Small Business, Big Fable

By Steven Pearlstein
Wednesday, July 8, 2009

One of the most enduring lies in American politics is the myth of small-business job creation.

You probably know it by heart: Small businesses create 60, 70, even 80 percent of all the new jobs in the United States.

Back in the 1980s, I was a senior editor at Inc. magazine, where I worked on some of the articles in which some of the seeds of this myth were planted. Up to that point, there was a widespread tendency to conflate the success of the economy with the fortunes of big business, so it was rather useful to have some data highlighting the importance of small firms.

By now, however, that analysis of net job creation has been repeated and embellished and oversimplified by so many lobbyists and politicians that it is only a matter of time before the magic number swells to 100 percent of job creation and small businesses will be demanding to be exempted from all taxes, all regulation and the Ten Commandments.

This is not the time or place for a long statistical explanation. Suffice it to say that, in terms of new job creation, the data show that most of it happens in a small number of very fast-growing companies that are no longer what most of us would consider small. There are lots of reasons for the success of these fast-growing firms, among them the ingenuity and hard work of their founders, the availability of capital and a culture that celebrates risk-taking.

But the dirty little secret is that a lot of small-business job growth has also been driven by the decision of big businesses to outsource many tasks that they used to do in-house. In an economic sense, jobs haven't been so much "destroyed" and "created" as they have been shifted from one company to another.

All of which brings us to the issue du jour: health-care reform.

From the beginning, President Obama and congressional leaders have said they want to pursue a reform agenda that builds on the existing employer-based health insurance system. One glaring problem with that employer-based system, however, is that every year more employers -- mostly small and mid-size businesses -- offer no health insurance. The result is that about 35 million American workers and their family members have no health insurance at all.

To fix that problem, most health reform proposals envision a new government-sponsored insurance "exchange" in each region through which all insurers would offer a basic health policy at the same price to all employers, regardless of size, and all workers, regardless of preexisting health conditions. For the exchanges to succeed in lowering the cost of insurance, all employers must be required to offer coverage and all employees must be required to purchase it.

The small-business lobby, however, remains just as stubbornly opposed to an "employer mandate" as it was 15 years ago when President Bill Clinton proposed it. Requiring small firms to offer health insurance, they warn, will drive millions of them out of business while sapping from all the others the profits they need to invest and grow. And since small business, as we all know, accounts for virtually all job creation, an employer mandate will stop the U.S. economy dead in its tracks.

This argument, of course, is 100 percent Grade A hooey, beginning with the myth of small-business job creation.

After all, one reason small businesses "created" all those jobs in the first place is that they enabled big companies with generous health plans to outsource work to small companies that had lower cost structures because they offered no insurance at all. If simply requiring those small businesses to offer health insurance would wipe out that cost advantage and drive them out of business, then maybe those companies weren't the great engines of innovation and efficiency that they always claimed they were.

Most likely, those small businesses today are no longer competing with big companies, but with other small firms with similar cost structures. Requiring all of them to offer health insurance wouldn't put any firm at a competitive disadvantage -- it would simply raise costs for all of them, forcing them to pass those costs on to someone else.

In the short run, that someone else would be customers. Business owners are always quick to claim that they can't raise prices because of competitive pressures, but if that were true, prices would never rise.

If a price increase is steep enough, some customers will probably decide to buy less of whatever the small businesses are selling, which could result in some job loss. But in the case of the cost of health insurance, a typical small company would be passing on a total cost increase of a couple of percentage points -- hardly the stuff of economic calamity.

Economists agree that in the long run, however, the increased cost for employee health benefits would be passed on to the employees themselves in the form of lower wages and salaries. That's what happened economy-wide in recent decades, as average wages stagnated while the cost of health insurance skyrocketed. If the same holds true for small businesses, then requiring them to provide health insurance should result in no job loss at all.

In the coming weeks, we'll find out if political mythology will continue to trump sound economic logic. After all, small businesses would be the big winners from those new health insurance exchanges, and Democrats in both the House and Senate have agreed to sweeten the proposal even further by offering tax breaks and exempting the smallest firms from any health insurance mandate. Still, most of the small-business lobby remains reluctant to sign on.

It gets you to thinking: Maybe there's a reason why these are small businesses.

Steven Pearlstein will host a Web discussion today at 11 a.m. at washingtonpost.com. He can be reached at pearlsteins@washpost.com.

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