America’s Small-Business Fetish

When it comes to job creation, size doesn’t matter.

On February 12, House Majority Leader Eric Cantor (R-Va.) sent a message to his 62,550 followers on Twitter: “Small business is the job growth engine in this country and we need to pursue policies that reflect that reality to create jobs.” Cantor was wrong on both counts. Despite overwhelming conventional wisdom to the contrary, small businesses are not the engine of growth. And the small businesses that do create jobs rarely stay small for long, which makes crafting policies that favor those fast-growing firms both difficult and unnecessary.

The cult of the small business is so prevalent that you are treated like a heretic in Washington if you don’t pledge to do something nice for the little guys. Targeted tax credits, special regulatory exemptions, preferential access to government contracts—nothing is too good for America’s DIY manufacturers and social networking startups. Support for the Small Business Administration (SBA), a federal agency tasked with handing out goodies to the modestly sized, remains strong, despite dozens of compelling studies demonstrating that its efforts amount to little more than poorly targeted corporate welfare.

In his 2011 budget, President Barack Obama requested $1.4 billion to fund SBA programs. Most of the agency’s money is spent on special credit programs for small businesses that have difficulty getting loans from regular banks. In fiscal year 2011, the SBA guaranteed $30 billion in such loans, which theoretically don’t cost taxpayers anything. In practice, however, whenever the economy goes south, the SBA can’t cope with the number of small businesses that default on the loans. In 2011 the SBA ended up spending $6.2 billion, a $4.8 billion increase over its requested amount, mainly because so many small businesses couldn’t make their payments.

The idea that small is glorious or that small businesses are the engine of growth is based on bad economics, and the result is bad policy.

The government’s definition of a small business has become absurdly broad. The category officially includes the “mom and pop” firms with fewer than 10 employees that most people think of when they hear the term. But companies with hundreds or even thousands of employees (depending on the industry) are also eligible for benefits and other preferences; they win the coveted designation by virtue of the fact that they are small relative to other firms in their industry. Based on the federal government’s bizarre classifications, 99.7 percent of firms in America qualify as small. 

The percentage of people who work at these small companies has remained constant during the last decade, holding steady at about 50 percent of the private sector work force. This fact alone should cast doubt on the claim that small businesses account for the bulk of new jobs. If that figure was accurate, it would mean that half of American workers are employed by 0.3 percent of firms. Shouldn’t we instead be cheering the tremendous job creation record of those powerhouse companies? 

The ubiquitous statistic that small businesses create 70 percent of all net new jobs is also misleading. The source of this figure is none other than the Small Business Administration itself. In a 2005 study published by the American Enterprise Institute, I noted that to arrive at this figure, the SBA divides net small business jobs—a figure that includes every single current employee of a small business—by the net job creation from all businesses combined. This is not an accurate way to determine the share of new jobs created by small businesses.

The results can be comical: One table published by the SBA in 2005 showed that small businesses created more than 100 percent of new jobs, a truly heroic (if fantastical) result. We should stop using this junk statistic.

Our national obsession with small businesses misses the point. It’s not micro-firms that drive our new, entrepreneurial economy. Young firms—the startups that will grow to be the next Facebook—do tend to be small. But their newness is the relevant factor, not their size.

A 2010 National Bureau of Economic Research paper by University of Maryland economist John Haltiwanger and researchers at the U.S. Census Bureau found there was no consistent link between net job growth rates and the size of a business. Instead, the researchers found that firms younger than 10 years, particularly startups, are the real sources of job growth. 

Another study, published the same year by economist Tim Kane of the Kauffman Foundation, came to the same conclusion after examining more than 30 years of data from the Census Bureau’s Business Dynamics Statistics. Both large and small firms continuously create jobs, Kane found, but also continuously destroy them. The Kauffman report found that without startups—defined as firms younger than one year old—there would be no net job creation in the United States. As Kane writes in the study, “Startups aren’t everything when it comes to job growth. They are the only thing.” 

