Say you own a small business making cake pops during the throes of the Great Recession. Luckily, you have the baker’s touch: Everything turns into sugar and profits. But then your oven breaks and you need a new one. How would you pay for it?

If you had the cash on hand, you could buy the oven using your own profits. The alternative is to get a loan, but the Great Recession was an era of timid banks and tight credit. The bank officer takes one look at your credit score, your overleveraged house, and says “no thanks.”

Between 2007 and 2012, roughly 60 percent of America’s job losses happened at companies with fewer than 50 employees. Put another way: Between 2007 and 2009, small companies lost 11 percent of their jobs; large companies lost 7 percent.

Why did small businesses suffer so badly in the Great Recession? One explanation is that they just couldn’t get loans. The recession inspired widespread wariness among the nation’s lenders. Large companies could still raise money in this climate by selling bonds or selling stock. But small companies were at the mercy of banks. Many believe the banks were too stingy, and that this caused unnecessary job losses.

To test this theory, economists at the Federal Reserve observed something of a natural experiment in the fallout of the Great Recession.

Not all businesses, they noticed, depend on outside financing to the same extent. Different industries have different habits. For instance, mining operations tend to rely heavily on borrowed or investors’ capital. There are a lot of upfront costs (digging a mine comes to mind), and profits might not show up until years down the road. Clothing makers, in contrast, tend to buy equipment and raw materials out of their own profits.

Using a database of companies and how they spent their money, the researchers sorted different industries by their proclivities for outside money. Some of the most dependent industries were furniture stores and metal mining; some of the most self-financing were forestry and insurance.

If credit constraints really did harm small businesses during the Great Recession, then the businesses in credit-dependent industries should have suffered more. That’s exactly what the researchers found in their working paper, where they argue that “financing constraints of small firms were one of the important drivers of unemployment dynamics in the U.S. during the Great Recession.”


Here are the key charts from their paper. In the top row, the researchers classified industries by whether they had low, medium, or high dependence on external financing. Start with panel (b), which shows that among small businesses, unemployment spiked the most in industries that were heavily dependent on outside money. Then, look at panel (a), which shows no such relationship among large businesses, who were big enough to raise money on their own.

The bottom row shows the relationship between unemployment and company size. In industries that were not heavily dependent on external financing, small and large companies did not differ. But in industries that were dependent on outside money, large companies fared much better than the small ones, who withered without access to loans.


The researchers also graphed their results over time. In industries with low dependence on external financing, companies large and small moved through recessions in the same way. The credit crunch did not affect these small businesses more, because small businesses in these industries didn’t need that much credit to begin with. In industries with high dependence on external financing, though, we see a big difference between the experiences of large and small companies, which highlights the differences in access to credit.

One criticism of the paper is that certain industries may have suffered beyond issues around access to loans. Here are the top 10 industries ranked by how much they rely on outside financing:

  1. Pipelines, except natural gas
  2. Metal mining
  3. Home furniture, furnishings, and equipment stores
  4. Water transportation
  5. Construction
  6. Transportation by air
  7. Building materials, hardware, garden supply, and mobile home dealers
  8. Automotive repair, services, and parking
  9. Automotive dealers and gasoline service stations
  10. Oil and gas extraction

Notice the problem? Since this was a housing crash, there are reasons to suspect that construction may have thrown off some of the results. But even when the researchers excluded construction jobs from their counts, they still arrived at the same conclusion. Small companies lost more jobs during the recession if they participated in industries that heavily relied on external financing. By a rough calculation, the authors say that the lack of loans to small companies was responsible for about 8 percent of the increase in the unemployment rate during the recession.

This is not to argue that banks should open their ledgers to all small businesses, though. A high-profile study recently found that counties where the Small Business Administration facilitated more loans ended up with slower income growth. The authors of that study speculate that the SBA programs may have diverted money from more profitable companies toward smaller, more risky companies.

Just as there can be too much lending, this paper contends that there is such a thing as too little lending. Credit is like fertilizer: Too much smothers, but too little starves the vulnerable shoots.