The title of this talk is ‘Entrepreneurial Myths, Legends and Public Policy’ by Marc Cowling. College of Business, Law and Social Science at the University of Derby. At the top left of the first slide is the University of Derby logo showing three peaks, and to the right is the inset video of the presenter Marc Cowling. The main photograph is of a young woman holding a virtual reality headset.
Thanks to everyone for giving up their evening, even though we've got limited opportunities to actually do anything these days, but thank you for taking the time.
Text animates on screen saying ‘Professor Marc Cowling. College Head of Research and Innovation’.
Can we go on to the next slide where I'll just quickly go through some thanks to people who were really important and key in the development of my career at various stages.
The title of this slide is ‘Personal Thanks’ and it lists the names of the people Marc wishes to thank, which he will read out.
So with my Dad a kind of unachievable benchmark was set. He won the Queen's Award for the highest degree mark in the UK in his graduating year. He discovered - he spent a career measuring the social costs of monopoly power, and did some key work around measuring the social costs of monopoly and how that impacted on firms and consumers. He was my harshest critic for sure, but a very fair one. Even up to the point he passed away two years ago, he'd always take an interest in my work, and he'd ask for copies. And I would get them back a few days later with red pen like he was marking an undergraduate essay. So, a harsh critic, but a fair one.
Now my mum, she set up a recycling project which is a social enterprise which she ran for 35 years. And its aim was to provide skills and employment training for people with disabilities of all kinds. And I think from those experiences and in my own work on intersectionality and inequality, it was very apparent that disability, although the disadvantaging characteristic with no voice, it's the single most socially and economically disadvantaging characteristic. David Story, as Camille said, my mentor in my formative years as an academic at Warwick. But what, apart from his general support and mentoring, he always said 'There's no point in doing research if you can't make a real difference', in terms of addressing important issues, and developing our understanding. But even more than that, about connecting with people who could meaningfully use that research.
Nigel Meager, my boss at the Institute for Employment Studies. He was a really great and deep thinker and a champion of social justice issues. He also allowed me to put the same time sheet in for approximately 5 years and turned a blind eye to it. So I thank him for that.
Will Hutton, my boss, a larger than life character at the Work Foundation, he was absolutely mad to work for, but he was absolutely full of ideas and energy and that kind of rubbed off, and he always wanted to know the answers to urgent and future problems. So, a very inspiring individual.
Rebecca Harding, we had some great years at London Business School and the Work Foundation. Hugely inspiring again, and she really had a great feel for the issues of the day or even issues that we would be facing and we always directed research in new directions. We actually Co-authored the first social enterprise report in the world. And also developed a classification of different types of social enterprises and entrepreneurs, which is still widely used today.
Debra Humphris, she's VC at Brighton. She was an academic who wanted to know, as she would put it, The Truth. The Real Answer. And she used to - I always wake up early and I always get to work early. We used to have meetings at 7:00 o'clock in the morning and she'd say, 'Mark can we have a coffee and a chat?' She said. 'I wanna know about pay inequality at Brighton.' And I said 'Fine, but we need to do it properly.' She wanted to know about the USS pension scheme, its viability, its liabilities, etc. About patterns in research income, but always, she always said, 'Tell me what data you need and I'll make sure you get it.' So we did a fantastic report with the full staff - anonymized obviously - records, pay, promotions, job status, college etc. etc. to really understand potential pay inequality at Brighton. Which is a really fundamentally key step, way above this reporting average salaries by gender, by ethnic group, by disability etc. etc.
And finally, Kamil, Martyn and all at Derby for making me feel really welcome during my time, helping me out with my complete incompetency around technology and systems, understanding Derby and generally just making my time at Derby really enjoyable.
Finally, back on the family front; my daughter Izzy who's building a career at Wiley in Content Marketing for preparing this lovely presentation, which is far beyond my capabilities, as most people will know. My favourite nephew Joe who's just started senior school and I hope Joe a) will understand what your uncle does for a living and b) it may inspire you to go to University when you finish school. And I believe my son Charlie is desperately trying to come up with a difficult question as we speak.
So, next slide please.
The slide is titled ‘The Three Pillars’. At the bottom is a blue block labelled ‘Small Business’. At the top is a red block labelled ‘Productivity’ which is held up by three blue arrows pointing upward. These are labelled ‘Financial Capital’, ‘Human Capital’ and ‘Innovation’.
This arose, what this actually is, is a graphical representation of a production function which is core to economics. About how we understand the relationship between the inputs that we use in production and what comes out the other end. Now this was developed in this form, for an Australian government policy document which formalized our thinking about how you get from a small business to a productive small business.
Next slide, please.
Slide is titled ‘Key inter-relationships’ and the picture shows three interlocking circles titled ‘Human Capital’, ‘Financial Capital’ and ‘Innovation’, respectively.
And for me the problem of the tension between government and knowledge from research and economics is typically a government will have an innovation ministry, or part of, here it is part of bays. It'll have Treasury, HMRC which deal with financing issues. Then it will have a Department for Work or labour or skills or something like that. And generally they don't speak to each other, which is a problem. They formulate policy independently, so we'll have an innovation policy, a finance and investment set of policies and the skills agenda etc. But my research very clearly, or the more interesting research that I've done, recognizes the interdependence between the three. So, the people side of things, the talent, the skills, the investment capital and the innovation part. And certainly you can never get innovation or growth at the firm level without talent, without financial capital and without good ideas. Independently, nothing helps. Doing more of one without the other two just collapses and you don't get growth or increase in efficiency.
