Small busineses do not work as microeconomic theory suggests. They don't maximise profit. Most, at best, provide their owners with a fair wage. That's why if you hit them hard – as Rachel Reeves has done – the economic impacts can be really serious.
This is the audio version:
This is the transcript:
We need to talk about the economics of small business.
What's very clear is that lots of people do not understand how small business really works. That's become apparent because of the budget. People are saying, how can it be that small businesses are so marginal that an increase in the cost of employers' national insurance might threaten their very existence? And my answer is, quite easily, actually.
What is obviously not understood is that small business does not make a profit. Now that's a very big thing to say because microeconomic theory, which is the theory that is used and taught at universities and applied by people like the UK Treasury, says that every business exists to make a profit.
And the truth is, that is not the case in the vast majority of small businesses. Small businesses exist for a whole range of reasons, but making profit is rarely one of them.
Now I'm not disputing that business owners do of course want to make a return on their effort, but the return that they make is very rarely better than a wage.
It's really important to understand the distinction between that wage and profit and I can use myself as an example here because it will be entirely appropriate to do so.
For many years, I ran a firm of chartered accountants. I was its senior partner. I had two women as partners. We employed quite a lot of people. We serviced hundreds - nearly a thousand - clients at one point, but in all the time that I ran that firm, I probably made no more money than I would have done if I had, for example, been employed by one of the large firms of chartered accountants in the UK.
It was a comfortable living. I'm not pretending otherwise. I'm not complaining. I chose to do it. But I did not make what in economic terms would be a profit. In other words, a profit - a sum that was in excess of what I would have earned in exchange for my labour. My labour was remunerated with a wage. A good wage, but nonetheless one that was not excessive to the point that it was obviously above the sum that I could have earned elsewhere.
And this is true of the vast majority of small businesses. In fact, it's so true that many people make less money by being self-employed than they would do, in alternative employment. And that takes some explanation as well.
Why do people work for themselves when they make less than they would if they took a job? Well, there are a number of very good reasons.
The first is, they don't want the jobs that are on offer. And why not reject those jobs when so many of them are dull, boring, repetitive, literally in environments where people do not appreciate those who are doing the work, and where the person is very often oppressed by the work that they do? They choose to work for themselves to simply have a better work experience.
The second reason why people work for themselves is they quite simply don't fit into the model of employment that most employers impose. The assumption is that people are neurotypical. I have mentioned this issue before in this video series, and I will no doubt mention it again.
Neurotypical is somebody who can fit into the mould of expectation that HR departments by and large create for their employees. But the fact is that there are a lot of people who are not neurotypical. Sometimes we apply labels to them which are quite inappropriate. Autistic is sometimes used, ADHD is also sometimes used, and these might be helpful in some circumstances, but they very rarely are in the workplace. Quite simply, people who are not neurotypical think in different ways from that which is normal.
There are large numbers of these people. They tend to make associations between ideas that are not created by neurotypical people. Those are exploited by the person who wants to work for themselves to create job opportunities that do not exist in the mainstream environment. They can, therefore, actually use their skills to best effect in self-employment, and that's exactly why they are self-employed.
It's not because they actually have chosen to be self-employed for that reason. It's because the mainstream employment environment provides them with no opportunity to use their skills in the way that they would wish, and so they become self-employed instead. And they are quite willing to accept a reasonable rate of wage in self-employment for the opportunity to do what they wish.
And then let's look at the other reason why many people are self-employed. It's quite simply because there isn't a job available to them. There are no jobs that suit their skill set, or are nearby, or provide the hours of work that they require to work around children, or other commitments of caring, or whatever it might be. And so, they need the flexibility that self-employment provides. Again, they'll accept a wage, in self-employment, but they will not be looking for a profit - in other words, a return over and above a wage to incentivise them to do the job.
Now, there are five million or more small businesses in the UK. It might be larger than that. It's a little bit vague as to how many people who are self-employed are really running businesses that provide them with their main income or not. But whatever the true number is, this is a significant part of the UK workforce. If those people who run these businesses are considered in isolation, that's roughly one in six people working in the UK.
