Correction to This Article
An earlier version of this op-ed incorrectly referred to Zoltan Acs as the SBA's chief economist. He is chief economist of its Office of Advocacy.

The little engine that can't: The myth about small businesses and jobs

By Ruth Marcus
Wednesday, September 15, 2010

It is taken as gospel among politicians of both parties that small business is the engine of job creation. "We're starting with small businesses because that's where most of the new jobs do," President Obama said this year. "Small businesses are the job generator of America," echoed Arizona Republican Sen. John McCain.

They're in good company. George W. Bush, John Kerry, Bill Clinton and Ronald Reagan have all made that claim. Only one problem: These assertions are overblown and simplistic. Take it from a reliable source -- the chief economist for the Small Business Administration's Office of Advocacy. "It's not true," Zoltan Acs told me when I asked about whether small business is, in fact, the engine of job creation. "It's half the story."

Small businesses are job creators; they are also job destroyers, as firms fail. Most start-ups do: About 40 percent of jobs created by start-ups are eliminated in the first five years. Meanwhile, established small businesses -- your neighborhood dry cleaners -- don't generate many new jobs.

The chief source of small-business job creation comes from a mere handful of firms -- the "gazelles," in the evocative term of economist David Birch -- that start small and prosper. The difficulty is that the gazelles among the herd can been seen only in the rearview mirror.

Existing firms that change with the times and expand are another major source of new jobs, but that's a phenomenon that the bipartisan fetishization of small business studiously ignores.

This conventional wisdom about small business was once revolutionary. About 30 years ago, Birch reported that small businesses were responsible for two-thirds to four-fifths of net new jobs (jobs created minus jobs lost).

Subsequent studies have supported his basic proposition: Small business plays an important, and previously overlooked, role in job creation. But the research suggests that Birch's numbers are overstated -- and that size isn't all that counts.

This matters because it serves as the basis for key policy decisions. The Bush tax cuts for the wealthy must be extended, Republicans argue, because -- all together now -- small business is the engine of job creation. The small-business bill pending in the Senate must be passed, Democrats insist, because . . . you know the chorus.

Except that the sound bite is not accurate. A 2008 paper by David Neumark, Brandon Wall and Junfu Zhang examining all businesses in California from 1992 to 2004 concludes, "Although we still find that small establishments create more jobs, the difference is much smaller than that originally suggested by Birch."

Likewise, a study that Acs conducted for the SBA found that "most, if not all, of the growth in employment comes from the 300,000 high-impact firms in the economy over any four-year period. Depending on the time period studied, this is about evenly split between firms with fewer than 500 employees (the SBA definition of small business) and firms with more than 500 employees. Therefore, it would appear that both small and large firms contribute about equally to employment growth."

A new paper by economists John C. Haltiwanger, Ron S. Jarmin and Javier Miranda adds another wrinkle to the data: the age of the business. In terms of job creation, younger is better. "Once we control for firm age there is no systematic relationship between firm size and growth," they write. "Our findings highlight the important role of business startups and young businesses in U.S. job creation."

Small business matters -- just not as much as and in more nuanced ways than politicians proclaim. Indeed, one key difference between this recession and its predecessors is that small business has been hit harder than normal, perhaps because the downturn was driven by turmoil in the financial markets.

Where a typical recession tends to wallop big businesses harder than small ones, this time around "young, small businesses have taken it on the chin more than usual," Haltiwanger told me.

Can government policy make a difference? Perhaps. If banks are wary of lending, loan guarantees, such as those in the measure awaiting Senate action, might help start-ups get launched -- and some of these might succeed in creating lasting jobs.

The argument that higher taxes would squelch job creation is far less convincing. The start-ups that need nurturing aren't apt to be the ones hit by higher marginal tax rates.

But here's a suggestion for policymaking about small business. Base it on the facts, not on wishful mythmaking -- however bipartisan.

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