And in fact, we looked at the causal chain in a Bays report a few years ago and actually, the only way it works in a causal sense, if you want growth and innovation or more growth and innovation at the firm level is if you've got talented people, skilled people in place, and only then does adding more financial investment capital lead to innovation and then growth at the firm level. In any other order or combination it doesn't work. So, having lots of investment capital, great ideas and then trying to find workers - talented workers - to make it happen doesn't work. You must have the talent in place in the first place.
OK, next question - slide please. OK, 'Does the future depend on new business?'
The slide posing this question shows an image of a magnifying glass within a red box.
Arguably, my whole career has been lived on the back of governments since Margaret Thatcher in 1978, I’m believing that to be true, so really, I've always been interested in finding out if the future does depend on new business. Because certainly we've got more of them with consistent public policy support for new business start-ups, the growth of existing small businesses, etc.
Next slide, please.
Slide is titled ‘Notable Believers’ and features a silhouette of a head with arrows pointing from it to several quotes from different people. The first is from David Cameron in 2012 and reads: ‘So if we want to make our economy stronger, this is where we’ve got to focus our fire power, on encouraging more people to start up and helping small businesses to grow’.
The second quote is from Margaret Thatcher in 1984, who said ‘Small firms are indispensable to the creation of jobs and wealth. The more small businesses there are, the freer and more enterprising that society is bound to be’.
The third name is Tony Blair, and next to it are the words ‘The Entrepreneurial Society’.
So, just a few quotes going from Margaret Thatcher. So, small firms very clearly linked to the creation of jobs and of wealth. And it is about freeing up the latent talents of society, which in her agenda is also tied up with the large corporate, large union sector of the labour force. So she felt that small businesses were the vehicle by which the latent entrepreneurial talents would be freed up.
There's also a sub-agenda which would be to reduce the welfare dependency of the labour force, supported by Tony Blair. That was quite funny. The Entrepreneurial Society, we got a call in a year out from the election in '97 from Tony Blair's people, saying 'We need a small business policy and we don't have one.' So it's largely Andrea Westhall and myself who actually sketched out - which was the book the 'Entrepreneurial Society' - an agenda and a policy agenda which Tony Blair's government then enacted when they were elected in '97.
So all politicians of whichever political shade, have been supportive since the late 70's of entrepreneurship, small business and particularly business start-ups.
Next slide, please.
Slide is entitled ‘Policy Issue (I)’. Text asks ‘How efficient are Small Businesses?’ and below appears a bar graph which shows ‘Efficiency’ along the x-axis and ‘Number of employees’ up the y-axis. It starts with a bar for self-employed people at the bottom, and bars above it are shown for businesses with 2-4 employees, 5-9 employees and so on up to the top bar for businesses with over 500 employees. Marc will explain the data shown in this graph.
So I thought, you know, these policies have worked, or this political will to have a more entrepreneurial society has clearly worked in the sense that they supported more and more people to start their own business, become self-employed, etc. But the underpinning policy myth was that, smaller businesses would be more dynamic, more creative, more innovative and hence more efficient, and they destroy inefficient larger businesses. So we get productive churn where old, inefficient industries and businesses would be replaced by new dynamic entrepreneurial firms who would grow quickly.
And some do, but not many, or not enough. This shows essentially a scaling where we set the best, best business in each class to one - so on the right vertical axis. Then the average small business of its type is benchmarked against the best in class, if you like. So we see two things. Even the largest businesses in the UK, on average, are only about 85% efficient, compared to the best in class, but as we go down the size kind of classes and end up with a self-employed or single self-employed, they’re operating at about 68% efficiency on average. As we look at the micro business classes, they're still well below 70% efficiency. Even medium-size companies, not even 80% efficient, on average.
So there are certainly question marks about whether having more small businesses, more self-employed, helps us economically, because productivity is the only thing - or increase in productivity - are fundamental to raising the incomes and wealth of the population. OK, so keep that in mind as we progress through.
Next slide, please. So, the broad question is, 'Do entrepreneurs sleep?' but the real question is, given this consistent government support for 40+ years and a very favourable tax system for the self-employed, for small business owners... Next slide, please.
The title is ‘Policy Issue (II)’. There are two bullet points. The first says ‘Since 1979 (Margaret Thatcher’s government), the UK tax system has been incredibly generous to those who choose self-employment and business ownership’. The second bullet point reads ‘This policy support reflects an underlying principle that if we financially “reward” entrepreneurs they will work harder and create even more of the good outcomes that we all benefit from (jobs, innovation, productivity etc.)’
So my real question is, given that there's been consistent support for a very favourable and generous tax treatment of self-employed and business owners, is it the case - if we effectively financially reward entrepreneurs - that they will actually work harder and supply more efforts and create even more of the good outcomes that we all benefit from: more jobs, more innovation, more productivity. All the rationales underpin the government support for more self-employment and more small business.
So what I'm looking for is clear evidence that the tax system, or its generosity, has incentivized self-employed people and small business owners to work harder than waged employees. Next slide, please.
A line graph titled ‘Working Hours Distributions’ shows ‘Hours worked’ from 0 to 150 on the x-axis, and ‘Density’ from 0 to 0.6 up the y-axis. It charts ‘ISE’ in blue, ‘JC’ in red and ‘Waged’ in green. ISE and JC both follow a similar path which peaks at almost 0.4 density at 40-50 hours, while Waged has a peak of 0.6 density at 40 hours.
