Monday, October 31, 2016

Small Firms are Admired. But are They Good Employers?

There has been a strong movement toward smaller firms in many economies. This is partly a result of larger firms doing less well than before, and shrinking as a result of failure, and partly because large firms find it convenient to subcontract work, making their payrolls smaller than the actual work done for them. Along with this, we are seeing increased admiration for small firms, entrepreneurs founding and running them (especially), and even the “gig economy” where many people are not really employees of anyone, just individual contractors. If you took an uber ride today, you had a gig (economy) with someone.

We may wonder what all this does to employment. That’s a big question, but a practical place to start is wage levels and inequality. We already know that large firms pay more than small firms do, for the same worker. There is also some indication that they have greater wage equality, because employees inside large firms can compare their pay more easily, and can protest when inequality is high. But how does the presence of large firms affect the overall employment, including those who work for smaller firms? That’s the ambitious question answered by a paper in Administrative Science Quarterly by Adam Cobb and Flannery Stevens. They look at how US states differed in the proportion of people employed by large firms over time, and measured the effect on the income inequality -- the spread of income across the population.

What they find is disturbing for those who celebrate the rise of small firms. Large firms in a state reduce income inequality, which is only possible if they reduce inequality both inside themselves and among firms around them. So, rise of small firms means rise of income inequality. Some other findings are interesting too, and suggest problems. Large firms can have higher wage inequality if their employees compare themselves less, which is easier if they have racial diversity (races are often separated by job title, just as genders are). Racial diversity in large firms increases income inequality in the state, and this effect is especially large if the large firms are dominant employers in the state. Dispersion of large-firm employment across locations, which also prevents comparison, also makes large firms a weaker force in reducing income inequality.

Many lament the lower freedom in large firms, and hierarchies can even feel oppressive for employees. But the freedom of small-firm employment has its costs too. Jobs are lost more often, pay is lower, and even as neighbors they are less valuable – being in a state with many people employed by large firms equalizes income. Something to think about.