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- Conceptual issues
- Data sources
- Gross domestic product by size of business
- Sensitivity analysis
Small and large firms play different roles in an economy. New firms that bring new products and ideas to markets are generally small at the beginning of their life cycle; later, as the industry turns to focus more on homogeneous products some firms begin to move down the cost curve by developing large-scale production processes that exploit economies of scale. Size diversity then exists within industrial populations because small and large firms fulfill different functions. The idea that small and large firms provide a different economic function is a feature of theories explaining the coexistence of large and small firms. These theories are often intertwined with the product life-cycle hypothesis. Porter (1979) and Caves and Porter (1977) speak of strategic groups within industries—with groups that focus on a survival strategy of achieving economies of scale and other groups that focus on a specialist's strategy of occupying market niches. More directly, Nooteboom (1994) argues that the difference in the core characteristics of small and large businesses means that they play alternating roles in the product life cycle: large firms have more resources to produce basic technological innovations; the closeness of small firms to their consumers means small firms are more able to translate these basic innovations into new products; larger firms are more able to exploit scale economies as price competition develops; smaller firms are in a better position to exploit residual niche markets. 1
Analyses often compare various measures of size distribution across countries in order to infer differences in dynamism, maturity and efficiency of their economies. 2 In most of these studies, the importance of the small and medium-sized businesses is measured in terms of employment, which is an input to the production process. A superior measure is the amount of output produced—because large amounts of an input may be used by a particular group of firms (either small or large) to produce relatively little output.
This paper adds to our understanding of the contributions made to the economy by small, medium-sized and large businesses in Canada. It does this by examining the shares of gross domestic product (GDP) produced by each of these size groups in the business sector in 2005. 3 Compared with other measures of output like sales, GDP provides a more complete measure of economic performance because it measures value added, the unduplicated value of goods and services generated by labour and capital. 4 The key difference between a firm's sales and a firm's GDP is the amount of intermediate inputs used by the firm. A firm could have high sales but low GDP because it adds little to the value of the intermediate inputs it purchases.
- As in many other papers, small, medium-sized and large businesses are defined by their employment size:
- Small businesses are businesses with 1 to 99 employees;
- Medium-sized businesses are businesses with 100 to 499 employees;
- Large businesses are businesses with 500 employees or more.
In this paper, each firm is allocated to a size class based on the employment size of the commonly-controlled group of enterprises to which it belongs. At the head of this group of enterprises is an ultimate parent, an entity in a legal structure that controls through majority ownership one or more firms. In this paper, enterprises are consolidated into groups headed by an ultimate parent because it is the ultimate parent that is entitled to make decisions for the group of enterprises it owns and controls. Hence, the employment size of a firm here is the sum of all the employment in each firm controlled by its ultimate parent. In the case of a group of firms headed by a foreign ultimate parent or by a domestic ultimate parent with foreign operations, only the employment in its Canadian-based operations determines which size category it belongs to.
To obtain the components of GDP at the firm level, a large quantity of data from administrative sources (T2 Corporation Income Tax Return, T3 Trust Income Tax and Information Return, T4 Statement of Remuneration Paid, PD7 payroll tax accounts, individuals' T1 Income Tax and Benefit Return, Business Register) and surveys (Survey of Employment, Payroll and Hours, Workplace and Employee Survey, Unified Enterprise Survey, etc.) are used. The firm-level GDP measures are consistent with the National Accounts. The value-added concept of GDP is identical to the one used in the Input-Output Accounts, the definitions of the components of GDP follow those found in the National Accounts, and the estimates of GDP by size categories are benchmarked to industry GDP measures from the Input-Output Accounts.
Small and medium-sized businesses accounted for 54.3% of GDP in the Canadian business sector in 2005. Small and medium-sized business shares of GDP vary by industry. They accounted for over half of the GDP in all industries, except mining and oil and gas, manufacturing, transportation and information where large-size enterprises dominated.
