impact on overall activity so money to both small and large firms was 'wasted'.

Further, as discussed yesterday, RSA didn't seem to have much effect on productivity, so it increases the employment share of weaker firms. Such firms are vulnerable to future shocks so its not clear whether this represents a long term solution. Our analysis also ignores the impact that taxation to fund the scheme might have on firms located outside of eligible areas.

In short, as usual, careful empirical evaluation cannot necessarily answer all the questions about a policy and more research is needed. But one central message does emerge: If the government is to have these type of investment subsidies, it seems clear that targeting smaller firms would be much more cost-effective.