That's a bit unclear, but the green line, this is just distributions, ignore the density bit, so the green line is waged employees and at the bottom the horizontal axis is hours worked per week. ISA are individual or solo self-employed and JC are Job Creating self-employed or small business owners. Next slide please.
A graph titled ‘Waged Employee Hours’ shows kernel density estimate, with ‘Hours Worked’ on the x-axis and ‘Density’ on the y-axis. It shows a peak close to the 40 hours mark.
So what we see for waged employees is a huge concentration between 35 and 45 hours per week, most waged and salaried employees in the UK work within 35 to 40 hours a week. On the very left we've got a little spike which accounts for the part time workers, but very few waged employees work more than 50 hours a week, so that's our benchmark and we're looking to see if the solo self-employed and job creating small business people work more hours. So next slide, please.
This graph is titled ‘Solo Entrepreneurs Hours’, and shows a kernel density estimate line with a much less pronounced peak than the last graph.
Here we don't need to even look at the numbers, but for solo entrepreneurs, self-employed people, we see that the distribution of hours worked spreads quite significantly. And actually the average is also shifted to the right. So the bulk of single self-employed people work between 40 and 55-60 hours a week, which is on average more than waged employees. And we get also a longer tail to the right hand side so that there are more solo self-employed people who work very long hours per week. Next slide, please.
The title of this graph is ‘Job Creating Entrepreneurs Hours’.
And if we look at the job creating entrepreneurs again, we see a shift in the whole distribution to the right. So on average, job creating self-employed work more hours per week than their solo self-employed peers and waged employees. So we're looking at 40-70 hours a week for job creating self-employed. So I think we could argue on that basis in terms of effort as measured by hours per week you put into your work, that certainly job creating self-employed and solo self-employed do work more hours on average, particularly at the very high hours end of the spectrum, than waged employees and the favourable tax system has played a major part in inducing more effort. Because you get a higher share. You get to keep a higher share of every pound extra you earn than a waged employee would if they worked excessive hours. So policy works in that sense. Next slide please.
This graph is titled ‘And if I could choose my hours…’ ‘Actual Hours’ run along the x-axis while ‘Desired Hours’ run up the y-axis. Marc will explain the data in this line graph.
But then I thought, and this was a lovely question in the data that said, ‘OK, tell us what hours you actually work, and tell us the hours you would choose to work if you had a complete freedom of choice.’ So the red line, which goes from bottom left to top right - anyone on that line would be someone who currently works the hours that they would choose to work if they had complete freedom of choice. As we notice, there are not many people on that red line, and there's a very small part where waged employees, solo self-employed and job creating entrepreneurs cross over. And actually the only place where all three intersect with the line of equality, which is a red line, is between about 30 and 40 hours per week - so what we used to call the ‘standard working week’. If we go to the very bottom left, so a person who works part time - on average 20 hours a week - given a choice, they would choose 25 hours, so more hours. At the extremes, a person who works 60 hours a week would choose to work 50.
So everywhere in this spectrum, if you work part time or very excessive hours, very long hours, given a choice, you would not work those hours. So I think that's also interesting and it kind of reinforces the influence of the favourable tax treatment and the trade-off between more income and more work/life balance for example, that people face and the choices they make, which in this case I'm arguing were incentivized by the government and their favourable tax treatment of entrepreneurs. Next slide, please.
This slide asks the question ‘Is IR35 Killing the Entrepreneurial Goose?’
OK. IR35. Now, apart from probably banks in the global financial crisis, IR35 seems to have generated a consistent wrath amongst self-employed people for at least 10 years, and there are very, very strong lobby groups arguing against it. So my question is, is IR35, given that since Margaret Thatcher the government has been encouraging, actively encouraging more people to set up their own businesses, more people to be self-employed, etc. But then HMRC comes in with the IR35, which I'll explain in a little bit, which seems to go contrary to everything every Prime Minister and Business Minister said since 1979. Next slide, please.
This slide is titled ‘Policy Issue (III)’ and shows a list of bullet points which Marc will read.
So in the year 2000 they introduced new and very strict legislation which tightened the rules around the legal classification of self-employment. And they're very strict definitions. And the policy target was to eradicate what they perceived as fake self-employed workers who were really waged employees in disguise, but in cahoots with their employer they re-classified themselves to self-employed, so the self-employed person would benefit from lower taxation and the firm would have reduced employment costs; no pensions, employer's NI etc. etc. So HMRC didn't like this, particularly in the construction industry, which was the first industry in the UK to really enact the shift in the 80's from waged employment, unionized employment, to self-employment for many of the skilled trades in building.
Progressively they tighten the legislation to the point where from April next year, all public sector and medium-large sized firms who contract with self-employed (people) must effectively prove that the people they contract with aren't really employees, disguised employees. So there are significant costs all the way through. So what I want to look at now or appeal to the evidence to say what actually happened and potentially were there unintended consequences arising from HMRC basically trying to re-classify fake self-employed people back as waged employees and hence raise higher taxes, or get more taxes from the same workers. Next slide, please.
This graph titled ‘HMRC – They Shot and Scored!’ shows a line for ‘Inflow’ in grey, ‘Outflow’ in red and ‘Self-employed workers’ in blue. Along the bottom is the year going from 1990 to 2005. There’s a vertical green line coming up from the year 2000 labelled ‘IR35’. Marc will explain what the data shows.
