(This is the original text of an article published in the Perspective section of the San Jose (California)Mercury News on October 23, 1994.)
State government officials eager to goose the state's job creation machine back into high gear have been hearing a lot of talk lately about how gazelles have been making monkeys out of dinosaurs. So, too, have the 15 members of the California Economic Strategy Panel, a blue ribbon committee of politicians, business people and economists appointed by the governor and the legislature. The panel, which held a public hearing earlier this month in Santa Clara, has been assigned the enormous challenge of devising an economic development master plan for the Golden State by next spring.
For those not conversant in the patois of policymaking, what's being discussed is the claim that small, highly innovative, entrepreneurial companies (gazelles) have emerged as the driving force behind California's economy, replacing the huge corporations (dinosaurs) that once dominated the economic landscape. Not only are small and medium-sized enterprises (SMEs) said to be responsible for nearly all of the new jobs being created these days, they are regarded as more technologically adroit than larger firms whose heavily bureaucratic structures are thought to stymie innovation and new product development. More than that, there are those who insist that a whole "New Economy" has emerged in which SMEs, not mighty defense contractors and other Fortune 500 firms, will play the decisive role in charting California's economic destiny into the next millennium.
In a widely discussed new book, Regional Advantage: Culture and Competition in Silicon Valley and Route 128, UC Berkeley economist AnnaLee Saxenian provides an intriguing and compelling description of how the electronics industry in the Bay Area has structured itself into intricate networks or "clusters" characterized by large numbers of generally smaller firms engaged in business relationships that are paradoxically both cooperative and competitive. Saxenian's clusters are "competing, complementary and interdependent industries within a region that are related to each other through buyer-supplier linkages and shared economic foundations such as a skilled workforce or common technology base." They thrive on social and technical networks that compel firms wishing to draw upon these assets to locate in narrow geographic confines.
While Saxenian's book deals with the electronics industry, others profess to discern the same economic structures in other and quite different industrial settings. In a Los Angeles Times column reviewing her book, David Friedman, an attorney who chairs the Los Angeles-based New Economy Project complained that the "open, entrepreneurial yet highly collaborative business culture" Saxenian describes represents "the fundamental organizational practices behind California's economic successes in several key sectors, a reality dangerously ignored by many of the state's political and business leaders." Friedman further insisted that "the core of [California's] industrial base is organized much like Silicon Valley, resulting in such thriving sectors as entertainment, computers, agriculture, business services, medical equipment and fashion."
Analyzes such as these which exalt the virtues of entrepreneurs and highlight the value of SMEs in general have enormous, bipartisan appeal in political circles. For one thing, the New Economy is veritable cat-nip to those politicians who seem preternaturally disposed to novelty. Even so, by tapping into a mother lode of popular American mythology about individual initiative, self- reliance, and the fruits of free enterprise, the New Economy school surely warms the hearts of conservatives. Perhaps most important of all, SME owners comprise a large and politically active constituency -- one that is much more likely to vote and make campaign contributions than are average citizens.
From a politician's viewpoint, the situation could hardly be more fortuitous: policies that are politically expedient for once also seem to be economically justified. Or are they?
Despite the hosannas currently being sung by pundits and policymakers in praise of small businesses, recent academic research casts serious doubt on much of what we think we know about small enterprises and thus calls into question the efficacy of economic development strategies which explicitly target SMEs for special tax breaks, regulatory exemptions, low-cost financing and small business incubators. In his latest book, Lean and Mean, Carnegie Mellon University economist Bennett Harrison offers a devastating indictment of the received wisdom about SMEs. Citing the propensity of SMEs to provide lower wages and fewer benefits and to make greater use of contingent (i.e., part-time and temporary) labor than larger firms, Harrison concludes that, far from boosting the common good, economic development strategies which single out small firms for special treatment could "actually contribute to a worsening of the national average standard of living." He further notes evidence which strongly suggests that SMEs are neither major creators of new jobs nor important innovators of new technology.
Moreover, there are growing indications that the economic analyzes on which the New Economy school are based are out-of-date. If anything, the relatively atomistic economy described by Friedman and Saxenian has actually entered a period of intense business consolidation. Indeed, virtually every sector of the U.S. and California economies have seen a surge in merger and acquisition (m&a) activity during the past eighteen months. While The Wall Street Journal's claim in August that "Corporate America is suddenly deciding - again - that big is beautiful" may still be a bit premature, it is certainly the case that, as The Financial Times reported a week ago Wednesday, there has been "a sharp upturn" in U.S. merger and acquisition activity through the first three quarters of 1994, with the value of completed transactions up by 33 percent.
Mergers & Acquisitions magazine, which tracks m&a deals, confirms that the pace of corporate mergers and acquisitions, which had slowed during the early 1990s, "erupted in late 1993 and continued into 1994." In its July/August issue, the magazine noted that, for the first time since the end of 1990, "straightforward acquisitions of stand-alone companies reasserted themselves as the dominant m&a format in the first quarter of 1994," replacing corporate divestitures which had formerly been the mainstays of deal making during the economic doldrums of the early 1990s.
According to the magazine's editors, the "Big Four" hotbeds of M&A activity are (1) health care, (2) banking and financial services, (3) defense, and (4) the rapidly melding telecommunications, entertainment, media and information areas. It is as if the old economy, having dismantled itself, is now busily reassembling the pieces into a new structure in which large corporations (while admittedly smaller than before) will nonetheless be the dominant players in services and merchandising as well as in manufacturing.
While consolidation appears to be the watchword in almost every industrial sector throughout the nation, m&a activity seems to be unusually pronounced here in California, especially in high- technology fields. According to figures compiled by Bradshaw Associates, a San Mateo County m&a advising firm, some 40 percent of the 750 mergers and acquisitions last year in the information technology sector involved at least one California company. Moreover, as the San Francisco Chronicle reported in August, the pace of m&a activity is quickening, with more than $6 billion worth of mergers and acquisitions involving California high-technology companies just in the month of July. That compares with $4 billion in similar m&a activity in all of last year.
Mundane but fundamental factors such as a scarcity of capital and the persistence of management biases seem to be driving what some observers have glibly dubbed "the urge to merge." The drying up of many venture capital funds encourages smaller technology firms to consider consolidating with similarly situated firms. Likewise, the slowing of the market for initial public offerings is compelling investors in many start-ups to pursue other liquidation options -- like selling out to competing firms. Finally, there are ample indications that many, if not most, American business executives are not psychologically prepared to cope with the more ambiguous structures and relationships inherent in the New Economy. If nothing else, the almost instinctive drive among corporate executives to want to exert control over every aspect of their firms' operations, including relations with vendors and sub-contractors, is feeding the momentum toward consolidation.
The broad contours of the "Really New Economy" being forged through mergers and acquisitions are apt to look more like familiar to us than the more intricate networks of businesses depicted by Saxenian and Friedman. To be sure, no one should expect a restoration of the post-World War II economic system in which industrial behemoths like General Motors, U.S. Steel and IBM came to be regarded as metaphors for American society. Nor is there any question that SMEs will still be of significant importance to the state's economy. (After all, they do employ 74.4 percent of all California workers and account for 69.4 percent of all wage earnings.) What is now doubtful, however, is whether, as the New Economy's proponents insist, SMEs will collectively determine the future course of the Golden State's economic development. For the foreseeable future, chances are that most of California's fastest-growing and most successful SMEs may simply wind up as lunch for a leaner and meaner species of corporate dinosaur.