Wednesday, October 12, 2011

The Myth of Small Business Job Creation

Charles Kenny tries to disabuse readers of the notion that the nation’s most prolific source of new jobs comes from small businesses. His article appeared in Businessweek. His subtitle summarizes the point he is making.
"Politicians may love to extol the virtues of small business, but big companies are still the key to growth."

There is quite a bit of data to support Kenny’s contention.

"In the U.S. in 2007 there were around 6 million companies with workers on the payroll. Ninety percent of those businesses employed fewer than 20 people, according to analysis of the latest census data by Erik Hurst and Ben Pugsley of the University of Chicago. Collectively, those companies accounted for 20 percent of all jobs. Most small employers are restaurateurs, skilled professionals or craftsmen (doctors, plumbers), professional and general service providers (clergy, travel agents, beauticians), and independent retailers. These aren’t sectors of the economy where product costs drop a lot as the firm grows, so most of these companies are going to remain small. And according to Hurst and Pugsley’s survey evidence, the majority of small business owners say that’s precisely their intent—they didn’t start a business for the money but for the flexibility and freedom. Most have no plans to grow."

"Looking at a sample of companies created from 2004 to 2008, Hurst and Pugsley found that only 3 percent added more than 10 employees during that time. An even smaller proportion had applied or were in the process of applying for patents. (So much for being seedbeds of innovation.) Many small businesses simply go bust after a few years."

There can be a large flux of jobs in small businesses as old ones fold while others start up, or if there is high employee turnover, but a flux of jobs is not the same as adding jobs to the economy.

"In 2009 economist Scott Shane at Case Western Reserve University surveyed the evidence on net job creation by each year’s cohort of new companies. He found that among small companies in their second year of business, more jobs were lost to bankruptcy than were added by those still operating. The same was true in years three, four, and five."

There are of course notable exceptions to this picture. Kenny mentions Apple, Google and HP as examples of small start-ups that took off. These companies are probably what the public thinks of when the reference is made to a dynamic small business community. But these don’t really fit the mold of "small business." All had grandiose plans and were only "small" in the sense that one has to start somewhere. Today a company trying to emulate the success of those big three would not gain much from typical fiscal policy initiatives such as tax breaks. They would need direct infusion of capital from a government grant or from venture capitalists. That puts them in a totally different category where "small business" does not apply. Greater precision in terminology is required.

From this Kenny concludes that if one is looking for a good job one had better hope that there is a large company with many employees, benefits, and a solid business plan in the neighborhood.

Kenny implies that the big corporations are the ones to look to for job growth, but how is this actually working out? Don Peck, in Can the Middle Class Be Saved, provides us with this insight:

"Yet for all their outsize presence, multinationals have been puny as engines of job creation. Over the past 20 years, they have accounted for 41 percent of all gains in U.S. labor productivity—but just 11 percent of private-sector job gains. And in the latter half of that period, the picture grew uglier: according to the economist Martin Sullivan, from 1999 through 2008, U.S. multinationals actually shrank their domestic workforce by about 1.9 million people, while increasing foreign employment by about 2.4 million."

Yes size matters, but there is more than that at play here. Google, Apple, and HP are enormously successful companies, but Google has generated very few jobs in comparison to the wealth it has generated. Also consider that every time you buy a product from Apple and HP, you are shipping a good deal of that money to someone overseas. Your fancy new toy is sucking money out of the economy.

It would seem that the old fashioned method of creating wealth by making things—in this country—is still the best way to increase employment. Reestablishing a manufacturing base is a good first step. The best way to create jobs immediately is to invest in upgrading our infrastructure. Recently I have encountered about a half dozen articles promoting that notion. One cannot have a solid economy without a solid infrastructure. That’s the way it is, so why not get started?

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