Understanding Enterprise

Entrepreneurship and Small Business, fourth edition

by Simon Bridge and Ken O'Neill

Case study: chapter 14

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The following case study describes the market conditions that currently exist in the economy of an unnamed nation. Identify the market failures that have occurred and suggest appropriate government intervention
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At present business start-up in this country is at an all time low. In general unemployment figures have remained fairly stable and have began to decrease slightly over the past three quarters. A recent report from the Global Entrepreneurship Monitor has highlighted the esteem that the population has attached to being employed by a well established organisation in comparison with self-employment. Rather than view working for themselves as something to aspire to, a large proportion of the population seem to view entrepreneurship as a failure to secure employment with a reputable business. In addition to this there was a widespread fear of the insecurity that came with working for oneself. The lack of a guaranteed salary coming in each month was cited as being one of the great fears that people had with regards to work and this was also one of the reasons given for not encouraging a friend or family member to start out on their own.

In terms of the businesses that have been established, the majority of them seem to plateau in size relatively early in their development. The GEM report suggested that while the decreasing unemployment statistics were good news as a whole, many local businesses were finding it difficult to attract the required talent to fill vital roles in their organisation. While this was a general complaint from most employers, it was the IT and manufacturing firms that were most vocal about how this was affecting their growth strategies. Businesses in the manufacturing sector stated that, while they were offering competitive wages on par with those of neighbouring countries, they found that most applicants were unwilling to accept the position offered as it would affect their benefit entitlement. While the IT firms did not suffer from this problem, they were finding it extremely difficult to source local talent with the necessary qualifications and experience which led them to have to advertise outside the country. This was affecting their competitiveness as the packages that they had to offer foreign employees, particularly in management positions, was driving up costs and chipping away at their bottom lines.

IT firms have another concern. At present many of the local firms are aware of the fact that the products and services that they offer are becoming somewhat obsolete in terms of what the competition are offering abroad. This is to a lesser extent echoed by the sentiments of many manufacturing firms which, while enjoying increased sales on a domestic level, are beginning to see a decline in demand for their products abroad. When asked why they felt this was, representatives from both industries agreed that a lack of resources devoted to research and development was perhaps the primary cause. Although there is a willingness to undertake the necessary R&D, they simply do not have the manpower or funds required to do so.

One area of the economy that had been performing exceptionally well, until recently, was the real estate industry. Property prices had risen at an astronomical rate due in part to the bubble created by cheap credit offered by financial institutions. This however was not the only contributing factor. Due to an extremely strict approach to planning permission around the major cities, suitable commercial real estate was not easy to come by. Developers had been put off by the increasingly difficult planning applications and, after a number of high profile cases, were all too aware of the hefty fines that could be incurred through lack of compliance. This had led to commercial rental properties maintaining their high rental rates and resulted in many organisations being unable to secure adequate premises that would permit them to grow their businesses in line with an increasing demand in the market. So dire is the situation that many businesses which can afford it have resorted to applying for both planning permission and funding in order to build their own premises.

The trend of businesses constructing their own premises was short-lived however. As the global financial crisis took hold, banks and other lending institutions were forced to write off significant amounts from their balance sheets in the form of bad debts as more and more individuals defaulted on their mortgage payments. This had a dramatic effect on the banks willingness to lend which almost came to a standstill overnight. Borrowing money to construct premises was close to impossible and this was not the only form of lending that was affected. In a panic, many financial institutions began to review the overdraft facilities of their clients and with little to no warning requested that customers start to reduce their exposure to the bank. Many businesses, although perfectly solvent, relied on their overdrafts to service their short-term liabilities such as payments to suppliers until their own customers had settled with them. The sudden withdrawal of overdrafts left many businesses struggling to pay employee wages and suppliers which in turn affected the credit terms they were offered - with serious cash-flow consequences.

Identify the market failures that have occurred and suggest appropriate government intervention.

Suggested solution

Supply of entrepreneurs

  • The supply of entrepreneurs to the market-place is evident in the business start-up rate being so low. At the root of this lack of entrepreneurial flair in the economy are the social and economic attitudes that the population appear to have towards self-employment. While creating the environment for entrepreneurially-minded individuals to act is one thing, changing the attitudes of a nation or region can be difficult. Offering generous tax breaks for the self-employed can prompt individuals with the right disposition to act but is probably not going to be enough to persuade an individual in employment to leave his/her job and start up a business. Changing attitudes requires targeting individuals at an early age by demonstrating the viability of self-employment and removing any stigma that may be attached to it. This might be done through offering entrepreneurship as a subject in schools as well as establishing a 'young entrepreneur of the year' award to get children actively involved.

Labour shortage

There are two separate issues to address here when it comes to the shortage of labour:
  • First, for manufacturing firms it would appear that the labour is available in-country, although there was an unwillingness to take up the positions offered. This seems to be due to the generous welfare packages available such that going into full-time employment would actually prove detrimental to the individual. Clearly this has to be addressed although exactly how is a matter of great debate. Some would suggest that a society can only be judged on how well it treats its members in greatest need and hence would advocate providing for those unable to provide for themselves. Others may argue that this provision should offer the individuals in question the bare minimum to survive and no more so as to incentivize them to pursue economically beneficial activities. Either way it may have to be addressed on a case by case basis with the cultural attitudes of the society in question taken into account.
  • Second, as far as the IT sector is concerned, the labour shortage experienced by is slightly easier to address, in theory at least. Longer-term, there have to be more initiatives aimed at producing graduates and school-leavers with the qualifications required by the relevant sectors of the economy. This can be achieved by offering scholarships for individuals interested in studying IT or providing apprenticeships through which school-leavers can learn on-the-job at a business for a period of time before potentially being offered a full-time position.

Supply of innovations

  • Simply put, firms in both the manufacturing and IT industries do not have the resources to dedicate to R&D. This can be particularly detrimental to the long-term health of businesses operating in the IT sector which has traditionally been known for changing often and rapidly with products becoming obsolete. A solution is perhaps to encourage R&D by providing a fund for firms interested in carrying it out. This could be done on a selective basis where businesses with the potential for high-tech products and fast growth are the more likely recipients of funding.

Bureaucracy and compliance costs & lack of premises

  • The highly bureaucratic planning permission process has had a knock-on effect for businesses in general throughout the city. With a lack of suitable commercial premises available, many firms took the substantial step of building their own premises - concluding that the exorbitant rental prices meant that ultimately, they would be better investing in an asset rather than simply eroding their profits. This was not an ideal situation however as this would mean cash being tied up in fixed assets rather than being readily available to take advantage of opportunities presented in the marketplace. There are two ways to potentially approach this issue. First, simplify the planning permission process in order to encourage the construction of more commercial properties. Second, in the shorter-term the government could investigate the possibility of providing affordable, managed workspace that would permit businesses to focus their capital on core revenue-generating activities.

Lack of capital

  • The shortage of capital resulting from the reviewed lending policies is something that can have a significant impact on the day-to-day operations of an organisation. The absence of loans for larger projects, such as constructing premises, can be detrimental to the growth of an organisation. However the more immediate concerns are the sudden reduction in overdraft facilities. The lag between invoicing a customer and receiving payment can leave many smaller businesses in the position of not being able to settle their more short-term obligations such as paying wages and their suppliers. Having an overdraft facility can assist, short-term, in settling these liabilities so the reduction in an overdraft means that enterprises must find alternative sources of finance. In this instance the government could provide credit guarantees, offer subsidised lending and offer tax breaks for SMEs.