Small Business, Innovation, and Public Policy in the Information Technology Industry

New firms have played a major role in fomenting innovation in information technology. A recent study by Greenwood and Jovanovic [1999] provide one dramatic illustration of these trends. These authors show that a group of “IT upstarts”—firms specializing in computer and communications technologies that went public after 1968—now account for over 4% of the total U.S. equity market capitalization. While some of this growth has come at the expense of incumbent information technology firms, the new market value and technological spillovers created by these new businesses appear to be substantial.

The role of new firms in the information technology industries has rekindled interest in the relationship between firm characteristics and innovation. Are small businesses more innovative in general? Are high-technology start-ups particularly important? If the answer to either of these questions is yes, how should policymakers seek to encourage these firms?

The relationship between innovation and firm characteristics has been one of the most researched topics in the empirical industrial organization literature. To summarize these discussions and draw some implications for policymakers in a few pages is thus a daunting challenge! Consequently, this essay takes a quite selective approach to these issues. First, I very briefly summarize the academic literature on the relationship between firm size and innovation. This work suggests that there appears to be a very weak relationship between firm size, the tendency to undertake R&D, and the effectiveness of research spending. Small businesses, in aggregate, do not appear to be particularly research-intensive or innovative.

I then turn to examining one subset of small businesses that do appear to excel at innovation: venture capital-backed start-ups. I highlight some of the venture-backed firms’ contributions. I also discuss why the success of such firms is not accidental. In particular, I highlight the key

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