The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

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September 30, 2010

Small businesses are the engine of job growth…or is the story more complicated?

Small businesses typically seek loans to grow their business, hire more workers, or purchase equipment needed to handle more activity. However, business owners have either been unwilling to take on debt or have been unable to find the small business loan opportunities they seek. This message is the one seemingly sent by small business owners who participated in polls such as the NFIB survey and the Atlanta Fed's own surveying efforts highlighted in past macroblog posts (here and here and also on our new Small Business Focus web page).

This week President Obama signed into law a new initiative to try to stimulate borrowing and spending by small businesses. Such policy actions are usually based on the premise that "small businesses are the engine of job growth." However, it is tempting to be skeptical of claims that talk about any large group of individuals or firms as if they are a single, homogeneous unit. Idiosyncratic features such as a firm's industry, location, or age might matter as much as does its size, which would seem to indicate that not all types of small business are equally powerful engines of job growth.

Economic research published last month by John Haltiwanger, Ron Jarmin, and Javier Miranda provides some compelling evidence on the relationship between firm size and job growth. It turns out that the age of a firm is important independent of its size. In particular, the paper finds no systematic relationship between net job growth rates and firm size after controlling for firm age. To quote from the paper's abstract:

"There's been a long, sometimes heated, debate on the role of firm size in employment growth. Despite skepticism in the academic community, the notion that growth is negatively related to firm size remains appealing to policymakers and small business advocates. The widespread and repeated claim from this community is that most new jobs are created by small businesses. … However, our main finding is that once we control for firm age there is no systematic relationship between firm size and growth. Our findings highlight the important role of business startups and young businesses in U.S. job creation. Business startups contribute substantially to both gross and net job creation. In addition, we find an 'up or out' dynamic of young firms. These findings imply that it is critical to control for and understand the role of firm age in explaining U.S. job creation."

This finding doesn't imply that firm size is irrelevant, but size matters mainly because, conditional on survival, young firms grow faster than older firms and tend to be small. In other words, because start-ups tend to be small, most of the truth to the popular perception that small businesses create the most jobs is driven by the contribution of start-ups to net job growth.

Because of the vital role that young firms appear to play in job creation, understanding the various factors that influence business start-up decisions is particularly important. To quote the conclusion of the paper:

"In closing, we think our findings help interpret the popular perception of the role of small businesses as job creators in a manner that is consistent with theories that highlight the role of business formation, experimentation, selection and learning as important features of the U.S. economy. Viewed from this perspective, the role of business startups and young firms is part of an ongoing dynamic of U.S. businesses that needs to be accurately tracked and measured on an ongoing basis. Measuring and understanding the activities of startups and young businesses, the frictions they face, their role in innovation and productivity growth, how they fare in economic downturns and credit crunches all are clearly interesting areas of inquiry given our findings of the important contribution of startups and young businesses."

One of the goals of the Atlanta Fed's new small business web page is to feature data, information sources, and research that helps disentangle the complex contributions of small businesses to economic growth and development. This web page will also highlight the findings from specific initiatives sponsored by the Atlanta Fed.

By John Robertson, a vice president and senior economist in the Atlanta Fed's research department

September 30, 2010 in Small Business | Permalink


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Also you should document the growth rates of these new winners as they get 'older.'

As with many things in business, there are often lopsided results where a few companies grow tremendously compared to the remainder. Understanding exactly what dynamics are involved in sustaining high growth rates would be worthwhile research.

Posted by: beezer | October 01, 2010 at 11:54 AM

This is a wonderful addition to the factual context of the job-creation problem.

Policies aimed at getting existing businesses to hire may be missing the point; the problem is that entrepreneurs are confused and demoralized and unwilling to take risks in an unstable environment. Someday, I hope to be one of them -- but at the moment I wouldn't go out and start a business unless there were no other way to feed my family.

I have also heard it said that a disproportionate share of small businesses are in the real estate sector, which of course is likely to remain depressed for at least another year.

But I suspect there are, or will soon be, job openings at class action law firms and forensic accounting firms, and that the foreclosure industry is going to have to triple its workforce in order to actually meet bare minimum legal standards in the future!!

Posted by: Wisdom Seeker | October 11, 2010 at 11:50 PM

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