THE fascination with Tech City stems from a perception that Britain is missing the kind of “entrepreneurship” culture that fuels Silicon Valley. This idea nurtures a British infatuation with small and medium enterprises (SMEs) which dates back to the early 1970s and is based on the idea that economic growth is created by “entrepreneurial” small firms. The thinking has informed not only the Tech City project, but also recent policies aimed at increasing lending to SMEs. Unfortunately, there is little empirical evidence to support such policies.
SMEs and the startups that form part of this group are neither under-financed, nor are they particularly valuable to the economy—whether measured by jobs, productivity or innovation. Research at the University of Cambridge (Hughes 2008) suggests that the British government spends (directly and indirectly) close to £8 billion ($13 billion) annually on SMEs—more than it spends on the police and close to the amount it spends on universities. Is this warranted? How do we know it would not be better to simply direct that money to teachers where there is plenty of evidence that quality education raises human capital and growth.
In fact, once you take into account the number of SME jobs lost after the first three years of their creation, there is very little net job creation by these firms. Only 1% of new enterprises have sales of more than £1 million six years after they start. Research at the University of Sussex shows that median sales of a six-year-old firm is less than £23,000 (Storey, 2006). These firms also tend to be the least productive and least innovative (R&D spending—the best measure we have for inputs in the innovation process—in Tech City is not higher than in other parts of London or Britain). Indeed, the few high growth innovative firms (about 6% of the total SME group, Nesta, 2011)—those that really should be supported—do not directly benefit from the hype that surrounds SMEs and startups: once they get the funds these are too diluted to make a difference.