Users of the GDP by size estimates should recognize that these estimates are point estimates. They are sensitive to the methods, the assumptions, and the particularities of the source data used to derive them. In absence of techniques to compute confidence intervals, one can show how sensitive the estimates are to seemingly small differences in methods or data. While presenting a comprehensive evaluation of the sensitivity of the estimates is beyond the scope of this first paper on GDP by size, some noteworthy assumptions are discussed later in the paper.
Section 2 explains some of the conceptual issues in developing GDP by size class. Section 3 describes the data sources. Results by industry for 2005 are presented in Section 4. A discussion of the sensitivity of the estimates to different assumptions is presented in Section 5. The last section presents concluding remarks.
2 Conceptual issues
2.1 The measurement of gross domestic product
Value added in the Input-Output Accounts is one of several GDP measures used in the System of National Accounts. Value added in the Input-Output Accounts is the sum of gross value added of all resident producer units. 5 It is also the difference between output and intermediate consumption (SNA 1993, paragraph 2.172). Using the Input-Output Accounts, GDP at the industry- or national-level can be calculated as follows:
GDP at basic prices = Wages and salaries
+ Supplementary labour income
+ Mixed income
+ Operating surplus (primarily corporate profits)
+ Indirect taxes on production less subsidies
This paper uses the same equation to calculate GDP for each business-size category. This calculation is possible because businesses report the above components of value added to the Canada Revenue Agency through their tax filing and to Statistics Canada through various surveys.
At the level of the total economy, GDP is also measured using the final expenditures approach, the sum of the final use of goods and services less the value of imports (SNA 1993, paragraphs 2.172 to 2.173). This approach does not permit the measurement of GDP by firm because some of the data are not collected at the firm level. For example, personal expenditures are collected at the individual or household level.
2.2 Assigning gross domestic product to the ultimate parent
Many firms often coexist within a hierarchy. Choosing the level of a business at which the importance of size is measured can therefore affect the results of the analysis. The Business Register defines an enterprise as a legal entity or consolidation (group of consolidated legal entities) associated with a complete set of financial statements corresponding to one economic entity. The ultimate parent enterprise is the entity in a legal structure that controls through majority ownership one or more enterprises. 6 In this paper, enterprises are consolidated into groups headed by an ultimate parent. The GDP of each firm is assigned to the ultimate parent that heads the group to which the firm belongs, and the size of the firm is the sum of employment across all the entities its ultimate parent controls. In this paper, enterprises are consolidated to the ultimate parent because it is the ultimate parent that makes decisions for the group of enterprises it owns and controls.
The example illustrated on the next page shows one possible complex structure headed by an ultimate parent. This ultimate parent controls one parent enterprise, which in turn controls two companies (Companies A and B), and Company C. 7 Company A has one establishment (A1), and Companies B and C each have three establishments.
It is not uncommon for large and complex businesses, such as the one below, to have establishments in various industries or to have establishments located in a number of different provinces. In this paper, the industry of an enterprise group headed by an ultimate parent is the industry where the group paid most of its wages. 8 On the other hand, the vast majority of businesses follow the simplest structure; the ultimate parent, enterprise and establishment are one and the same; they are located in only one province and they belong to only one industry. 9
In the case of franchises, the franchisee is independently owned by a company or person and not owned by the franchisor. Based on this definition, the paper does not include the franchisee as part of the franchisor's ultimate parent legal structure. 10 However, since the franchisor developed the products and services offered by the franchisee, it could be argued that the franchisee does not operate independently from the franchisor and may very well be part of the larger business operating under the franchise brand.
Example of a complex structure
Note: The example illustrated above shows one possible complex structure headed by an ultimate parent. This ultimate parent controls one parent enterprise, which in turn controls two companies (Companies A and B), and Company C. Company A has one establishment (A1), and Companies B and C each have three establishments.
2.3 Total economy versus business sector
In the previous section, it was stated that the ultimate parent makes decisions for the group of enterprises it owns and controls. However, when it comes to government entities, it is more difficult to ascertain the level at which decisions are taken. In addition, the wide variety of reporting entities in the government sector makes comparisons across entities and jurisdictions problematic. Size of entity has much less meaning because of the wide variety of practices across government in terms of consolidating payroll into small or large units. As a result, this paper focuses on the business sector.
