Angels to aid granny

Getting finance right for small businesses is the key to a sustained economic recovery in the mature industrial world.

For reasons that are still not clear, there has been a marked shift in the comparative advantage between small and large businesses over the past 15 years or so: while size still carries useful advantages in many businesses, being big is no longer essential to commercial success, nor indeed a guarantee of success. One can see this from the daily news. Despite the fact that giant companies keep announcing redundancy programmes, employment is growing: the country is creating new jobs at a rate of about 100,000 a quarter. The only way of explaining this apparent contradiction is is that the smaller companies are providing these new jobs.

Some research by Newcastle University confirms this. The work, noted in the speech by Eddie George, the Governor of the Bank of England, last night on the financing of small firms, suggests that between 1982 and 1991 firms with fewer than 20 employees created 2.4 million net jobs, while their larger counterparts cut employment by 250,000. This squares with the rise in the numbers of small businesses - from 1.7 million in 1979 to 2.6 million in 1991.

Yet as he pointed out, the issue of finance for small business has long been a source of tension. In particular, business people feel their difficulties are compounded by the lack of understanding of the banks, while bankers resent much of the criticism as unjust. The root cause of the tension, concludes Mr George, is the volatility of the economy. But a series of meetings organised by the Bank to bring the two sides together has shown that there are a number of areas where the relationship could be improved.

The Bank reached a number of conclusions, which are reported elsewhere in this section. The key point that is worth making in addition to these perfectly sensible comments is that an efficient financial services industry is now becoming as important an element in international competitiveness as having an efficient manufacturing sector. The issue here is not just that financial services, plus other business services, are almost as large a contributor to GDP as manufacturing. It is more that big businesses throughout the developed world operate on a common financial basis. They can borrow money on much the same terms, choosing the currencies or markets from which to borrow. They can gain similar terms for their spare cash. They have access to the same range of sophisticated financial services. And they can negotiate similar, and keen, terms for the more routine financial services that the banks provide.

It is very difficult, therefore, for any one country's large companies to gain a comparative edge by having access to better or cheaper financial services. This is not so for small companies, which do not in general operate internationally and which have to rub along with the local financial system. The Bank exercise, fine though it is, does not look at the British system for financing for small firms in its international context. Potentially, Britain's ability to create small firms gives an enormous comparative advantage certainly against the rest of Europe, perhaps even against North America. But the advantage will be squandered if the finance to underpin their growth is inadequate.

Given that this is a growth area, it ought to be one into which it is worth financial institutions putting more resources, but in fact the spur to the banks at least has been the potential for disaster, rather than the prospect of triumph. The scale of the loan losses incurred by the banks through the recession did force them to put better- resourced staff on the case. But they found that intensive care was hideously expensive - the trick in the future will be to supply the same degree of attention to detail but at a much cheaper cost.

However, in the future the nurturing of small business will not only be a matter for the large banks. They will be expected to provide basic banking services, of course. Insofar as they can also provide technical help and advice at a price their customers can afford, that will be enormously welcome. But much of the key to the sector's future health will turn on the ability of financial institutions other than the banks to fill the 'granny gap' - provide the small-scale risk finance that has typically come from family savings.

Look at the part of the world where new businesses are being most rapidly created: East Asia. There, most of the finance to support their growth comes from the family: the savings of grandparents, uncles and aunts, and cousins who have already established their own businesses.

Britain lacks the extended family structures of East Asia and in any case there are obvious objections to families risking too great a proportion of their savings on any one business venture. But there is already evidence of a financing gap for small-scale ventures.

We will soon get a replacement for the Unlisted Securities Market, which will help larger ventures, but the most promising suggestion by the Bank is to encourage the growth of 'business angels' - informal networks linking potential investors with potential entrepreneurs. The savings are there; the demand for funds is there. It ought to be possible to develop ways of linking the two sides more effectively and more cheaply.