How does the government help small businesses

This essay will discuss how the government offers aid to all small businesses. In the current economic climate it is becoming increasingly difficult for small businesses to successfully set up and meet financial goals set by owners. It is fortunate however that here in the UK, the governement provides aid for small businesass, improving chances and encouraging others to set up. This aid may come in many forms, financial support being the first obvious such as various grants where applicable. Help is offered in other forms too however for example, Inland revenue offers advice in how to go about making important decisions for your business and also providing information on what businesses are expected to pay. i.e taxes. The main way that the government helps small entreupeneurs is by providing ‘monetary assistance’ as mentioned above, with the idea that it is ‘of the publics interest.’ The government intervenes in multiple ways to protect its domestic producers, such as; directly subsidizing producers so that they produce more goods and sell at greater prices, introducing price floors to protect producers from losses, and introducing price policies such as tariffs, quotas and imposing embargoes. It is worth noting that, ”small firms pay a 21 per cent rate of corporaton tax compared with 28 per cent for larger companies ” Sloman,J. Wride, A (2009). Economics. 7th ed. Pearson Education Limited, Edinburgh Gate, England: Prentice Hall.

Finally when domestic producers are less competitive to foreign producers, sometimes the government takes protectionist measures to protect them from the low prices of the products that countries which have comparative advantage at the production of certain goods. This can be tarrifs, quotas or even in more extreme case embargoes.

Let us take an example of the car industry in the UK; this is an industry where there are many small firms which are developing. The next diagram will show how a direct subsidy to small firms helps the producers as well as the consumers.

economics subsidy.png

In this diagram we see the initial supply and demand where Q.equilibrum cars are demanded and sold at the price P.equilibrium. Now when these small firms are given the subsidy they are encouraged to produce more and therefore their supply curve shifts to the right. Now there is a new equilibrium at price P2 and Q1. Now this is beneficial to both the producer and the consumer because the price that the consumer now pays is P2 at the new equilibrium point. However the price that the producer is paid for his products remains P1, thus leading to an increase in his revenues. This is because Total Revenue is calculated as Price times Quantity and hence the price remains the same and quantity sold increases it is clear that this is greater revenue. When the subsidy is paid there is loss in consumer’s surplus taken from producer’s surplus. The green shaded area represents the amount of subsidy that is paid by the government. The only real problem is that even though the consumer pays a lower price when the subsidy is added, the subsidy itself comes from tax. Therefore the only way subsidies can take place is by increasing taxation on people’s incomes. Although protectionist measures and price floors are also another way of helping small firms the main way the UK government helps small firms is by direct subsidies.

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Now we will see how the government intervenes in world markets in order to protect small firms which engage in world trade. The following protectionism measures are used to help infant industries and small firms: (Sloman and Wride, 2009, p 683)

Ad valorem tariffs: This is a tax on imported goods and it

Is usually a fixed percentage of the price of the goods. This will work if there are close substitutes to the imported goods, thus forcing the consumer to move from the imported products to the ones that are domestically produced. So consumer here must have a price elasticity of demand greater than one. If the consumers are inelastic this will only lead to an increase in government revenues but domestic producers will not be protected.

Quotas: This is a simple restriction on the amount of imported goods that the rest of the countries can export. This limit is set by the UK government and it is agreed with the rest of the countries.

V.E.R( Voluntary Export Restrain): In this case the government investigates which imported goods are facing inelastic demands from consumers. Then they request from importers to decrease the amount of their exports in order to enjoy greater revenues. Foreign producers then will decrease their exports to enjoy greater revenues. This works because of the inelasticity hence in goods that have inelastic demand a fall in the quantity demanded can be followed by a relatively higher increase in price which leads to a great increase in sales revenue. This measure has the same effect with quotas because now small domestic firms will have to produce the amount of goods that the importers have stopped producing.

Embargoes: At the very extreme case the government can completely ban some imported goods that harm the domestic firms. However this is not very usual because it might lead to retalion from the other countries

The main arguments favouring protectionism are the ones of infant industries and senile industries. Small firms could probably be found in either of these categories.