The business sector is composed of all corporate businesses and unincorporated enterprises that are organized for profit, and other entities that produce goods and services for sale at a price intended at least to approximate the costs of production. Income trusts are included in the business sector, as are government business enterprises (GBEs), but rent that is imputed to owner-occupied housing is not. 11
3 Data sources
In order to obtain measures of the different components of GDP, data from a number of sources are needed. Data at the firm level are available for most of these components: wages and salaries; portions of supplementary labour income; other operating surplus, and indirect taxes less subsidies. In these cases, the components of GDP for each firm are added up and allocated to the size category of the group of enterprises to which the firm belongs. For the remaining components of GDP, some are allocated entirely to the small-size category (mixed income, interest payments and depreciation for unincorporated businesses), and others are distributed across size categories using supplementary information (unlegislated portion of supplementary labour income—private pension plan contributions, supplementary medical and dental benefits, etc.). The resulting estimates of the components of GDP for each size class are then summed and benchmarked industry-by-industry to the Input-Output Accounts. The GDP by size estimates for the business sector are the sum of the benchmarked industry estimates. 12 The sub-sections below describe the mainly administrative tax data sources used to obtain each component of GDP. 13
3.1 Labour income
Every business that employs workers, both incorporated and unincorporated, is required by the Canada Revenue Agency (CRA) to issue its employees a T4 form for tax purposes. The T4 summarizes, among other things, employment income and the legislated portion of supplementary labour income (including employment insurance, 14 and Canada and Quebec pension plan contributions).
Also on each of the T4 forms is the Business Number (BN) of the employer, the unique identifier assigned to the business by the CRA. Ultimate parent enterprises that follow the simplest of business structures, cases where the ultimate parent, enterprise and establishment are one and the same, generally only have one BN. On the other hand, complex enterprises may have many BNs. As shown in the example of a complex structure on page 10, BN identifiers may cover one or more establishments. This paper uses the T4 file prepared by the Income and Expenditure Accounts Division (IEAD) at Statistics Canada. IEAD edited the file to remove erroneous entries, restricted the file to cover only the business sector and assigned enterprise identifiers from the Business Register to each BN. Only ultimate parent identifiers were added to the file before it was used.
The non-legislated portion (including private pensions, worker's compensation, and health and dental benefits) is estimated using the Workplace and Employee Survey (WES). The WES is used to obtain the ratios of non-legislated labour income to gross payroll for each business-size category and industry. The ratio is then applied to the employment income from the T4 to obtain estimates of the non-legislated portion of supplementary labour income by size and industry.
3.2 Other operating surplus and indirect taxes
When corporations file their T2 Corporation Income Tax Return, they are also required to submit their financial statements (income statement and balance sheet) codified according to the General Index of Financial Information (GIFI). The GIFI is the main data source used to generate a measure of other operating profits (operating profits as defined by SNA 15 ) and indirect taxes less subsidies. Since the business identifiers on the tax returns are BNs, the Business Register is used to match the tax records to the appropriate ultimate parent. This paper uses the GIFI file prepared by the Enterprise Statistics Division (ESD) at Statistics Canada. ESD assigned enterprise identifiers from the Business Register to the tax records in this file. As in the case of the T4 file, ultimate parent identifiers had to be added.
Other data sources, in addition to GIFI, are used to obtain estimates of other operating surplus because income trusts do not file T2 Corporation Income Tax Returns and because GIFI data for GBEs are generally missing. Profits from income trusts are taken from the T3 Trust Income Tax and Information Return, and data on GBEs are taken from Statistics Canada's Public Sector Statistics Division.