OK, so the red line is really the one that's important here, which is the outflow from self-employment. The green vertical line is when the IR35 literally came into legal being. We see actually the late 90's was a boom period, largely. Lots of nice waged jobs around, and certainly there's evidence that talented self-employed people were accepting very well paid jobs in the waged sector during that period. But in the post IR35 period, which is actually a recession, the early 2000's, we also see an uplift in outflows from self-employment at a time where inflows - entry in self-employment - was fairly modest and unchanging over a significant period of time.
So in that sense the policy works, HMRC got their revenge on the fake self-employed, as they would consider them - despite the rest of government encouraging people to become self-employed over a 40 year period. Next slide, please.
This slide is titled ‘The IR35 displaced self-employed’. A picture of a medal containing the words: ‘HMRC – More tax collected per £ of earned income’. To the right are bullet points covering ‘Employers’, ‘Former self-employed’ and ‘The UK Economy’ which will be read in full by Marc.
OK, so HMRC, certainly from the people that they would see as fake self-employed, who then just were employed by the firms that we're contracting to, they certainly collected more tax per £ of income, so HMRC - Gold Star. They had a policy, it worked, in a narrow sense. But what I'm really interested in in my research when I look at policies, are the unintended consequences. So, other effects which HMRC clearly didn't consider, when they were designing this policy. So from my work around this, so for employers: a higher tax burden - so they have to pay Employer's National Insurance, holiday, now pensions, etc. etc. Some of them you'd consider a good thing. But for the former, self-employed who were re-employed in a waged position, their gross income went down by 8.5% on average, which is quite a significant drop in income. And then if you add the higher tax burden on top of that, their net incomes were even lower than the 8.5% gross. So it's punished the former self employed who were lucky enough to be re-employed in a waged role to a significant degree.
One of the consequences - one they clearly forgot about - was that around 1/3 of the self-employed population are actually small business owners who employ other people in a waged job. So every time three of those people leave, in fact every time one of those people leaves, another job is lost, an additional job from their employee is gone. So there's a double penalty. But on average for three exits from self-employment, there's one additional job loss. But the real unintended consequences: HMRC naively believed that firms would just hold their hand up and say, 'Oh yeah, we got it wrong. We tried to pull the wool over your eyes and actually these really are employees, so we'll just take them on the books.' But that didn't happen. Not all of the exits moved into waged jobs. Many flowed into unemployment, and even HMRC knows you can't tax the unemployed.
So that really encompasses my work. So I know the rationale that government uses to justify a policy. I can measure the effectiveness in a narrow way with fairly good clarity. But I'm really interested in the unintended consequences, and tracing out the full effects every time the government does something - and that's really where my work has been for 30 years. Next slide, please.
This slide asks ‘Are Bankers Evil?’
OK, this arose out of actually the very first piece of research I did. It was in the 1990 recession. And we have the same story roughly every 10 years. We have an economic recession or some kind of crisis. It normally starts in a year beginning with 0 and ends in a year beginning with 3. And every time it happens we get massive media coverage about entrepreneurs, small business people who've had their overdrafts withdrawn by banks, or they're being turned down for loans, etc. etc. and general media hysteria about how nasty banks are. Banks don't help themselves by often announcing bonuses in January in the middle of a recession, when small businesses are suffering. So my broad question is, 'Are Bankers Evil?' My real research question is 'Do banks in the UK serve small businesses in a reasonably efficient and helpful manner?' Next slide, please.
This slide is titled ‘Policy Issue (IV)’ and shows two bullet points which Mark will discuss.
So that's my broad policy issue question, but certainly small business financing and imperfections or problems in capital markets, particularly with banks, but also the venture capital, have inspired a lot of government thinking, like government commissions, reports, and a lot of very good and proactive policy making in debt markets and equity markets. And they've all been targeted at removing perceived constraints on access to finance, particularly for small businesses, but also young and innovative companies. Then on the back of that, that there have been consistent concerns about potential discrimination, access and the terms of bank loans, to women entrepreneurs, particularly, but also to ethnic minority entrepreneurs. Next slide, please.
This slide is titled ‘Just how big are UK banks?’ It presents a graph titled ‘Chart 7: Sizes of the UK and US banking systems’. It shows the difference in the percentage of GDP in UK and US banks between the years 1960 and 2010. The United States is shown in pink and the United Kingdom in blue. Mark will explain the data in just a few moments.
OK, but to understand the way small businesses, entrepreneurs and banks interact in the UK, we need to go back and understand the evolution of the banking sector in the UK, and it's importance. Because that underpins governments, general supports, as we saw in GFC, underwriting or overtaking banks and their activities, and managing banks through crises rather than directly intervening to help small businesses who were suffering from a banking crisis. So if we go back to the 1960's we see that in the UK and US the banking sector was, the total assets held within the banking sectors of the US and UK were well below what the US and UK earned each year measured by GDP, so it's below 100. Since the United States banking system has stayed below its equivalent GDP for 60 years now. And that's clearly in very stark contrast to the UK, where in the banking system we had waves of all sorts of regulation all the way through, from building society acts, all sorts of demutualization, all sorts of freeing of the banking sector, if you like, and its activities, and we've reached a point now where the banking sector or the assets held within the UK banking sector are nearly six times as big as the whole UK earns in a year. It's absolutely monumental, the relative scale and importance of banking in the UK. Even compared to the US where it's less than the equivalent GDP. So banks, the banking sector in the UK, is unique in the whole world. Six times bigger in a relative sense, than its US comparator. Next slide, please.
