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The case for subsidies

Should the State play any role at all in fostering new businesses? Are all forms of subsidies sinful in this age of free-market orthodoxy? How can governments offer such economic stimuli without generating hopeless addictions?

These were some of the questions that nearly 70 policymakers from the Americas, Europe and Japan wrestled with during a roundtable on small and medium-sized enterprises (SMEs) hosted by the IDB on July 6 and 7. The exchange of views and experiences will be used by the Bank to refine its support for small business.

In one presentation, IDB President Enrique V. Iglesias tackled the issue of subsidies head-on, remarking that over the past few decades they have been branded as the economic equivalent of a grievous sin. That may be so, he said, when subsidies distort market rules. But it is an entirely different case if subsidies are explicitly budgeted for and sanctioned through a public political process that seeks to produce a socially desired effect.

"In that case they should not be outside the realm of what we may call healthy practices," Iglesias said. "Personally, I am not that afraid of the word."

So how can governments use subsidies without risking economic damnation? Aída Alvarez, head of the U.S. Small Business Administration, argued that her government has an interest in giving start-ups an opportunity to succeed, because it sees new enterprises not only as an important engine of the country's economy, but also as key to social mobility and a fairer distribution of income.

"It is difficult to overstate the importance of small business in the United States," she said in her address. "Much of the economic success we are enjoying is due to the vibrant contribution of small businesses."

There are some 23 million small businesses in the U.S., and these create two of every three new jobs, generate nearly 40 percent of GDP and are a major source of technological innovation.

In its early days the SBA was involved in direct lending to small businesses because commercial banks were reluctant to extend credit to entrepreneurs who lacked collateral or a proven track record. In 1958 it started its Small Business Investment Company program to channel venture capital to little companies and start-ups and create some private sector competition for bankers. Among those that benefitted from the program when they were small are such present-day giants such as America Online, Intel and Federal Express. The SBA points out that the income taxes paid by microchip manufacturer Intel in 1996 alone would cover two years of the agency's budget.

Gonzalo Rivas, executive vice president of Chile's CORFO small business agency, offered some pointers as to how to prevent subsidies from turning into permanent aid for unsustainable enterprises.

"Nothing must be free," he stressed, explaining that CORFO requires beneficiaries to cofinance their programs and to take the risk of gauging demand for their products or services. The Chilean agency also evaluates companies' performance to check whether they are meeting agreed business targets.

Government support must also be limited in time, Rivas cautioned. "These are not crutches. They (companies) must get ahead or go under."

CORFO also operates through agents, mostly in the private sector, who deal directly with small businesses across the country. That system also allows the intermediaries to offer the services of other Chilean government shops such as the ProChile export promotion agency and the SENCE national job training service.

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