There is something magical, almost mythical, about small business in America.
While big business often is seen as a faceless model of corporate efficiency, small businesses stand in for the noble American values of hard work and self-reliance. And to top it off, small business is the engine of U.S. economic growth, responsible for 75 percent of all net new jobs, we are frequently told.
President Bush, who rarely sings the praises of big business in his speeches and public appearances, waxes positively poetic in his frequent meetings with small-business owners.
“You're welcome to the American Dream, no matter who you are or where you're from,” he said in one such session in October. “The entrepreneurial spirit is strong, and that's what's going to lead this recovery. The people are going to be able to find work because the small business owners of America are risk takers, bold thinkers, and love their country, and are willing to expand the job base.“
If small business is supposed to be leading the recovery, it is doing a pretty lousy job in terms of job growth.
Over the past five months the economy has added a mere 278,000 jobs, including a barely measurable 1,000 jobs in December, according to the Bureau of Labor Statistics. That is certainly an improvement after the economy shed 2.3 million jobs over the previous two and a half years, but the five-month total is just a bit more than the average monthly gain in the last two expansions.
That may be about to change. According to a monthly survey by the National Federation of Independent Business, member firms expanded their payrolls in each of the final three months of last year on average. That was the first time in three years the group’s payroll figure grew for three straight months.
And an index of small business hiring plans rose to its highest level in 39 months, said William Dunkelberg, chief economist for the NFIB, which represents 600,000 businesses, the vast majority of which have fewer than 40 employees.
“We had a huge surge in the percent of firms planning to increase hiring,” Dunkelberg said. “I think we’ve beaten everything we can out of the existing labor force.”
Small business jobs undercounted?
Dunkelberg is among a number of analysts who believe recent Labor Department figures may be understating the contribution of small business. The government’s closely watched payroll survey does not count self-employed people, he noted.
“Obviously the payroll survey misses new firm formation,” he said. “So there are a lot of pieces that get missed, and most often they get missed when the economy is moving in one way or another.”
Self-employment is tracked in the government's separate household survey, but those figures are considered less reliable than the payroll survey, Labor Department officials said. Chad Moutray, chief economist for the Small Business Administration’s advocacy office, said the government actually knows very little about these smallest businesses.
In 2001, the latest year for which information is available, the government listed nearly 23 million firms doing business, but only 5.7 million had employees. The remaining 17 million were one-person firms, which could be anything from a retired person selling collectibles on eBay (and declaring the income) to a full-time independent business consultant.
“Unfortunately we know very little about them,” Moutray said of the non-employer firms. He speculated that the economic downturn may have led to a surge in formation of one-person firms because of the increased “opportunity” created by corporate layoffs and cutbacks.
“If you are working for a company making six figures you might want to go out and work for a small business, but you don’t do it,” he said. “With the recession comes increased opportunity for a lot of people, especially in the tech area. There are a lot of very smart people with a lot of high-tech consulting skills.”
Data that breaks down employment by firm size is closely guarded by the Census Bureau and Internal Revenue Service, dribbled out to researchers only with a lag of several years. But several studies have shown that in recent years small businesses have accounted for 60 to 80 percent of net new jobs added to the economy.
This is not immediately obvious. Small businesses, defined as those that employ fewer than 500 people, account for 99.7 percent of all employers but only 50 percent of private-sector employees. The other 50 percent are employed by the nation’s 17,000 large businesses.
The joys of youth
A study of net job growth in 1996 suggested why small can be beautiful. Firms that were at least two years old that year cut employment by 7 to 36 percent overall, with the biggest job losses coming at the oldest firms. Meanwhile, job growth of nearly 150 percent was seen both at small firms that were less than two years old and at new branch offices and stores opened by larger firms.
“For employment growth, it looks as if the more important factor is age and not size,” said the study by economists John Haltiwanger and C.J. Krizan. “One clear pattern that emerges is that net job creation rates decline with plant age.”
This is not to say that large businesses never create jobs, or that small businesses never lay off workers. But large businesses, which by definition can take better advantage of economies of scale, may have more to gain by boosting productivity, particularly when demand drops off. Small manufacturers, to take one example, are unlikely to ship production work overseas because they simply do not have the resources to assure quality control and quickly adjust run rates.
“I think what small businesses do is they continue to innovate,” said Moutray. “In order to gain their niche in the global economy they need to find something that nobody is doing and innovate on it.”
He pointed to a recent study that found an association between spending on research at universities and the formation of new businesses nearby.
“Hopefully if they are successful they are going to become larger businesses and/or be acquired,” Moutray said. “But much of your innovation is coming at the smaller level.”
Paul Reynolds, a professor at the London Business School and Babson College who studies entrepreneurs, draws a distinction between those who start businesses out of necessity and those who do so because of opportunity. Countries like Uganda and Venezuela have a higher rate of entrepreneurial activity than the United States, but only because people there have a much harder time finding traditional employment.
“The thing that makes (entrepreneurship) special in the United States is that it is not special,” he said. “If someone wants to start a business we say fine, go to it. … No matter what happens, as long as you’re not a thief, it’s considered an honorable career option.”
The same cannot be said in many parts of Europe, where a business failure is considered more of a disgrace and self-made millionaires more suspect, Reynolds said.
While the economy technically has been expanding for more than two years, the lack of job expansion and slow acceleration of growth lead many economists to suspect we are still at the turning point of the business cycle. For small business start-ups, this decade is looking much different than the 1990s, when the Internet bubble drove an explosive wave of job growth.
“If you look at this first decade of the 21st century, it is not clear what is going to be the entrepreneurial driver of the decade,” said Zoltan Acs, a professor of finance at the University of Baltimore. “It’s not the PC, not the Internet, not the semiconductor. It could be wireless, it could be biotech or health. … People are just not sure where the real growth in this decade is going to come from.”