This slide is titled ‘Loan demand and supply in GFC’. A line graph titled ‘UK SME loan demand and supply: 2008 - 2013’ is shown and Marc will now describe the data.
OK, so this is looking at the Global Financial Crisis period which began in October 2008, so, it's mapping it out. The blue line is the proportion of SMEs who applied for a bank loan, going from GFC - the immediate period, the month after GFC - right through to Feb 2013. The yellowy-orange line is, of those firms that applied for finance, how many got - or what proportion of them - were given a loan?
Now the really interesting bits for me, just eyeballing the two lines: every time the blue line goes up or down, which is the 'I'm a small business, I would like a loan please', the yellow line - the willingness of banks to actually give you a loan - goes in the opposite direction. So, starting from the left hand side - so two months after GFC - banks were being very nasty in terms of reducing their willingness to offer loans, at the same time as more small businesses were asking for one. And then over time, if we go up to the period to autumn 2011, banks were actually getting nicer in terms of being more willing to supply loans to SMEs, at exactly the same time as SMEs were reducing their demand for loans. So what's clear, in any crises, is that banks initially over-react. They credit ration too much, too severely. But small businesses act almost in a three month time warp. So, a small business today observes the bank being quite harsh in terms its lending policy, and then it thinks about it and then it reacts to a world in three months’ time that doesn't exist anymore. So it is completely out of equilibrium and it actually took round about three or four years after the Global Financial Crisis before we got back to an equilibrium where small firms and banks were singing from the same hymn sheet. Next slide, please.
This slide is titled ‘Loan Application & Success Rates in Europe’. It shows a bar graph with the countries of Europe listed up the y-axis, and each country has two lines along the x-axis - one in blue showing ‘Success Rate,’ and one in red showing ‘Applications’. Mark will now explain this data.
OK. Everyone, Lourdes particularly, the German banking system, but more generally, the continental European banking system, are banks dominated by four banking groups who have about 80% market share of SME accounts and SME lending, and they have done for about 30 or 40 years. So our big banks invest billions in IT, clever credit scoring algorithms etc. and that's called ‘Transactional Banking’ and it is based on hard data. 40 years ago in the UK we used ‘Relational Banking’, where as a business you would have a local bank manager who would know you and understand your business, you'd meet socially, possibly, so that allowed the transfer of softer information which would then inform their lending decision rather than just some computerized algorithm. That was then in the UK, but that kind of system is still very pervasive in Europe.
So in terms of the application rate in the UK, on average, our businesses are less reliant on bank financing than those of Spain, Italy, France, Germany, etc. which are heavily bank-based-systems and relationship-bank-based systems. But the blue bars, which are ‘Of all those businesses which applied for loans, how many were successful in obtaining finance?’ Then, I mean, Greece was in a particular economic spot, so success rates were very low during that GFC period, but generally UK success rates for loan applications were kind of approaching 85-90%. So we're not too far out of kilter with success rates for relationship banking systems and countries. Next slide, please.
This slide is titled ‘Loan Interest Rates in European Countries’. It shows a bar graph titled ‘Net interest margins, 2014’ and has a bar for each country. Along the x-axis is ‘Interest Rate’, with Belgium at the top with the lowest rate of 2.5% over the base rate, and Greece at the bottom with the highest rate of almost 8% over the base rate.
OK, so then the issue is, or a fundamental issue when you're accessing financing is the interest rate you pay - the net margin over over base rates you pay on borrowing. And that ultimately effects a) the ability to repay a loan and b) the types of projects that are needed to meet those kind of loan and interest repayments. Here we see actually, loans in the UK to SMEs, the margins are quite low, less than 3 1/2%, about 3.3% on average. Whereas the relationship banking systems, the big ones, Germany, the average small business pays 5% on lending. In Italy, more than 5%. Obviously in Greece, for particular reasons, very, very high interest rates. So in that sense, although there are clearly problems, in the immediate period after a crisis - be it Covid, be it the Global Financial Crisis, or any other deep economic recession - for the most part, I would suggest that UK banks - whilst their bonus systems might be evil - generally they provide a pretty good service and have a fairly good relationship with their small business customers, compared to their European counterparts. Next slide, please.
This slide is titled ‘Thinking about the whole bank-firm relationship’. A graph titled ‘UK banks’ sources of earnings’ runs from 1980 to 2005, with net interest income (left-hand scale) in solid blue, non-interest income in solid red (left-hand scale) and an orangey-yellow line showing non-interest income/net interest income (right-hand scale). Marc will explain what this graph shows.
And why is this? And what this graphic shows is where banks, or how banks earn money from customers. And the blue chunk is their interest income, which is the money from lending, effectively, that income from lending. And the red bit is their interest from services and other charges - banking services. But the important part of this, which is the orangey-yellow line, is that the importance of non-lending associated income or earnings for banks has increased dramatically. From about 40% in 1980 - a ratio of 0.4 in 1980, to a ratio of 1.8 now. So 2/3 roughly, of the profit a bank makes from a small business account or even a customer account, is non-lending associated. So I would argue that banks, unlike the government, look at the whole relationship, and they'll often give you soft lending, that's why we saw the relatively low interest rate, willingness to lend, cause that locks you in as a profitable customer and they'll make extra profit from the other bits of your banking; you know, when they charge you £10 for being overdrawn for about 2 minutes, or arranging a currency exchange etc. etc. So it's erroneous of policy makers and also banking commissions to separate out the different elements of a customer-bank relationship, because that is key to understanding the lending side of things. Next slide, please.