Former Obama administration economic adviser Jared Bernstein explained this concept concisely in an October 2011 New York Times op-ed. “It’s not small businesses that matter, but new businesses, which by definition create new jobs,” Bernstein wrote. “Real job creation, though, doesn’t kick in until those small businesses survive and grow into larger operations.” 

Today, according to Haltiwanger and his co-authors, businesses younger than a year account for 3 percent of U.S. employment but almost 20 percent of new gross jobs. Furthermore, 60 percent of small businesses that have been around more than five years act as a slight drag on the number of jobs available. These older small businesses cut about 0.5 percent more staff than they add in a typical year, according to Haltiwanger.

Real job growth comes not from people dreaming of being small but from entrepreneurs committed to building large and sustainable companies. This shouldn’t be news. A seminal 1987 study by David L. Birch, a former MIT researcher, explained that small-firm job creation occurs within a relatively few firms, the ones he calls “gazelles.” Gazelles are high-growth entrepreneurial companies that start small and quickly grow larger. This subset of small firms, not small firms in general, is the powerful job creator of every central planner’s dreams. 

Which means that even if it were the government’s role to create jobs, it wouldn’t be able to. No one can identify a gazelle before it leaps. The label can be applied only by looking at past growth, long after the firm has created those sought-after new jobs. Since no one knows where true innovation will come from, it is impossible to accurately pinpoint the job-creating firms in advance.

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  • stout77||

    I get the point, but inasmuch as small business breeds more robust competition, keeping quality high and prices low, all else being equal I would say small business does play a more important role.

  • o3||

    misses the point that small biz profits roll thru the local economy many moar times rather than being exported outta state or country.

  • sloopyinca||

    [citation required]

  • o3||

    Benefits of Supporting Local Business
    http://en.wikipedia.org/wiki/S.....l_Business
    _
    plenty of cites there

  • sloopyinca||

    Actually, there are two cites there. And if you look at how they are written, it's pretty apparent the "Benefits of Supporting Local Businesses" section was written by an advocate.

    Are you aware of the editorial process at Wikipedia? Or are you a mendacious twat that tries to pass off bullshit talking points as a valid study?

  • sarcasmic||

    Come on! With a subtitle like that that picture is just begging for an alt-text!

  • Scruffy Nerfherder||

    "His business was just too big..."

  • sloopyinca||

    "I'm from the government, but I'm only going to assfuck you thiiiiis much."

  • sloopyinca||

    "And by 'this,' I mean this wide. Depth-wise, we're going all the way to your adenoids."

  • John||

    The small business favoritism in the federal government contracting rules is appalling. Costs the government billions every year.

  • Scruffy Nerfherder||

    And does nothing other than to reward those that can navigate the paperwork. There are thousands of companies out there that do nothing other than push paper to fulfill some check mark on a form. They don't inventory, they don't service, they don't do anything other than fulfill some imaginary need for a small business, disabled vet, eskimo, etc...

  • John||

    Imagine if you ran your household like the feds run contracting. Want a new TV? No you can't just go to Costco and get that LG 57 inch they have on sale. No, you have to give a small business preference and buy it from the small business down the street for more money. Want clothes? Forget Old Navy or Macys or any of the big chain stores. Nope, only the local mom and pop boutique for you.

    And we wonder why everything the government does costs too much.

  • Scruffy Nerfherder||

    I don't like to sell to the government simply because of the overhead involved. The paperwork sucks. I can't imagine how much they process on their side of the equation. Besides which, every time I quote something, some joker who does nothing but fulfill the gov't paperwork requirements swoops in and sells the stuff at 5% margin. If the product goes bad, he won't be around to support it. It's just not worth the trouble.

    Meanwhile, if you have an 8(a), it's a license to steal.

  • deified||

    What's an 8(a)

  • deified||

    sorry, just saw your comment below. I will do my own googling.

  • Brandon||

    Do you really think they actually process the paperwork on their side?

