Low-income entrepreneurs suffer most when government makes it harder to start a business
Chicago’s many bureaucratic barriers to starting a business shield established businesses from competition and keep low-income entrepreneurs from getting ahead.
Starting a business can be difficult, especially in Chicago. Aside from the risks and uncertainties that come with entrepreneurship, business owners must often comply with a complicated web of rules and pay substantial fees, all before they can even begin selling their products or services. But the burden of these rules does not fall evenly: It is greatest for the least well-off. New research shows that when government makes it harder for people to start businesses, these barriers to entry can make it even more difficult for the poor to get ahead.
Just starting a business in Chicago requires a $250 license. Setting up a storefront requires additional costly permits and may involve substantial delays. Displaying a sign adds six to eight weeks to the process, or a minimum of 60 days if the entrepreneur wants to hang the sign himself. Moreover, it is difficult to obtain a definitive list of all the requirements an entrepreneur must meet before he can welcome customers – this in itself is a barrier to starting a business. Many entrepreneurs must hire city-licensed expediters to shepherd them through the process.
For low-income entrepreneurs in particular, these high costs and lengthy wait times can result in insurmountable barriers to getting started. These entrepreneurs often have less savings and less access to affordable loans to cover permits and other upfront costs. And navigating a complex bureaucracy such as Chicago’s can also pose extra challenges for entrepreneurs with less education and fewer connections. An entrepreneur struggling to pay for permits and other start-up expenses is unlikely to have the means to hire someone with the expertise or connections to steer an application through the city bureaucracy.
Entrepreneurship can promote social mobility. So when governments erect barriers that shut out those on the lowest rungs of the income ladder, they effectively help keep the poor from moving themselves and their families out of poverty. And a new Mercatus Center study by Patrick McLaughlin and Laura Stanley shows this: Increasing the barriers to starting a business significantly increases income inequality around the world.
The researchers took a World Bank study that measures the average number of steps required to start a business in 175 countries, and compared that to the GINI coefficient, a standard measure of income inequality on a scale of zero (everyone has the exact same income) to 100 (one person controls all the income).
The study revealed that adding just one step to the process of starting a business increased a country’s GINI coefficient by nearly half a point (0.44).
Put in context, Illinois has the 11th-highest measured income inequality among the 50 states in the U.S., and the highest in the Midwest, with a GINI coefficient of 47.7. That’s only five points higher than Wisconsin, which has the lowest income inequality in the Midwest.
Given that the global average number of steps to start a business is just under nine steps, and a Chicago entrepreneur must go through five separate steps just to have a sign approved for his business, a difference of nearly half a point for each step could explain a significant amount of income inequality in the Windy City.
Making it harder for entrepreneurs to start businesses can concentrate wealth at the top by protecting existing businesses from competition, hurting both potential entrepreneurs and customers. The study showed that increasing the number of steps to start a business by just one shifted 1.6 percent of total societal wealth to the top 10 percent. These numbers are significant when one considers the number of steps required to start any business in Chicago.
Restrictions that benefit established businesses while harming consumers and striving entrepreneurs are likely to increase income inequality and reduce social mobility. That combination makes it harder for low-income people to rise and shields wealthier incumbents from competition. The income gap widens, not because of differences in how hard people work or how much risk they take, but because of rules that protect those already at the top.
Maximizing social mobility by reducing burdensome regulations and the number of steps required to open a new business can counter bureaucracy-fostered, entrenched income inequality, and could go a long way toward helping low-income entrepreneurs and their families get ahead.