3.3 Mixed income
Since the GIFI data only cover corporations, mixed income, interest payments and depreciation for unincorporated businesses must be separately estimated. Following Rispoli (2009a,b,c), these estimates are obtained from the Tax Estimate Program for unincorporated businesses and from the T1 portions of several Statistics Canada surveys: the Census of Agriculture, various Unified Enterprise Surveys (e.g. retail and accounting), various transportation surveys (e.g. motor carriers of freight), and various service surveys (e.g. automotive repairs). At this time, a methodology to split these components of unincorporated GDP by size has not been developed. Currently, these components are allocated to the small business category as most of these businesses are sole proprietorships or businesses with very few employees.
Finally, the CRA requests that employers remit payroll deductions a number of times over the course of the year (bi-weekly, monthly or quarterly, depending on the size of the businesses). The number of paid employees (working owners of unincorporated enterprises are excluded), the amount paid to employees and the amount remitted to the CRA are reported in a PD7 form at the time of the remittance. These administrative data form the basis for the monthly employment estimates presented in the Survey of Employment, Payroll and Hours. Since in this paper the only interest is the business sector, all firms in the government (for instance, hospitals, schools, universities and colleges) and the non-profit sector are removed. Once again, ultimate parent identifiers are added.
4 Gross domestic product by size of business
Small and medium-sized businesses accounted for $536.5 billion, or 54.3%, of business-sector GDP in 2005, while large businesses accounted for $451.9 billion, or 45.7%, of business-sector GDP in 2005 (Table 1). Large businesses accounted for just over half of GDP in the corporate sector.
The share of each of the GDP components accounted for by small and medium-sized businesses is shown in Table 2. Small and medium-sized businesses, including unincorporated businesses, accounted for 58.1% of labour income, but 47.8% of operating surplus and mixed income. This is consistent with the claim that smaller businesses are more labour-intensive.
There is another sharp contrast within the labour income component of GDP. Small and medium-sized businesses, including the unincorporated, accounted for 59.8% of salary and wages, but 44.9% of supplementary labour income. This reflects the fact that larger businesses are more likely to include in their employee compensation packages non-wage benefits, such as a private pension plan, and health and dental benefits. 16
Small and medium-sized businesses, including unincorporated businesses, received 94.9% of the subsidies on production. However, since the level of subsidies is relatively small and because 73.1% of the indirect taxes on production were collected from small and medium-sized businesses, the small and medium-sized businesses accounted for 72.7% of the indirect taxes less subsidies. It should be noted that entities from whom taxes are collected are not necessarily the same as the entities that ultimately bear the tax. 17
The share of GDP accounted for by large businesses varies by industry (Chart 1). Ordered from the smallest to the largest shares, large businesses accounted for less than half of GDP in agriculture (0.5%), health (3.4%), education (8.4%), other services (9.9%), construction (10.0%), accommodation and food services (23.3%), professional services (23.9%), wholesale (35.5%), administrative (36.4%), arts and entertainment (40.4%), finance (41.6%) and retail (42.6%). The Industries that had a greater large-firm presence were utilities (91.4%), information (81.2%), mining and oil and gas (74.5%), manufacturing (62.9%), and transportation (52.4%).
5 Sensitivity analysis
Users of GDP by size class estimates should recognize that the methods and assumptions used herein affect the results. A number of noteworthy assumptions are made in this paper. First, firms are consolidated into enterprise groups headed by an ultimate parent. If one were to use a legal structure below the ultimate parent level, the GDP accounted for by the small and medium-sized categories would likely increase since businesses would be separated into smaller groups. Second, as a business may operate in a number of industries, estimates of GDP by size for a particular industry are sensitive to whether all the operations of a business are included in that industry. Third, if one were to include all independently run franchisee firms under the ultimate parent that owns the franchise brand (the franchisor), the GDP accounted for by the large size class would increase. Fourth, GDP can be produced at different valuations, for example, basic or market prices.
As an illustration of the first and second points above, the estimates from this paper for manufacturing can be compared to those from the 2005 Annual Survey of Manufacturing (ASM). The results of the comparison are shown in Table 3. In this paper, large businesses in manufacturing represent 63% of GDP, compared to 54% in the ASM. The employment distribution between the results of the paper and those of the survey of manufacturing are more similar.
