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Who is the bigger jobs creator — small businesses or young companies?

For nearly four decades, politicians and policy-makers on both sides of the aisle have asserted that small business is the dog pulling the sled when it comes to job creation. As Washington and the states struggle with stubborn high unemployment, that conventional wisdom is front and center in debates over key policy initiatives to jump-start job growth.

But a spate of new economic research suggests it’s not small businesses (500 or fewer employees) but younger businesses (less than a decade old) regardless of size that are the significant generators of new jobs.

While it may seem a subtle distinction, it has potentially large policy implications. For example, should job stimulus efforts focus on broadening such initiatives as Minnesota’s Angel Investor tax credit, which is intended to encourage technology start-ups, instead of general small-business tax relief? 

The new research has not changed recent policy debates that repeat the conventional wisdom describing small business as the major source of job creation.

Republican talking points, for example, argue that elimination of the Bush-era tax cuts is “a job-killing tax hike” on small business. Across the aisle, Democrats described the $30 billion small-business lending package recently passed by the U.S. Senate as a “small-business jobs creation bill.” Neither specifically calls out the importance of young companies, as distinguished from small companies, in creating jobs.

And the three major candidates for governor in Minnesota talk about the importance of small business in job creation, with Republican Tom Emmer specifically citing small business as the major driver of job growth. (See Mark Dayton (PDF), Emmer and Tom Horner job plans here.)

A recent article from the Federal Reserve Bank of Minneapolis discusses research findings linking job growth with young firms. A second paper by the U.S. Small Business Administration (SBA) Office of Advocacy details some of the newer data surrounding small business and jobs, detailing the importance of start-ups in job creation.  Following is a brief summary of both papers.

Federal Reserve Bank: Youth, not size, matters
The article in the current issue of Banking and Policy Issues Magazine, Sizing Up Job Creation” by Fed staff writer Phil Davies, cites a recent paper from University of Maryland economist John Haltiwanger and researchers at the U.S. Census Bureau. The economists analyzed 13 years of Census data and found no systematic link between net job growth rates and the size of the firm.

“But the contribution of firms less than 10 years old, particularly startups, to job creation was substantial,” Davies reported. For instance, startups less than a year old account for only 3 percent of U.S. employment but almost 20 percent of new gross jobs,” he writes.

Davies describes how the sheer complexity of accurately measuring job growth over long periods of time, incomplete and inconsistent sources of data, and “statistical pitfalls” all have plagued past studies of small-business job creation. Some previous research, for example, used commercial credit bureau data that did not capture startup activity. Other research used census data from manufacturing employment that did not capture job growth in the service sector.

Statistical bias, known as “reversion-to-the-mean,” describes how unusual growth or decline in any given year will be offset as a company ‘reverts’ to its ‘normal’ employment level in subsequent years. That phenomenon can systematically credit job growth to smaller firms and job losses to larger firms, skewing the conclusions.

SBA: It’s about startups
Brian Headd, writing for the U.S. Small Business Administration, recapped recent findings based on newer data sets that had not previously been available to researchers. (Headd’s full paper, “An Analysis of Small Business and Jobs,”is here.)

While he credits small businesses with significant job creation, he describes the importance of startups in that equation: “The major part of job generation and destruction takes place in the small firm sector, and small firms provide the greater share of net new jobs. In some ways this role as a major creator and destroyer of jobs is a result of being the major creator and destroyer of businesses in general.”

Headd then cites troubling recent findings that the size of startups has declined. From 1993 to 1999, the average start up employed between 5.5 and 6 workers. That average started to slide in 2000 and has leveled off to 4 to 4.5 employees per startup from 2005 through 2009.

“Whatever the cause of the decline in startup establishment size during and following the 2001 downturn, it is a worry; it seems to show a reduced degree of churning or creative destruction, and perhaps a decreased appetite for entrepreneurial risk-taking,” he writes.

Finally, Headd cites research that argues the current increase in unemployment is driven by a lack of job creation as much as layoffs. “It appears that the media story of a few big firms’ layoffs driving employment losses is more myth than fact. The lack of firm expansions is as much a factor in net employment losses as firm employment contractions. Unfortunately, the contribution of expansions to employment levels for the first quarter of 2009 was at a 17-year low and well below 2001 rates, while contractions were at the peak reached in 2001.”

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Comments (1)

  1. Submitted by Greg Kapphahn on 09/20/2010 - 11:26 am.

    If I remember correctly, the average entrepreneur starting a new business has three or four failures before the one that finally takes off, works and becomes a stable, profitable business venture.

    It is also my understanding that these initial business failures often drive the leader(s) of the startup into bankruptcy and that the changes in the bankruptcy laws from a few years back made the liquidation of a failed business and its attendant debts much harder to accomplish, thus making it much more difficult if not impossible for the average entrepreneur to move beyond initial failure into additional startups until they find success (or it finds them).

    Coupling this with the lack of available credit throughout the economy and the aversion to risk bordering on paranoia that most banks and many venture capitalists are currently demonstrating, makes for an environment where the lack of available financial backing for a new business startup means there are far fewer of them happening (at least here in the US). This may very well be one of the primary reasons for such dismal job growth over these past many months.

    Perhaps this new study will help create government programs that seek to stimulate job growth by assisting with the financing of new ventures.

    Meanwhile, I strongly suspect that the better “business climate” so desired by our Chamber of Commerce is aimed in a completely different direction – that of increasing the incomes of the wealthy members of the chamber, themselves.

    I suspect the members of the Chamber would prefer not to see successful new startups since those new businesses may, in fact, provide competition for the existing businesses owned by those wealthy moguls who run the Chamber; competition that, despite all their worshipful whining and whinnying about the “free market,” they would rather kill in the cradle or never allow to be conceived in the first place.

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