This slide is titled ‘Lending and Gender Aspects of Entrepreneurship: Demand’. A line graph shows the % of SMEs applying for bank finance from July 2011 to March 2013. Male-owned businesses are shown in a dotted black line and female-owned businesses in a solid black line.
Then getting into the concerns about gender discrimination, here. So what inspired a lot of the unsophisticated discussion and debates - and also initially, the policy-thinking around this - was the observably lower rates of female entrepreneurs applying for finance. Consistently over time, this is a short time window here, but male entrepreneurs and business owners over time and countries always have a higher rate of applying for bank finance and bank loans. And that's often erroneously taken as evidence that there's some discrimination in the market. But there are other reasons for that. Women have a higher level of retained earnings, so when they make profit, because they're more cautious, more risk-averse, they'll tend to save more profit in the business. Hence they have less need for external finance. Next slide, please.
This slide is titled ‘Lending and Gender Aspects of Entrepreneurship: Supply’. A graph shows the % of SMEs receiving at least part of finance applied for from July 2011 – March 2013. Again a dotted line indicates male-owned businesses and a solid line indicates female-owned businesses.
And here we see that on average, in most time periods, female entrepreneur funding applications are more likely to be received favourably by banks. So they have a higher success rate than their male peers. So actually, not only is the initial discrimination arguments, debates, not rooted in evidence, but in fact, there's evidence to the contrary.
The next slide is titled ‘The Twist in the Tail: Over-optimism and Gender’ with a graph showing ‘Entrepreneurial overconfidence’ along the x-axis, with male-led in red and female-led in blue. Marc will describe the data.
But we see from the next slide that this is actually to do a lot with what, in business literature they call ‘Hubris’. I call it kind of over-optimism - and other things, depending on the people I'm with at the time. What this does is, so the bottom axis is, so, zero on the horizontal axis is where your ability matches your judgment of your ability. So anyone with a minus figure undersells themselves or doesn't realize how good they are, so they are underconfident. Anyone to the right of 0, going positive, increasingly over-estimates their true ability. So they’re more hubristic the further right you go away from zero. And here male business owners are in red and women business owners in blue. And this maps out the relationship between your judgment or misjudgement about your own ability - your true ability - and the likelihood that the bank will give you a loan. Now what we see in the middle bit, so people whose judgment of their true ability is quite close to their actual ability, so realistic people, entrepreneurs in this case. So women, for most of the fairly realistic range of entrepreneurs are more likely to get a loan application approved. But the interesting bits are at the tails; so, for a very unconfident male and female entrepreneur, an unconfident female entrepreneur who understates their true quality, only about 40% of them will get a loan. But for an identical male entrepreneur, that's getting up to kind of 45% of them will get a loan. So significant difference for unconfident entrepreneurs on gender. But if we go to the 'I think I'm super man or woman - but I'm really not.' end of the spectrum, so, the right hand side, again, we get a gender difference, again in favour of male entrepreneurs. So if you're full of rubbish, a female entrepreneur will be penalized more heavily than a male entrepreneur. Given that they're both so over-optimistic and hubristic about their true abilities. And there the gap, the gender gap, is much bigger than for the unconfident end of the spectrum.
So it kind of goes into some quite interesting territory that myself and Sue Marler and various people are having a think about. And where we've got to now in our thinking is that banks like realistic entrepreneurs. They particularly like realistic female entrepreneurs. But if a woman entrepreneur particularly over-sells herself then the penalties are quite harsh, certainly compared to their male peers. So there are some interesting twists and tails, but the gender bit doesn't stack up on the broad base of the evidence. OK, next slide please.
OK, 'Is Brexit damaging for business?' I'm ignoring the policy things, my simple question is, 'We're likely to head to some kind of tariff-based trading system - certainly for businesses that trade into the EU - so what are the consequences?' Next slide, please.
This slide is titled ‘Policy Issue (V)’ and contains two bullet points on Brexit tariffs and international trade which Marc will read.
So before Boris and Donald we were always looking at trade liberalization, the removal of tariffs and non-tariffs which are generally around standards, the world forming into economic blocks, so it's all about free trade effectively. Next slide please
This slide is titled ‘Effects of tariffs on UK firms trading in the European Single Market’. A table with columns along the horizontal showing the percentages of a firm’s competitors which are local, regional, national, EU and world. The vertical columns show the geographic region of the firm’s main market, again from local through to world. Highlighted text shows 42.8% of UK small businesses trade into the EU in direct competition with EU SMEs.
But my concern is that our best small businesses, those who compete in Europe against European firms, if there was even a modest tariff, a 10% increase in the cost of doing business, what would the consequences be? And how many firms would it impact on? And the 42.8% of UK small businesses trading into the EU as their main market and facing direct competition from EU firms who don't have a tariff cause they're in the single market. So next slide please.
This slide is titled ‘The Consequences’ and shows four bullet points which Marc will go through.
So I estimate around 41,000 UK SME's compete directly with European firms. And just over 7000, largely within the European Single market area. So my predictions are that even for a baby tariff of 10% - and some tariff schedules are about 30% on certain goods and services - the average small business trading in the Euro single market area would suffer a decline in sales of about £700,000 per year. So aggregating that up across all those small businesses, it's about a total revenue loss of about £5 billion to UK SMEs, but more importantly they're our best SMEs because they're internationalised, they're making sales in international markets, which clearly benefits the UK more than internal-trading businesses. More worrying in the world of chlorinated chicken, and then an additional relaxation of regulations around standards which are non-price bits of trade would make this problem even more severe for UK businesses trading into Europe. So Brexit for businesses, particularly small businesses, my area of particular interest, would be an absolute economic nightmare. Next slide, please.
