Our vision is to harness the support of the government and Australia’s small business sector in order that they can both make a major contribution to resolving the impending productivity crisis that Australia faces. We see the government’s role as a facilitator and promoter of the small business sector, whose role is not only to make Australia a country in which people can start new businesses and engage their entrepreneurial talents, but also a country which is characterised by a productive and dynamic small business sector capable of generating jobs, creating and sustaining innovation, and being internationally competitive. To do this we need to understand the characteristics of Australia’s small business, their current capabilities, their latent potential, what factors are critical to achieving successful outcomes and what factors are constraining small businesses seeking to grow, innovate, and become more productive.

A role for government

In our view, the key role for government is firstly to identify market failures or gaps in these key areas and, secondly, to design appropriate policy responses to address these failures or gaps. To achieve this, we need to build an evidence base in order to understand what the market failures and gaps are for small businesses and how they constrain small businesses from achieving better outcomes. Only then can we help direct design and target effective policy action.

The importance of small business in the economy

The Australian Bureau of Statistics (ABS, 2001) defines a microbusiness as an actively trading business that has less than five employees, a small business is one that has 5–19 employees and a medium-sized business is 20–200 employees. The employment size ranges are calculated by the ABS on a ‘headcount’, rather than a measure of full-time equivalent persons.

In June 2009, there were approximately 2.05 million businesses actively trading in the Australian economy. By June 2013, there were 2.08 million businesses actively trading (ABS, 2014), showing a modest 1.42% increase over the 2009–2013 period. Of these actively trading businesses, 60.8% (1,264,298) of businesses had no employees, 27.1% (563,412) employed less than five people (micro-business), 9.5% (197,412) employed between five and 19 people (small-sized business), 2.4% (50,946) employed between 20 and 199 people (medium-sized business), and 0.17% (3,598) employed more than 200 employees (large-sized businesses).

While there was modest growth in the number of businesses actively trading over the 2009–2013 period, however, new firm entry rates declined from 16.7% to 11.2%, and exit rates rose from 13.1% to 14.1%. Of the stock of firms that were trading in 2009–10, 62.9% were still operating in June 2013. For new firms that entered in 2009–2010, only 47.5% were still in operation three years later.

The three pillars of productivity

There are three key elements (pillars) that government and small business need to focus on if Australia is to achieve the end goal of building a more productive and dynamic small business sector. Drawn from the economic theory of the production function, the three pillars are human capital (people), financial capital (investment), and technological change (innovation).

All three pillars have been found to be critical, both on an individual and collective level, to productivity and economic growth since the formal development of a theory of the production function, and the later work on economic growth which related economic growth to increases in labour, capital, and technical progress. Recent developments emphasise the important role of producing new technologies and human capital. Wider implications of economic growth models relate economic growth to openness, competition, change and innovation.

While it is clear that doing more of any one of the three pillars is preferable to doing nothing in terms of productivity growth, there is a strong evidence base to support the view that there is a high degree of complementarity between the three pillars (Coad et al, 2014). Even within each pillar there are likely to be internal complementarities. For example, Milgrom and Roberts (1993) argue that while undertaking product or process innovation will ultimately lead to higher profit, undertaking both simultaneously, or in close sequence, will lead to higher profit than simply adding the two together.

In the context of securing term growth from innovation at the firm level, Coad et al (2014) empirically show that there is a set of causal, and sequential, building blocks that must be in place to achieve this.

Here, the first sequential building block is to expand the human capital available to the firm. Only when the firm has a strong pool of human capital (skilled and talented people) does it make sense to invest in physical assets (such as new technologies, plants, or machinery) or commit more expenditure to R&D. Having a talented workforce, with appropriate physical capital and investment funds available to them, improves the ability of a firm to generate innovative and creative new products and services. And it is this that ultimately leads to growth. New investment expenditure without the human capability required to fully exploit it will lead to improved, but sub-optimal, outcomes.

This does present some potential problems for government and policymakers seeking to support small businesses as the three sequential building blocks cut across functional ministries and departments. The first block, which refers to labour force skills, would typically be associated with the education department on the supply-side, and the employment department on the demand-side. The second building block relates essentially to investment and would cut across the Treasury and business departments. The final building block would typically be associated with the innovation and science department in the case of technology firms and business department in the case of low-tech firms.