FOR IMMEDIATE RELEASE: April 1, 2004

Small enterprises are of critical importance to the functioning of an economy and thus economic development, write Anders Åslund and Simon Johnson in a new Carnegie Paper entitled “Small Enterprises and Economic Policy.”  However, much of the world’s economic production is very small scale: one or two people operating “under the radar” as individuals rather than as an organized business. Åslund and Johnson believe it is primarily the risk of expropriation by government and powerful individuals that constrains entrepreneurial investment and causes business people to stay very small scale and completely unofficial in many countries.

To foster economic growth, countries must therefore persuade people to invest, employ others, and then pay taxes.  The question, then, is how can this be encouraged in countries where there are weak institutions, i.e., no rule of law, a weak judiciary and less-than-ideal laws?

This Carnegie paper suggests that, at least for former communist countries, the right way to begin strengthening institutions is by lowering the barriers to entry for new small businesses and reducing the costs of running these firms by switching to a simple, low, lump-sum tax.  This lump-sum tax would combine taxation, regulation, and property rights together. Lower taxes will have a positive direct effect on strengthening the small business sector and an additional indirect benefit of lowering regulatory burdens and corruption.  Former communist countries that have implemented such taxes have quickly created a large small-scale business sector.

Access “Small Enterprises and Economic Policy” at www.carnegieendowment.org/pubs.

Anders Åslund is director of the Russian and Eurasian Program of the Carnegie Endowment for International Peace. Simon Johnson is an associate professor at the Sloan School of Management at the Massachusetts Institute of Technology.