Slide is titled Can we rebalance the economy away from the South East and are regional investment funds part of the solution?‘
OK, the southeast is clearly the economic, the wealthiest region and the economically most robust, if you like. But governments, well even now, Boris is on about his ‘Levelling Up’ agenda etc. Then a part of that with the Midlands engine that we're in at Derby, but all the other engines etc. ‘Business Angels’ and venture capital has been a fundamental part of the policy solution. We're talking about regional investment funds, regional venture capital funds, support of ‘Business Angels’ to channel money to our best small businesses, our most innovative companies. So I thought I'd have a look at patterns in ‘Business Angel’ activity - where they live, where they invest and see if we're any nearer to a levelling-up or a re-balancing agenda. Next slide, please.
This slide is titled ‘Policy Issue (VI) Creating a Regional Investment Base’ and it consists of four bullet-points which Marc will discuss.
So we've been at it quite a long time in the policy sense, and in my opinion, the single biggest small business policy failure was ‘Regional Venture Capital Funds. You don't need to understand all the finance-y terms to know that they were an absolute dog of an investment, a way of channelling money. They lost money on their investment. 36% of the total capital raised was paid out in management fees. And then I have a particular problem - I don't have problem with rewarding performance with pay, but I do have a problem where fund managers take out a third of the money capital and then lose my money on the back of it. Have we done better in the intervening period from the 90s till now? Next slide please.
This slide is titled ‘The Geography of Business Angels’ and a map of the UK is divided up into different counties and coloured various shades of blue and grey. Darker blue counties have a higher concentration of ‘Business Angel’ activity. Mark will describe the data in full.
And that simply maps out where ‘Business Angels’ are and where they invest, and the darker the shading, the more thick the market is, the more ‘Business Angels’ making investments in businesses. Again, we see the darkest goes all the way across the South actually, including Southwest. Reasonable representation of ‘Angel’ investment activity in the West Midlands, Yorkshire, East Anglia, around the kind of high tech bits round Cambridge. Very low levels of that activity in our own area, the East Midlands, the Northwest and Scotland, and even lower levels of activity in Northern Ireland, Wales, in the Northeast. So significant geographic issues if we see ‘Business Angels’ as part of the solution to the levelling-up agenda and the re-balancing-the-economy agenda. Next slide please.
The slide titled ‘Business Angel Investing and Geography’ is divided into two. In red on the left-hand side it reads ‘Local Investors (25%)’ and on the right-hand side in black it reads ‘Regional and National Investors’. Next to each is a list of three advantages.
So what do we get? From local ‘Angels’, which policymakers think is a dream. Certainly that only accounts for 25% of ‘Angels’ who invest in their immediate locality. The rest invest further afield. You're more likely to get some strategic management support, we would generally agree that's a good thing. They're more willing to lose their investment capital, they are more willing to take risk. And they make larger single investments. So they're kind of generally good things. But the flip side of that - so if I'm a ‘Business Angel’, particularly in one of the light-coloured regions of the UK, a) I have got a three in four chance of not investing in my own region, but I also have other attributes that are very beneficial, particularly for levelling-up. I'm more experienced as an investor, I build larger portfolios so I can diversify risk and help more businesses. And particularly important from a policy and levelling-up-agenda point of view, is I'm more willing to invest in early-stage businesses.
So, plenty of work to do, and I do think ‘Business Angels’ are a key part of the solution. But where we're at now: the dominance of the Southeast. Not only do they have more ‘Angels’ investing locally, but they attract the finance of ‘Angels’ from other regions – who are desperately and more in need of cash equity investment. So more to do there. Next slide please.
This slide asks ‘Covid 19 – who suffered more?’
Covid - Who suffered more? We'd better whizz through this, so next slide please.
This slide is titled ‘Policy Issue (VII) – The Asymmetric Policy Response’ and contains three bullet points which Marc will explain.
We know the stuff around lockdown, we've all lived it. We know the furlough scheme and the self-employment equivalent, which is actually less generous. So it's based on 70% of average trading profit rather than 80% of salary. So there's an asymmetric policy response, depending on whether you are waged: very helpful - or self-employed: less helpful. Next slide please.
This slide is titled ‘Deterioration in well-being’. In red are listed the key negative effects which Marc will read out, and on the right in blue are the groups who suffered the least effect. At the bottom the text states ‘For a common reduction in hours and income the self-employed suffer a greater deterioration in well-being than waged employees. The deterioration in well-being caused by losing hours is nearly 3 times that caused by losing income’.
So I looked at the well-being effects of Covid and who it impacts on worst, or most. Clearly those who suffered a reduction in hours and incomes, those not protected by furlough, suffered negative wellbeing effects. Now the interesting ones for me were younger people and females. But from my general body of work which is concerned about self-employment, the self-employed suffered disproportionally in a well-being sense, from the Covid lockdown. Interestingly, we tend not report nil effects, but there were no ethnic effects, keyworker effects, having children or - bizarrely - your Covid test status. So even people who tested positive didn't appear to suffer any further negative well-being effects. Next slide, please.