Differences between the findings in this paper and those in the ASM can occur for several reasons. In this paper, a business is defined as a group of enterprises headed by an ultimate parent. This group of enterprises may operate in a number of other industries besides manufacturing. In contrast, the ASM is an establishment-based survey. It collects only information on the manufacturing operations of the group headed by the ultimate parent. Therefore, the share of GDP accounted for by large businesses in this paper would be higher than that found in the ASM if the tax data contained a large amount of activity from other industries. This is because value added coming from other industries within the same group of enterprises is taken into account in this paper. For example, some activities of non-manufacturers would be included in manufacturers in this paper, but not in the ASM. If large manufacturers are more likely to have their own wholesaling arms, then the share of GDP accounted for by the large businesses in this paper would be higher than that found in the ASM.
Defining the business size entity at the plant or enterprise level (the operating enterprise in the statistical structure used by the ASM) by means of the aggregation of plants within an industry contained in the operating statistical enterprise in order to define the size of enterprise rather than the ultimate parent level lowers the share of the large size class. This is because the enterprise group headed by an ultimate parent is broken down into smaller enterprises or establishments; this allows for much larger small and medium-sized classes.
Thus analysts who make use of the estimates presented herein—especially for cross-country comparisons of size distributions—should be cognizant that the point estimates of GDP by size are sensitive to changes in the methods and assumptions used to produce them. Decisions made at each step of the production process—e.g., the definition of a firm as a group of enterprises headed by an ultimate parent, the use of payroll to assign a firm to one industry, the treatment of independently-run franchisees as separate from the franchisor, the valuation of GDP at basic prices, and the assignment of all unincorporated profits to the small firm size category—have an impact on the final estimates. Users should pay close attention to differences in these methodological details, especially in the context of cross-country comparisons.
Moreover, even if the methods are consistently applied, estimates will be sensitive to differences in data sources—e.g., financial statements may be consolidated or unconsolidated, the employment at a firm may be the number of jobs at the firm or it may be the number of individuals that worked for the firm in a particular year, and the employment size of a firm may be its average size over the entire year or it may be its size at a point in time during the year. Decisions that are taken in each of these levels can affect the estimates of the importance of small and medium-sized firms. It is beyond the scope of this paper to provide comprehensive estimates of the sensitivity of the estimates to changes in all these dimensions, but one illustration suffices to make the point.
The Survey of Employment, Payroll and Hours (CANSIM Table 281-0041, seasonally unadjusted employment by employment size of enterprise) can be used to show that the share of employment accounted for by small firms with less than 100 employees varies seasonally by roughly 1.5 percentage points. Distributions of employment often choose one particular point in time to establish the size of a firm. Doing so with this survey then could provide variations of up to 1.5 percentage points. If a relatively simple distribution of employment across firm size categories has a margin of error of 1.5 percentage points, then one would expect at least the same margin of error in the more complex calculation of GDP by firm size.
This paper examines the contribution of small, medium-sized, and large businesses to the Canadian economy in 2005. While past studies measure contributions in terms of employment, this paper presents contributions in terms of GDP. GDP is a superior measure to the employment measure because large amounts of input may be used by a particular group but relatively little output may be produced. To develop this measure, firm-level data from a number of sources were utilized.
Overall, large firms with 500 or more employees are found to have accounted for 45.7% of the GDP produced in the business sector. Small and medium-sized businesses, including unincorporated businesses, accounted for the other 54.3%. The large-business share of GDP varied across the components of GDP. Large businesses accounted for the majority of operating surplus and supplementary labour income, but for less than half of overall labour income and indirect taxes less subsidies. The share of GDP accounted for by large businesses varied widely by industry. Large firms had a substantial presence (more than 50% of GDP) in utilities, information, mining and oil and gas, manufacturing, and transportation and warehousing, while they had little presence (less than 10% of GDP) in construction, other services, education, health, and agriculture, forestry, and fishing.