If we add in the people who work for them, and there are quite a lot - although probably 80 per cent of small businesses employ no one, bar the owner - if we add in the rest of the small businesses that do employ people, we find that nearly half of all employees in the UK work for smaller companies.
Now, some of those will be at the higher end of the small range, because the government defines small and medium businesses as entities with up to 250 employees, and I don't think they're small at all.
But if we look at the smaller ones, there are still a large number of people who work in these organisations. But even though people who have set up their own businesses begin to employ others, and I did, that doesn't necessarily mean they are doing so because they want to make a massive profit out of them.
As I've said, I made a decent wage out of what I did, but I never really made a profit. The people that I employed were doing jobs that were really valuable to support what I wanted to deliver to my clients for their benefit at a price that they could afford and I wasn't trying to exploit anyone, and the vast majority of small businesses work that way. They employ people to make it possible for the owner to do what they wish to do. That's it.
Now if you do something like Rachel Reeves has done now - not with regard to the minimum wage - I support what she's done on the minimum wage; let's be clear. I would like young people to have at least 10 an hour. It still doesn't seem very much. I would like the minimum wage to be at least £12.21 an hour. It's hardly enough to provide somebody with an opportunity for independent living. So I'm not complaining about the minimum wage increase - but if she believes that increasing employers' national insurance is going to help a person who is employing others in their business to diversify and to take people on to help them deliver to their clients, she's wrong. Because once you get to the point where it becomes too costly, in terms of the reduction of the owner's wage, to supply that thing that the customer might want, which the business owner might want to supply, but which can only be delivered at cost to the business owner's wage, then, it's as simple and straightforward fact that the business owner does eventually reach a point where they make the tradeoff, saying, “I can't afford to do this anymore because however much I enjoy being in self-employment, because it suits my circumstances, I do eventually have other costs to meet and I will be forced either out of self-employment or back into employment.” Or into nothing at all in some cases.
So, there's a limit to the extent to which additional costs can be imposed on smaller businesses and I do not think that Rachel Reeves has understood this.
It is claimed that her increase in the allowance for small businesses that don't have to pay employers national insurance of up to £10,000 a year should cover this circumstance. But, if you're in hospitality, if you're running a care service, if you're running a nursery, if you're running another of these deeply labour-intensive businesses, the likelihood is that you're going to have more than three or four employees on something like the minimum wage to deliver the service that you want to supply.
In that case, you can't get around this problem using that allowance. You've got a bill and you've got to pay it, and either the owner picks up the cost or the customer does because there is no choice if the business is going to survive.
Now I've heard lots of people say, well in that case these businesses aren't viable. They are within constraints, the constraint being that the owner needs to make a wage. You can force them out of business, you can say that the owner should put up with this, but they won't. And then society loses.
We don't seem to have people in our society, or people in our political parties, or people in the Treasury who really understand what small businesses do, how they work, how they think, how they reward their owners, and so on. They've bought hook, line, and sinker that you go into a business to maximize your profits. This is the biggest load of nonsense with regard to small business that has ever been written. That is simply not how it works for, I would suggest, well over 90 per cent of small business owners. They're there to make a wage, to do a job that they enjoy, for the benefit of society, because people want to buy something from them, but not because they're there to make a profit over and above the wage that they could make anywhere else.
Rachel Reeves didn't understand that. The cost for the small business community will be high, but it will also be passed on to many elsewhere in the economy. And that means this error on her part is going to have widespread implications. And that worries me because we need a vibrant small business sector if, as an economy as a whole, we are going to provide the employment, the growth and the prospects that the people of this country need.
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The Employer’s Allowance, currently the cost of employer’s NI payments up to a limit of £5,000 annually and soon to increase to £10,500, is not available to every business:
You cannot claim if you’re a public body or business doing more than half your work in the public sector (such as local councils and NHS services) – unless you’re a charity.
You also cannot claim if your company has just one director and that director is the only employee liable for secondary Class 1 National Insurance.
