Why It's Better to Bet on Small Business

Why the U.S. city that wins over Amazon to become home to its second headquarters could lose out in the end.

Why It's Better to Bet on Small Business

IN APRIL, AMAZON ANNOUNCED the 20 cities still in contention to be the site of its new second headquarters (HQ2), promising that the winning city would benefit from the company’s US$5 billion investment in HQ2 construction costs and the creation of 50,000 new jobs. Cities throughout the U.S. and Canada have tried to woo Amazon by offering monumental tax breaks and monetary incentives.

But will the chosen city actually be a winner? Likely not, says Aaron Chatterji, a professor of strategy at Duke University’s Fuqua School of Business in Durham, North Carolina. When cities manage to lure big companies like Amazon with tax breaks and other incentives, he says, they do so to the detriment of the real drivers of the local economy: entrepreneurs and small businesses.

In June, Chatterji published a proposal in conjunction with the Hamilton Project. Launched in 2006 by the Brookings Institution, based in Washington, D.C., the Hamilton Project is dedicated to promoting innovative economic policy. Chatterji cites research stating that, each year, U.S. states spend US$40 billion on incentivizing big business. Amazon is just the latest example: New Jersey offered the company $7 billion to build HQ2 in Newark; Maryland offered Amazon a package of $8.5 billion in tax credits, grants, and other incentives to choose a site near Baltimore, according to the Baltimore Sun.

Rather than pay out huge incentives to large companies, states could do more to boost their economies by using those resources to encourage small business creation and growth, Chatterji argues. “Evidence suggests younger, smaller firms drive job growth, and giving out incentives to individual companies disadvantages new firms. Also, the lost government revenue can do significant harm to the U.S. economy, leading to less spending on schools and healthcare,” he says in a July interview in Fuqua Insights. “We need a different approach.”

In his policy proposal, Chatterji recommends that the U.S. government create the Main Street Fund, an intergovernmental fund to be managed by the Economic Development Administration within the Department of Commerce. The Main Street Fund would allocate funds to each state according to its population and economic activity. States would receive these funds as a reward for eschewing large-company incentives and instead investing those monies “in evidence-based approaches for improving the grassroots environment for entrepreneurship.”

At the same time, states that provided new incentives to large companies would see their Main Street Fund payouts docked. In this way, the fund would “nudge” states to refocus their resources.

Chatterji breaks down four types of approaches that his Main Street Fund would support. These include investing in broadband infrastructure, offering management training to small-business owners, recognizing the credentials of workers with out-of-state licenses, and investing in high-potential early-stage firms via resources such as accelerators and capital programs.

Such a shift makes sense because “young firms grow much faster than older firms,” he writes. “This job creation is significant: 20 percent of total job creation comes from startups even though they are 10 percent of all firms.”

Chatterji recognizes a few potential downsides to the Main Street Fund’s objectives. For instance, without incentives, large firms might consider moving their facilities to other countries. But if the Main Street Fund was rolled out slowly, it might foster environments attractive to large firms for other reasons.

“Creating a stronger entrepreneurial environment and building broad-based infrastructure will also attract larger companies, possibly offsetting any negative effects,” he writes. “To the extent that it is necessary to provide U.S. businesses with subsidies, it should be done at the national level in a way that balances national economic objectives and does not discriminate between incumbents and startups.”

Read Chatterji’s proposal, “The MainStreet Fund: Investing in an Entrepreneurial Economy.