The infant industry argument says that some firms that are in their infancy may have a potential comparative advantage. However these firms are too small and lack of technology experienced workers and most importantly economies of scale. Therefore these firms without protection they are very likely to shut down due to foreign competition.

The senile industry argument simply states that small firms may have the comparative advantage but because they are not making great profits, they are unable to make appropriate investments. Therefore they need protection to survive competition .This has been the case with small firms in the automobile and steel industries in the U.S.A.(Sloman and Wride, p. 684)

Now we will be looking at the last way that governments can help small firms within their country. This is by setting a minimum price. A minimum price or price floor is a specific price that is set by the government itself or some other agency e.g 10 euros per/kg . The price is not allowed to fall below this level but it is allowed to rise above it. If the minimum price is set above the equilibrium this leads to a surplus hence more quantity is supplied than demanded. This surplus could be stored in case of future shortages. minimum prices protect the producer’s income by giving the price that let the firm run at normal profits, whereas in the previous price level the producer was experiencing losses.

Other forms of government intervention include ‘price fixing’. Price fixing is a price set by the government or distributors that small companies are ‘forced’ to charge ensuring that all are able to afford it. For this to work however government again has to provide subsidies so that inefficient small businesses can afford to keep supplying goods at these prices.This proves such intervention and form of help to be arguably too expensive. Such policies help small businesses by reducing competition.

To summarise it is clear that the governement helps small businesses in many ways (even if that is at a cost to consumers) protectionist measures being a big one. Using tarifffs as mentioned above is a way for the government to help otherwise inefficient domestic producers from competition especially foreign competition. With heavy taxes on imported goods forcing prices of imported goods to increase, such tariffs encourage british citizens to buy domestic goods sold by small companies which otherwise struggle to compete. Although generally speaking tariffs are a boon to the country imposing them UK, with price increases, consumers cannot afford to buy as much of a good and so sales will go down, representing a decline in the economy.

Tariffs are seen to be more desirable than quotas which as mentioned above are a simple restriction to the amount of imported goods allowed to enter the UK. Other then the argument that tariffs are more economically efficient then quotas, quotas can encourage corruption. For example if a country has to suddenly introduce import quotas into an industry to protect domestic producers in an economic crisis, it may have to turn away a fraction of companies to stay within the limits of that quota introducing problems. Which companies does the government stop? The answer is simple; whoever is most powerful in bribery, corruption! Imposing tariffs protects small businesses and domestic producers without corruption as by slightly increasing the price of a good the demand for the good decreases. So it could be said that by introducing tariffs the government almost has control over demand and supply. Further critiques of this protectionist measure include the idea that quotas encourage more smuggling and high prices for consumers. If a quota is set at a ridiculously low level and the demand exceeds this limit then it could be seen extremely profitable to smuggle goods and feed this demand.

Subsidies are useful as they encourage increased competition and decreased prices which is good for consumers! Subsidies benefit the firms as they provide small businesses with the money needed to invest, expand and increase output. Another pro of this protectionist method is that subsidies would increase domestic competition and decrease imports!

However there are cons, it can be argued that subsidies are an inefficient allocation of resources if it over subsidises and creates market distortions and may permanently alter the equilibrium price. Furthermore Subsidies may cause increased competition, therefore supply and drops in price and some unsubsidised firms may go bankrupt until supply reverts back to previous levels and price increases back to normal. It appears that for this method of protecting small businesses the cons outweigh the pros.

Just recently an article was published in ‘The Times’ expressing how under government reforms, ‘500,000 small businesses could see their business rates and bills cut..’ all in a bid to stimulate economic growth. it is recognised that through the services that a small business offers and the taxes it pays which goes towards public services such as the NHS, businesses contribute to our economy in multiple ways. Also businesses offer more jobs, much needed after the recession. It is good for an economy for businesses to work closely with the government, proving beneficial to both government, and the public, but also owners. The grants and subsidies mentioned above that the govenrment offers are concrete support for business owners but can negatively effect consumers as such ways of helping small businesses are paid by consumers through high prices where government get their money back.