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Introduction

The promotion of small business is a cornerstone of U.S. economic policy. Policymakers constantly point to small businesses as important sources of employment and economic growth.  There are about 25 million small firms in the U.S., employing almost 50 percent of all workers.  Hence, even when politicians find little else to agree on, there is strong bipartisan support for government intervention aimed at promoting small business.

A particular area of concern for policymakers is whether, in a free market, small businesses can access sufficient credit. The imperfections of credit markets, particularly for small businesses, are often used as the quintessential illustration of a market failure that necessitates government intervention.

Growing firms need resources, but many small firms may have a hard time obtaining loans because they are young and have little credit history. Lenders may also be reluctant to lend to small firms with innovative products because it might be difficult to collect enough reliable information to correctly estimate the risk of such products.  If it's true that the lending process leaves worthy projects unfunded, some suggest that it would be good to fix this “market failure” with government programs aimed at improving small businesses' access to credit.

Encouraging lending to small businesses is one of the primary purposes of the Small Business Administration (SBA). Established as a tiny lending agency in 1953, the SBA has mushroomed into a multibillion dollar financial institution with a significant presence in the credit market. By the 1990s, the SBA had become a conglomerate agency pursuing multiple policy objectives. New programs were established to provide venture capital to growth-oriented companies, assist minority entrepreneurs, and lend management assistance to firms struggling to compete.

According to the SBA's Office of Advocacy, nearly 20 million small businesses have received assistance from one of the SBA's many programs since 1953. In particular, the SBA's flagship loan guarantee program, the 7(a) program, has grown significantly over the past decade.

This paper is devoted to a basic question: are these SBA loan guarantees desirable? Should the SBA remain in the banking, credit allocation, and subsidy business or should these activities be terminated? The paper asks whether there is in fact a market failure that justifies government intervention via the SBA. If there is a market failure, are the SBA programs well designed to address the problem? Or if there is no market failure, does the SBA help achieve policy goals important enough to justify its meddling in a well-functioning market?

This paper concludes that there seems to be no failure of the private sector to allocate loans efficiently, thus discrediting the economic justification for any government-sponsored small business lending or loan guarantee program. Absent such a clearly identified problem, the SBA's activities are simply a wasteful, politically-motivated subsidy to this sector. Moreover, even if to some extent the private sector fails to allocate loans efficiently, it remains to be proven that government intervention is a more desirable alternative.

The paper also demonstrates that even if credit were a serious problem for small firms, SBA loans wouldn't make a significant difference. Judging based on the SBA's ability to meet announced public policy goals--namely filling the gap between the demand and supply of small business loans, particularly for minority- and women-owned small firms--this work finds no evidence that the SBA loan guarantees serve any focused or rigorously defined public policy purpose at all.

Veronique de Rugy is a resident fellow at AEI.

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