It’s a refrain we’ve all heard many times before: Small businesses are the engine of job creation in America. Small Business is the engine of job creation in America, right? We’ve heard that over and over again from politic ians on both sides of the aisle. At one of the stops on his three-day, three-city bus tour last week, President Obama took to the stage to talk about the importance of small businesses in getting the economy back on track. “We genuinely believe that small business is the backbone of America. It’s going to be the key for us to be able to put a lot of folks back to work,” Obama said.
The trouble is, small business’s role as the star of job creation is not completely accurate. It’s true that small businesses—defined generously as companies with fewer than 500 employees—account for more than half of all private-sector employment, but the repeated emphasis on those businesses may overshadow some broader truths about the job market. Small businesses do create the most jobs overall, but as the businesses shrink or die off, they also eliminate the most jobs, leaving little net gain. And while the Small Business Administration says companies with fewer than 500 employees have generated nearly two-thirds of all net new jobs over the last 15 years, economists who sliced the jobs data differently reported in an August 2010 paper that the size of businesses doesn’t really matter when it comes to adding jobs — but their age does.
“The only group that disproportionately creates jobs is startups,” says Ron Jarmin, assistant director for research and methodology at the U.S. Census Bureau and coauthor of that research paper, titled “Who Creates Jobs? Small vs. Large Vs. Young.”
Startups account for only about 3 percent of U.S. employment, but they account for nearly 20 percent of the gross number of jobs created year to year, according to Jarmin and his coauthors. And the net new jobs from startups can be credited for all the job growth in the U.S. over a stretch of roughly three decades starting in the late 1970s, according to Robert Litan, vice president for research and policy at the Kauffman Foundation, which promotes entrepreneurship. That’s because while other businesses both create jobs and destroy them as they grow and shrink in a changing economy, startups by definition only add workers initially.
Many of those startups will fail, of course, and kill off jobs in the process, but some new businesses that survive also go on to thrive and grow—think Google, Facebook, or Groupon—rapidly adding lots of employees. That historic importance of young businesses may be why Obama made a point of specifically mentioning startups along with small businesses his remarks last week.
Now with the economy still struggling to dodge a double-dip recession and with the unemployment rate hovering stubbornly above 9 percent, it’s clear that mass layoffs at large companies have taken a significant toll. But a sputtering job-creation engine at startups has also played a large part. So as the president gets set to make a post-Labor Day announcement about initiatives intended to boost employment, a slew of other data suggest he’ll need to confront some troubling trends that indicate a broader decline in American entrepreneurship.
The Kauffman Foundation highlighted three negative developments in a report released last month: Fewer new companies are being born, they’re hiring fewer employees, and they are dying off faster than they had in the past.
“The United States appears to be suffering from a long-term leak in job creation that pre-dates the recession and has the potential to persist for an unknown time,” Litan and E.J. Reedy wrote in the report. “The heart of the problem is a pullback by newly created businesses, the economy’s most critical source of job creation, which are generating substantially fewer jobs than one would expect based on past experience.”
The number of new establishments rises and falls with the economy, but has been in decline in recent years. The Bureau of Labor Statistics says that, after climbing through the late ‘90s, the number of new businesses in the year ending March 2010 was lower than in any other year since 1994, when the agency began tracking such data. The 12 months ending in March 2010 had 505,000 businesses less than one year old, off from a peak of 667,000 in 2006 and lower than the 550,000 in existence in 1993-4 (see chart below).