So pharmacies probably canot claim, doctors’ and dentists’ practices cannot claim, many nurseries cannot claim, particularly in more disadvantaged areas as they are mainly state funded, the huge number of director-only small businesses cannot claim and many others. Yet I am sure I heard a minister suggesting that the increase in that allowance would help GPs and small businesses.
I really wonder if the change in NI thresholds can survive.
Me too
And I did warn about this before they even officially announced it
This video is getting a lot of upticks on YouTube from small business owners. I always make a point of watching the daily video directly on YouTube, and I find the comments quite revealing, very different in focus from the comments here on the blog, and quite overwhelmingly positive. You are clearly appealing to a new and different audience (is that the right word, too analog?) and people are keen to listen and learn. There’s not much positive to celebrate these days, but this is progress.
The average is at least 98% positive on YouTube, which amazes me.
Thanks
Good points. I run a small orchard/woodland activity. Its not a business as such thats largely because there is not an income associated with it, so I do the work for free. Thats because I like the work and consider its making a useful contribution to the environment and environmental services. In economic terms its not viable – so should I stop doing it? Its where positive externalities arise but the market cannot fund that.
Keep going!
Spot on Richard
The people in government and the Treasury have not the faintest clue about small business they have swallowed the neoliberal bullshit hook line and sinker.
There will be many people having nervous conversations with their accountants this coming week.
Much to which I can relate. For most of my four decade working life I’ve worked in a small independent business in that most challenging of sectors, publishing. Initially as commercial lead, and then as MD for almost two decades
In the early years I was driven to achieve growth. Initially this was about generating critical mass….what joy the day we could afford to hire someone else could do the invoicing and credit control! Later for its own sake and it came; but running the business became less fun, then technological change and an economic crash require turning back to ‘start up’ mentality and business became fun again.
That experience shifting focus from business growth to sustainability and rooting the purpose of the business into attempting to make a meaningful difference. The reason we set the business up in the first place.
You’ll find it unsurprising that the business has building a team of like minded people – most quite unsuited to thriving in a corporate environment. Staff turnover seized to be an issue. I see something similar in most long running small professional practices and specialist suppliers. All of whom innovate and survive.
Thanks
Back in the late 70s I studied for “O” level Economics (my only formal Economics qualification). Our teacher asked “what is the main aim of a small business?” “Make a profit” was the universal answer from the class… or even “maximise profit”. He said “No, survival”. His point was two-fold.
First, most small businesses are in a constant struggle just to stay in business and provide a modest living for those involved. Strategizing about how to “maximising profit” doesn’t happen, you don’t make the weather, you are subject to it; a price taker, not a price maker.
Second, survival implies sustainability. Most small businesspeople just want some comfort that they can feed themselves/family today…. and in the future. They could take on debt, hire more people and expand… but most do not; it is risky, a lot of hassle and they are content with what they have. They are not the “profit maximising robots” implied in most Economists’ models. They are as far from the Private Equity model as it is possible to be.
The problem is that those involved in representing small business or making policy for small business are “self selecting” – they are pushy, ambitious, profit driven… and fundamentally do not understand what motivates most of us.
So, this increase in Employers’ NI will add strain to all small employers and some will fold as a result…. but having tied themselves with foolish promises on tax and debt it was inevitable that bad tax choices would be made.
Finally, I would add that this Economics teacher taught that Governments spent first, taxed later; Banks lent first, raised deposits later. Either he was far ahead of his time… or are we only now remembering was were held as fundamental self-evident truths in the 60s and 70s.
Thanks and much to agree with.
Who is this Darren Jones, Secretary to the Treasury? Where has he has come from? Looking him up, he seems like an intelligent chap put forward to toe the line for his party. Well, if he’s a good boy, he will be rewarded.
On C4 news he was saying that the tax take on small businesses pays for service improvements; on Sky he has said that the tax hike has been imposed by the Treasury – not the Labour Government, so no promises have been broken. Oh right! I thought that the politicians called the shots?