  • Jerryskids||

    Based on the federal government’s bizarre classifications, 99.7 percent of firms in America qualify as small.

    A big part of the problem with talking about "small businesses" is that what most of us think of as small businesses are not even big enough to qualify as small businesses under SBA definitions. The real "small businesses" - the mom-and-pops and the sole proprietorships - don't profit too much from all the various 'small-business friendly' laws because a sizable chunk of what they do is black market, under the table, cash transactions. They certainly aren't lining up to deal with the government when so much of what they do is involved with hiding from the government.

    Or so I have heard. Just because I have been self-employed in the construction business all my life doesn't mean that I would accept a lower cash price with no receipts involved to install a new dishwasher in your house on a weekend with no permit than I would charge you for the same work paid by check with a receipt done on a Tuesday morning with a permit. I report every penny I make to the IRS and make sure every job is properly licensed and permitted.

  • Jerryskids||

    When you start talking facts and figures and statistics, you can trust that public corporations are going to be fairly transparent on their financials. Billy Bob's BBQ and Oil Change Lawn Service not so much.

  • Scruffy Nerfherder||

    As a small business owner, I would settle for policy that doesn't alter the market in perverse ways. A couple of suggestions:

    - Get rid of the SBA / 8(a) programs
    - Get rid of the freaking nightmare of paperwork that the gov't demands in order to sell them a paperclip

  • EDG reppin' LBC||

    Since no one knows where true innovation will come from, it is impossible to accurately pinpoint the job-creating firms in advance.

    The small business initiatives that governments enact are not intended to pinpoint job-creating firms. The initiatives are intended to funnel taxpayer money to political donors, brothers-in-law, friends, and business associates of politicians. If the firms are successful, great. If they fail, who cares? They can just get back in line for more taxpayer money.

    Private equity, on the other hand seeks "gazelles" because investors are seeking profits. It's funny how you get good at picking winners when it is your own money on the line.

  • sloopyinca||

    Dude, you need to call or txt me. We're going to be down Wednesday night (probably)for the book shindig. We need to drink.

  • Robert||

    Decades ago an article in The Freeman laid it out with the numbers: It was big businesses, not small, that were creating the most jobs.

  • Proprietist||

    This article seems to be based on the ludicrous notion that small business welfarism and preferential treatment exists in anywhere near the same realm as big business welfarism and preferential treatment. The SBA should go away undoubtedly, but it is chump change compared to TARP, the military industrial complex, preferential Fed loans to big businesses, the countless loopholes that only the biggest corporations have the accounting and legal resources to exploit, competitive welfare for professional sports, local tax breaks for megachain relocations, etc.

    Many megacorporations with political connections pay zero taxes, while their smaller business competitors, who already lack competitive advantage in the first place, get shafted and audited.

    Small business gets great lip service (for they are comparatively harmless, blameless for economic problems and carry populist charm with voters). But big business gets free BJs, even from the politicians that claim that giving big business BJs is disgusting.

  • John||

    The SBA should go away undoubtedly, but it is chump change compared to TARP, the military industrial complex, preferential Fed loans to big businesses, the countless loopholes that only the biggest corporations have the accounting and legal resources to exploit, competitive welfare for professional sports, local tax breaks for megachain relocations, etc.

    Your post ignores the massive preferences small business get in contracting. If you think that the military industrial complex doesn't benefit small business, you clearly don't know what you are talking about.

  • Proprietist||

    You're right. I wasn't aware that small business was being given multi-billion dollar contracts to build jet fighters the Pentagon said it doesn't really need. This one $66.7 billion piece of needless corporate welfare alone would fund the SBA for 6 years.

    Point being, bigger fish to fry. I wouldn't shed a tear for the end of the SBA, provided all the other corporate welfare, subsidies, contracts and preferential treatment goes away first (or simultaneously). Until then, the SBA is merely helping small businesses keep up with the government's preferential treatment to their larger competitors.