This slide is titled ‘Rishi saved us but wants payback now’. A line graph of ‘UK National Debt – % of GDP since 1727’. Peaks in the level of National Debt coincide with the Napoleonic Wars, World War I, World War II and - to a lesser extent - the 2008 Financial Crash. Debt dropped swiftly in the post-war boom that followed WWII.
I'll whizz through this quickly, but I'm concerned even though Rishi saved us in one sense with the furlough scheme etc. Now he's talking about clawing the money back, and yesterday they leaked to the media a desire to reduce the International Aid Budget, for example. So he's desperate to claw it back in a very short time period. But what UK history, going back to about 1760, tells us is that in wars and other crises the ratio of national debt GDP rises significantly. And now, it's only about 80% now, even with the additional spending it will probably only go up to 1-1.2 times GDP. So, way below historical precedents. But the key lesson for me is that everyone appreciated that with whatever the crisis was, the Napoleonic War, World War I, World War II, GFC, governments have taken a longer view. Like it's unrealistic to try and pay back an unprecedented, an unanticipated increase in debt in a five year political cycle. So I would argue that Rishi needs to forget that and treat it as a generational debt and just pay it back as you would do a mortgage over a 25 year period. Particularly as borrowing's so cheap at the moment for governments. Next slide, please.
This slide asks ‘Does Entrepreneurship Pay?’
Now the final one, which is, I guess, crucial if you've been encouraged to become an entrepreneur by the government and by favourable tax regimes etc. 'Does Entrepreneurship Pay?' Next slide, please.
This slide is titled ‘Policy Issue (VIII) – Should we encourage more people to start their own business?’ and it lists three bullet points. First: ‘As we saw from slide 6, all UK Prime Ministers since 1979 think we should’. Second: ‘Very few have questioned whether this is an economically “good” thing for people to do’. Third: ‘What’s the defining characteristic of “airport entrepreneurs”?
OK, what really annoys me are these, what I call “airport entrepreneurs”. And they've got one defining characteristic: they have an elite education and they have extremely wealthy and well-connected parents. For those of you concerned, the fees at a dance college range between £8,000 and £30,000 a year depending whether you want full board or just day tutorials. So I completely ignore any advice on how or what makes a 'great entrepreneur' in books written by these kinds of people. They're just throw-away airport books to me. I'm more interested in the broad populus which is about 5 million people who've chosen a self-employed or small business path. Next slide, please.
This slide is titled ‘Income and Entrepreneurship I’. A bar-graph shows the level of earned income of full time workers per month. In blue is self-employed, red is small-business owners and grey is waged. Marc explains the data.
So again, we've got the breakdown between waged employees, solo self-employed and small business owners. And what we see, this is across the whole of Europe so the numbers won't really make sense, but we've got deciles in the earnings distribution, so 10% chunks if you like, and what is clear is that only in the top quarter of entrepreneurs do they earn more than they would do, or their twin brother or sister would get, in a waged job. And for the individual self-employed - significantly less across the whole income distribution. So for the self-employed it doesn't pay, compared to their waged equivalent, And only for very elite small business owners does it pay, in an absolute sense. But we also know that both types of small business-owner work longer hours and that's just their total income. So the next slide paints an even more stark picture.
This slide is titled ‘Income and Entrepreneurship II’. A similar graph, only this one is showing income earned per hour instead of per month.
Here only the top 10% of small business owners earn a higher hourly income than they would if they were in a comparable waged job. Everyone else in the whole distribution would be better off, in an hourly income sense, being waged, being employed by a company. So entrepreneurship does pay - but only for one in ten entrepreneurs. Next slide, please.
This slide is titled ‘Summary’ which Marc will read.
So I've covered all sorts of issues, but they all had a policy-underpinning. Efficiency, hours, taxes, banking, Brexit, regional investment, Covid, income. So hopefully you've learned, or certainly gained an insight, into the types of work I do, the issues I look at. Next slide please.
This slide is titled ‘What I think we’ve learned…’ and contains five bullet points which Marc will go through.
I mean, you can draw your own conclusions, but from this, small businesses are relatively inefficient. Taxes incentivize people to do things they wouldn't choose otherwise. The benefits of a cunning policy - IR35 - can be negated by the unintended consequences. So we need deep thinking. UK banks generally serve small business quite well and when they don't, our government has a really good track record in intervening in capital markets. Banks can spot hubris a mile off and act accordingly, but we just get these quirky results at the extremes where women entrepreneurs who generally benefit from their realism, are penalized for being completely unrealistic at either end of the spectrum. Next slide, please.
This is a continuation of the last slide, with more six bullet points under the heading ‘What I think we’ve learned…’
So, tariffs. If we do move to a tariff-based regime trading into Europe, then I think that will be a hugely devastating thing for our best businesses. I think ‘Angels’ are a key part of the levelling-up solution, but we've got so far to go with that. Covid's a cause of very significant deterioration in well-being across the population, but particularly hard-hit are young people, women and the self-employed. Importantly, work in its own right has a bigger well-being effect than income. So people actually, there's a value in work which transcends the money you earn from it. High quality entrepreneurship is rare. And government needs to just take a bit more time when it thinks about policy, and how to resolve issues, and certainly in the first instance to make sure its evidence base is there. And that's me. Thank you.
This slide says ‘Thank you.’ In the background there is a photograph of a student reading a book.
Now the University of Derby logo is displayed, showing three peaks in white against a blue background.
Audio described version of Inaugural Lecture Series: Professor Marc Cowling video