This looks like it could get messy. It’s either policy by ‘special advisor’ all over again or its is than small business has been out spent by big business in affecting who is targeted for the tax take because ‘there is no such thing as government money’.
I’ve been musing about this all week, and going back to my MBA where we studied management theory for sure, but what we also spent a lot of time studying and observing/thinking about was ‘operations’ – how the work worked. We had a saying – ‘There is nothing as good as a good theory’. And how did we know? We tested it, used it, and then watched and learnt. By the time you were finished, you either new that the theory was bunkum or it worked or you had made the theory better.
I don’t see any of this in our politics. The operation of raising money for what we need now does not work because in effect all you are doing is moving money around, accepting that there is a limited pool of it, when what is already acknowledged is needed is that a lot of money has been taken away which has produced this mess and needs to be put back in. Yet withdrawing that money has not led to any so-called debt to come down. So, from an operational point of view you’d think that a change in operation would result because the desired affects have not come about. But it hasn’t meant a change in much.
The operation of the economy is another area of operation that needs to be managed – cause and effect needs to be monitored but instead we have a ‘set it and forget it’ sort of money management operation from the Government based on the really bad theory provided by the Neo-liberals. so, through a mixture of bad theory and political corruption, government has chosen the smallest shoulders in the business community to shoulder the burden. Real incomes continue to drop, private debt is escalating again and there is rampant price exploitation.
It is as though government is stuck in pre-Covid, pre-BREXT thinking and genuinely thinks all that matters is government debt and austerity, yet this government – like the previous one – chooses to sit on huge financial power and do nothing with it except sustain policies that are hurting people whilst sparing those who can afford to pay more in the flawed model they use.
As a result, there is no relationship between the operation and theoretical models meant to manage it that I can see.
The theoretical models do not work because they are corrupted by ideology.
The political models do not work because they are corrupted by lobbying and money.
The managerial models in the allocation of money do not work because they are corrupted by high pay that buys complicity in faulty models.
I think we need a new theory of the State, which in turn will result in a new operation. Richard produced ‘The Courageous State’ in 2011. Paul Spicker produced ‘The Welfare State: A General Theory’ in 2000 and I think that the two work together.
But when will we get it and from whom? Seemingly it won’t be through mouthpieces like Darren Jones and his boss or his party.
I totally agree with you on the importance of small businesses and how they are not set up for profit but to be viable – they contribute so much to the vibrancy and well being of a community.
My hairdresser was talking about the NI issue yesterday. He’s always very well informed on local opinion having a wide range of clients that he’s known for many years. He is not affected as the people who work in his salon are all self employed but has a friend with two salons who takes great pride in taking on young employees and training them up with the skills they’ll need for their future – he now thinks he’ll be unable to continue doing this. Just one amongst probably very many examples.
The ignorance of these consequences are just extraordinary ….
My hairdresser suggested that no one should be allowed to stand for election without 10 years of working in the wider world, whether in business or the public sector and I tend to agree.
I also agree
It would be interesting to hear why so many hairdressers who work in the same salon day after day are considered “self employed”. Perhaps they prefer flexibility and ok without holiday pay, sick pay, pensions, employment rights, etc, but I suspect the main reason is NIC. 6% rather than 8% and no employer NIC.
The hike in employer NIC encourages so-called “self-employment” of this nature, where the “worker” is embedded in a larger business but treated as a casualised pool of piecework labour with no or limited employment rights. Taxi drivers, plumbers, IT consultants, delivery drivers, etc etc.
Another difficult problem the government has not gripped is the gulf in tax treatment between employers, the self employed, and people operating through a personal services company.
Agreed
Hairdressers also do this to avoid the salon being VAT registered – despite rules to prevent that.
They rent a chair in the salon, choose their own working hours, have their own clients and are not answerable to the salon owner, except to pay the chair rent. They are among the least blatant disguised employees I have come across.
That’s not what VAT officers think
Good point about the VAT. Fragmentation to fall below the registration threshold.
