The Death of Small Business Investment

There once was a time, long, long ago when small business was the driver of the US economy and where big business did not dominate our economic policies and concerns. While it is true that small businesses still employ a huge proportion of the working people in the USA, it is also true that this proportion has been shrinking and that small business has been suffering in the post recession economy while big businesses have been hording cash and recording record profits. http://www.forbes.com/sites/scottshane/2012/04/21/small-businesss-share-of-employment-is-shrinking/

This has become an area of concern both for economists and politicians alike as stagnant job growth has plagued our economy and economic policies of late. Currently, worries about the Fed tapering their monetary easing programs has a greater effect on the stock markets than good fundamentals reported by the companies themselves. This is a sign that our current tepid growth is capital driven instead of driven by company fundamentals. http://www.usatoday.com/story/money/markets/2013/06/19/stocks-wednesday/2437101/

One of the major things that separates big business and small businesses is access to capital. A large business with an established balance sheet and a long track record of profits is a much more credit worthy entity than a small start up with few employees that is in the process of developing marketable products and services. This is true, by the way, even if the large business is not public and does not have access to public stock and bond issuances to fund expansion. Its track record allows it to borrow money at a much lower cost from investment banks at rates that the small business would envy. In a post recession world where banks are increasingly reluctant to lend to business at all, this advantage is only compounding. Where a large business today can use a large chunk of restricted stock (essentially a large stake in the firm itself) and other company assets to secure a business loan, a small business owner usually has to mortgage both his business and his house to secure similar funding. And even then they borrow at much higher interest rates than the big business. A lot of this is driven by the perceived relative risk in investing in both companies.

But...

Complicating this factor has been the slow erosion of a post Great Depressions set of laws called Glass Steagall. Glass Steagall was a set of regulations that separated investment banking from consumer banking. The idea behind this was that, if the government is going to give you access to the Fed borrowing window, and access to deposit insurance, that it wanted you investing that money in the local economy to promote small business and home ownership. With the erosion of these laws, banks were free to invest in complex securities and derivatives instead of their communities. This sort of investment is what helped inflate the economic bubble that popped in 2008/2009. While arguments go both ways for whether repeal actually caused the Great Recession, not enough analysis has been done into how the repeal has affected small business borrowing and liquidity. What we do know is that small businesses have had a harder and harder time competing with big business in the years since repeal, and the extra competition from the securities markets now available to banks could not have helped. What I mean is that instead of competing with other small businesses and real estate for loans, now small businesses compete with investments in the securities markets as well.

At some point, we as a nation are going to have to revisit this change in regulatory scheme. Because the end result has been that while our banks and large businesses are investing in international capital markets, using international operations to avoid domestic tax liability and outsourcing jobs around the world, small business is suffering. Small business, the former driver of our economy, does not have the capital it needs to expand an flourish. And when small business can't expand, it can't hire, and thus our unemployment rate stays stubbornly high, tax revenues stay low, and our economy flounders.