The unhelpful lionization of small business

By Felix Salmon
October 24, 2011
Jared Bernstein has the wonky version in the NYT, but Jim Surowiecki has the soundbite:

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Jared Bernstein has the wonky version in the NYT, but Jim Surowiecki has the soundbite:

Small businesses are, on the whole, less productive than big businesses, and though they do create most jobs, they also destroy most jobs.

Both of them are making the important point that high-flying rhetoric about the importance of small business is much better politics than it is policy. We’ve been hearing a lot about the individual 99% of late; here’s the corporate 99%, from Bernstein.

New research by the Treasury Department finds that small businesses — defined as those with income between $10,000 and $10 million, or about 99 percent of all businesses — account for just 17 percent of business income, and only 23 percent of them pay any wages at all.

The facts of the matter are stark: larger businesses are more productive (this will come as a shock to anybody who spends most of their life in meetings, but it seems to be true), and they even create more jobs, once you control for firm age. Or, to put it another way: it’s not small businesses which create jobs, it’s startups. Here’s the chart, from this paper by Haltiwanger, Jarmin, and Miranda (HJM):

haltiw11.png

The statistic that small companies create the most jobs comes from the purple line. But firms mean-revert when it comes to size: as they fluctuate in size over time, they tend to add jobs when they’re smaller, and lose jobs when they’re bigger, and even if they add no jobs overall, that still makes it look as though smaller companies add more jobs.

If you control for mean-reversion effects and look at a firm’s average size, the effect seen in the purple line becomes much less pronounced, and you get the green line instead.

And then look what happens when you add age controls — that is, when you control for the fact that younger companies are more likely to create jobs than older companies. A small family business which has been around for decades is unlikely to be an engine of job growth; meanwhile, large young companies (think Groupon) can hire extremely quickly.

Once you adjust for company age, you get the blue line in the chart — small companies actually lose jobs, on average, and it’s not until you get to about 500 employees that they manage to create any jobs at all.

Here’s Bernstein:

The big story here is that startups—which can only grow at first but which also have high death rates—play an important role in these dynamics. They’re small at first, and many perish—about 40% of the startups’ jobs are lost through firm death after five years. But if they survive, they will generate significant job growth (HJM: “conditional on survival, young firms grow more rapidly than their more mature counterparts”).

This finding and the flip of the lines in the figure when the proper controls are applied have important policy implications. Once we account for the startup effects, small businesses, per se, are not the engines of job growth they claim to be.

The policy implication here is that if you want to create jobs, you’re much better off encouraging startups than you are bending over backwards for small businesses, most of which are reasonably long in the tooth. And the interests here do diverge, although of course there are overlaps.

For me, the most important difference is the degree to which the two groups are reliant on a social safety net. Precisely because most startups fail, the founders and employees at such shops need to be able to know there’ll be someone to catch them if they fall. The success of Silicon Valley can be attributed in large part to a culture where people who have worked and failed at a startup are extremely employable. But on a national level, there are good reasons why we would want to move towards the Norwegian model.

Finally, it’s worth resuscitating this classic Kinsley column from 2008: the fact is that some of the richest members of the 1% are small business owners, while many of the hard-working 99% are in fact large business owners.

Big businesses are not owned by big people, and small businesses aren’t necessarily owned by small people. The typical shareholder in a big business is a worker in some other big business whose pension fund has chosen to invest in that company. Or a retiree who has bought this stock as his or her nest egg. Or it’s somebody’s 401(k).

So the next time a politician lionizes small business owners, remember that you are in fact a large business owner. And that small business, while it sounds romantic, isn’t nearly as important as the political rhetoric tends to make it out to be.

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