VAT avoidance and NICs avoidance.
So pervasive that people think this is the right way to do things, because any other way that actually respects the rights of workers cannot compete.
And this is purported to be the benign end of disguised employment.
As someone who has run more than a dozen start-ups, I totally agree with your analysis. In my 20s I turned down the opportunity to be an early employee of ARM, for example, simply because I preferred to be my own boss. Small business owners definitely don’t do it to maximise personal income or ‘profit’.
Thanks
Richard,
Thank you for that
I think I was using the same definition of profitable as you its just how I expressed it
Badenoch has been elected leader of the Conservative Party. Apparently some of the votes cast in this “most sophisticated” electorate, in a two candidate run-off, voted for more than one candidate. Says it all, really.
We now have two dud political parties, both run by two people unfit to hold high office; and an electorate that cannot see the wood for the trees. I am reminded of a Preston Oracle, who said this recently in a media Vox Pop: ‘We didn’t vote for this. I’m not sure what we voted for, to be perfectly honest’.
As long as people keep voting for Labour and Conservative in an FPTP system, Britain’s decay will continue and nobody will ever know what they voted for. How many times does everyone think we require to go round this absurd, no exit political roundabout; before the penny drops?
Scotland, at least cannot go on like this.
Now, back when it was first introduced, National Insurance was just that ie it was intended to fund a number of contributory benefits for workers and health care for the ‘Nationally Insured’
These days health care is universal and apart from the State Pension the scope of ‘Contributory Benefits’ has been much reduced.
So I might ask what exactly is the justification for an increase in employers NI?
I can understand bringing part time and full time workers into identical arrangements and the case for a levy on employers of low paid workers but again why are we taxing work and not income?
Because taxing work is a fundamental neoliberal principle.
Coercion across all employment markets is the absolute foundation of neoliberalism.
Unless there is a return of a commitment to full employment in macroeconomic policy, instead of using unemployment to control inflation,( and primarily to protect capital values), nothing will change.
As far as I am aware employers NI does not give the employee (or the employer, or anyone else) any entitlement to pensions or other benefits.
It is just a payroll tax. Nothing more. Literally a jobs tax.
It would certainly be possible to reform the welfare state to depend more on a contributory principle like Germany. You then have to have a safety net for those without contributions and justify privileging the contributors in terms of higher benefits from contributions when others may have greater need.
You are right
Let me guess, you’re an expert on small businesses, despite never having run one?
This is very funny…..
I was senior partner of a firm of chartered accountants who advised hundreds of small businesses and helped create and direct quite a number of small and medium sized ones.
But of course, I know nothing about small business.
You trolls never research anything do you?
You are right in your analysis Richard. I was fortunate to take early retirement from the civil service in my early 50s. I set up my own business and never looked back. Of course I had the cushion of a pension. But I don’t think I was motivated by a search for profit. It was more to do with the satisfaction of being my own boss and a lifestyle that allowed me to do what I want. I’ve been modestly successful but I don’t think I fit the Treasury’s stereotype.
Totally agree Richard, my dad had a small business, i still qualified for a full grant. I have worked for large and small businesses and can say the ethos is totaly different.
What perplexes me is the media and opposition declaring thus to be a left wing budget.
I think its two things, cynical and incompetent.
Its cynical because its trying to finesse the economy. Much the same as they finessed the election – no moral compass behind it just the bunko booth approach to keeping a promise that should never have been made.
Its incompetent for the reasons you describe but because (a) there were plenty of ways to raise the money needed – as you and others have pointed put and (b) because even measured on its own criteria – the growth projections are paltry.
Thanks
I would wonder what kind of economic metrics small businesses would really care to have measured to represent their circumstances. Mainstream economics shoehorns their particular ideological view into every economic metric, and that would seem to include metric that tracks profit over any other factor that might be of interest.
Survival
Age is a factor here.
When I hit 50 I began to see already the reluctance of employers to choose people of my age.
When I went for a job, one of the first questions was about my age.
As a contractor no one asked me my age.