Start-Ups Create Jobs, Right? So Let’s Stop Praising Small Businesses — and Fund More

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By pretty much any measure, lending to American small businesses is weak. Most recently, small business borrowing dropped 5% from May to June, according to the research firm PayNet, which tracks such lending. And while May’s borrowing had encouragingly reversed a four-month decline, June’s numbers were actually in sync with a broader trend.According to the recent annual report from U.S. Small Business Administration Office of Advocacy, a year-0ver-year comparison of outstanding loans to the nation’s small business revealed a decrease of almost 7%, for the 12 months that ended in June 2011. At that point,  banks had $606.9 billion in outstanding loans to the U.S. small businesses, compared with $652.2 billion for the same 12-month period ending in June 2010.  That’s not good news for anybody, except maybe the Romney campaign.

But understanding why lending to small firms is down—and how important small firms are to the economy in general and employment in particular—is not simple. Because for as much as politicians glorify entrepreneurs, it’s unclear how crucial they are  when it comes to job creation. For that matter, it’s a little unclear what we’re talking about when we talk about small business. Because one entrepreneur’s small business is another’s gigantic competitor. According to the SBA, for example, a small business is defined in one of the following ways, depending on industry:

  • Annual revenues of $750,000 or less for most agricultural industries
  • $33.5 million or less for heavy construction industries
  • $14 million or less for specialty trade contractors
  • 500 employees of fewer for most manufacturing and mining industries
  • 100 employees or fewer  for wholesale trade industries
  • $7 million or less for most retail and service industries

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That’s a wide range of range of definitions, especially given the way politicians and Chamber of Commerce types like portray entrepreneurs as an urban version of the family farmer. In fact, even the SBA’s small-business loan data is based on a a sort of proxy measure. The agency defines a loan to small business as any business loan of $1 million or less. So a $1.1 million loan to a chain of dry cleaners with $5 million in revenues doesn’t get counted, while a $500,00o loan to a 150-worker auto parts wholesaler does.

Small wonder  there’s no consensus as to why lending is down. Despite speculation that banks are still making it harder for small companies to borrow, PayNet president William Phelan says his firm’s research reveals that banks are actually making it easier. Indeed, while the most recent survey from the National Federation of Independent Business reports that 7% of respondents  in June described loans as “harder to get,” that figure is actually two percentage points lower than it was in May. And 93% of respondents said “that all their credit needs were met or that they were not interested in borrowing.”

Which makes sense. Small businesses often have a relatively thin barrier between success and failure. Facing minimal economic growth—not to mention uncertainty about the effects of healthcare reform and other regulatory and legislative agendas—only the most confident and/or desperate of entrepreneurs will increase their borrowing. And pretty much any rational business owner would be hesitant to expand, as the NFIB survey shows. The question is, How big a deal is that to the nation’s employment picture?

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Depends on who you ask, of course, but in the next few months you can expect to hear a lot about the importance of small businesses to the U.S. economy—and not just because of President Obama’s mischaracterized “You didn’t build that” sentence fragment regarding the role of  government in business creation. As they do with American small farmers, politicians overemphasize the importance of American small-business operators. That is, small farmers aren’t the reason U.S. food prices have plummeted over the decades (adjusted for inflation); most of the credit goes to the efficiencies that came with the rise of corporate farms. Likewise, medium- and large-sized firms likely account for one half to two thirds of U.S. non-farm and non-government employment. Small businesses are important, certainly, employing tens of millions of people and driving innovation. But many if not most small concerns stay that way—or go out of business entirely.

The real Little Engine That Could when it comes to job creation, as shown in a 2010 study from the National Bureau of Economic Research—”Who Creates Jobs? Small vs. Large vs. Young”—is new companies, regardless of their size. As the authors (John Haltiwanger, Ron Jarmin, Javier Miranda) concluded: “Firm startups account for only 3% of employment but almost 20% of gross job creation. The fastest growing continuing firms are young firms under the age of five.”

This distinction might seem nuanced—very few business launches start with 1,000 employees—but it’s important. When politicians criticize government for small-business-strangling regulation, they’re being disingenuous. Most small businesses fail to grow because that’s the nature of the beast. What you want, from a job-creation perspective, is government to foster an environment in which starting a business—period—is easy. It’s a numbers game really; since most small businesses will fail or stall, you want to throw as many ideas on the pavement as possible so that the small percentage of start-ups that thrive is part of an increasing  pool of new companies. The success rate may not change, but the absolute number of successes will.

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Judging by that measure, the state of U.S. entrepreneurship is ripe for meaningful discussion. On the one hand, the Romney campaign might focus on the most recent annual data for U.S. business start-ups, which dropped to a record low in 201o. Conversely, the Obama campaign might highlight the World Bank‘s most recent “Doing Business” annual report, which ranks the ease of organized commerce in 183 countries, based on business-friendly regulations. The U.S.—which finished 4th overall—ranks 13th when it comes to starting a business. That’s the second-highest ranking among the world’s 10 biggest economies.

Rather than arguing over who’s more supportive of existing small-business owners—or harping on regulations, which are not the problem; or worrying about weak borrowing, which is most likely a cyclical phenomenon—both candidates should explain how they’d help wannabe entrepreneurs take the big leap. Because the more of those folks we can guide from fantasy to reality, the more jobs we’ll create down the line.