  • John||

    Yeah because those multi billion dollar contracts all go to one company. No subcontractors or anything.

    If you think Lockhead builds a fighter all by itself instead of relying on subcontractors all of whom benefit from small business preferences, you don't know what you are talking about.

  • Proprietist||

    I don't deny it would benefit some small businesses. It just benefits Lockheed Martin predominantly. Of course, it shouldn't exist on any scale in the first place, and it would still be just as wrong and wasteful if they divvied it up amongst a hundred small businesses. But it's hard to dispute that the bulk of corporate welfare does not go to small businesses.

    Wal-mart getting a specialized tax break to move into your neighborhood probably benefits some small businesses in the area too (at least the ones that aren't directly competing with Wal-Mart).

  • KPres||

    But it's hard to dispute that the bulk of corporate welfare does not go to small businesses.

    What does that mean without context? Even if I assume it's true, don't big businesses represent most of the revenues generated in the economy? And wouldn't they garner benefits from their size even in a free market (ie, network effects)? I'm not saying your perspective is wrong, I just don't see how this is so black-and-white.

  • KPres||

    I don't know, I'm a small business owner, and the local Air Force base is pretty much my sugar daddy. Took a while to get locked in, but at this point, they pretty much throw money at me. And just think how many thousands of other little guys are getting the same deal.

    In general, any government contract I get is going to be 20% higher than it's private equal. Most of that is due to compliance costs and the general PITA it is to deal with the government, but don't think a good chunk doesn't end up in my pocket as well.

  • triclops||

    The small business feitshism, on the prog side at least, is a way for them to pretend they don't hate all of the free market, just "big ________".

    It is similar to when the MSM decides to like some milquetoast republican moderate for a while when he goes against the repub establishment.
    "See, we don't hate all R's, we can be nice to one for a few weeks!"

  • Proprietist||

    I'm libertarian and I dislike big business in practice (though not in concept), as it is largely a function of the government's socialization of risk (aka state incorporation), prioritizing profits and growth over responsibility and individual rights.

    In a true free market, businesses would naturally be smaller and have safer practices to offset liability risk to their owners, and the prohibitive cost of liability insurance would naturally end the concept of infinite growth in dangerous industries.

  • NihilistZerO||

    Nice balanced post. The dogmatic approach to libertarianism says any cut, any where, any time, is good. In reality the Republican Party has shown this futile in practice. The big boys never see the cuts (The MIComplex grows unabated) and the cuts in support for small businesses, etc justify the increase in the welfare state once Dems get to the leavers of power again.

  • KPres||

    "I'm libertarian and I dislike big business in practice (though not in concept), as it is largely a function of the government's socialization of risk (aka state incorporation)"

    How does this socialize risk? It's creditors that get shafted (often other large corporations), not the public at large. And have you never heard of an LLC (aka, small businesses that get essentially the same benefits as a c-corp without the extra taxes)?

  • Smallbizowner||

    Small is relevant in that job creation from so called gazelles occur as these small businesses grow to become big businesses. She is right though that being for small biz in general is bad public policy as most of the small mom and pops never create more than a job or two. The fact is the government talks a lot about small business but most of its policies have little beneficial effect for these businesses. They need to get out of the way.

  • sweeterjan||

    grow larger. This subset http://www.vendreshox.com/nike-shox-r4-c-9.html of small firms, not small firms in general, is the powerful job creator of every central planner’s dreams.

  • Robert||

    So...it's the shoe business that grows the economy, eh?

  • jason||

    The small business provides a great income to the states and these types of news gives the message to the small entrepreneurs.

  • Skippy||

    I agree. Small businesses suck. Only big business is the way to go. Too big to fail is even better. I remember when Chrysler shut down its plant here. Tens of thousands laid off. The town was ruined. But small business suck, so that's okay.

  • KPres||

    If the town was ruined when Chrysler left, then didn't the town owe its existence to Chrysler in the first place?

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