Small Businesses? Where Do the Jobs Really Come From?

Politicians love to make statements describing our nation’s small businesses as the engines of job creation. This sentiment has been repeated so often that it has attained the status of dogma. Fortunately, there are doubters out there who actually have data to work with.

We recently discussed some of the arguments against this conventional wisdom in The Myth of Small Business Job Creation. It was pointed out that "true" small businesses create few jobs because most fail—almost immediately, and the ones that endure are mostly intended to stay small. It was also pointed out that huge multinational companies have been ineffective at creating jobs—at least in this country. One was left with the suspicion that job creation comes from the entrepreneurs who think big but are forced to start small. In other words, we need another category or term to describe the enterprises where the jobs are actually created.

A recent article in The Economist closes the loop on these thoughts: A helping hand for start-ups.

"The data suggest that lately the country’s entrepreneurial growth-engine has been misfiring—which is alarming given the role it has played in creating employment. According to research funded by the charitable Kauffman Foundation, in 1980-2005 firms less than five years old created 40m net new jobs—equivalent to 100% of the net new jobs created in the entire American private sector."

This statement is consistent with the notion that job growth comes from small companies, but additional specification is required.

"A new study published by the Brookings Institution, a think-tank, called ‘What do small businesses do?’, finds that: ‘While most aggregate employment growth may come from small (new) firms growing big, the vast majority of small (new) firms do not grow’."

The implication is that the focus should not be on "small businesses" but on start-ups with promising ideas and grand ambitions. It is suggested that these types of entrepreneurs have been seriously hindered by the effects of the recent financial disaster.

"In the past three years—ie, roughly since the financial crisis of 2008—the number of new companies formed each year fell by nearly a quarter, and with it the rate of job creation by start-ups: from 3m new jobs a year on average to 2.3m in 2009. Had the rate of job creation remained what it was in 2007, there would now be nearly 2m more people employed in America."

Given this input, the advice is to provide more support for this class of "small business" and worry less about the traditional, broad class of small businesses. There is a role for government to play, but the article is more enthusiastic about private contributions in support of start-ups. It references an initiative called "MassChallenge:"

"....launched in 2009 with a mixture of personal and corporate backing and a grant from the state of Massachusetts. It selects around 125 finalists to spend three months in its ‘accelerator’, where they get free working space, help from mentors, networking with investors and the encouragement of working alongside others facing similar challenges. Up to 20 winners are then chosen to share a $1m prize."

"John Harthorne, a co-founder of MassChallenge, wants to improve on the typical Silicon Valley model of incubating start-ups. Venture capitalists insist that the start-ups they help surrender equity; MassChallenge does not. This makes it easier to attract broader support and voluntary help from businesses, and allows non-profit start-ups to take part. Helping such firms grow is an extremely cost-effective way to create jobs, argues Mr Harthorne; the first class of finalists have already hired over 500 more people than the 330 they began with."

Apparently this message is being heard in Washington.

"Earlier this year President Barack Obama launched a campaign supported by leading entrepreneurs ranging from Steve Case, the co-founder of AOL, to Fred Smith, the founder of FedEx, and Magic Johnson, a basketball star turned property developer. On September 13th, the Startup America Partnership declared itself officially open and invited firms under five years old to register for free support services donated by 25 large companies. This support is worth a startling $730m, Startup America claims."

This all sounds great—now let’s hope it works. At least we now have a better understanding of where to focus resources.