Are Small Businesses the Engine of Job Growth?

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Are Small Businesses the Engine of Job Growth?

By Marianne Brunet
January 21, 2014  Go to page 2, 3, 4, Next

What do George W. Bush, Bill Clinton, Ronald Reagan and Barack Obama have in common (besides a conviction that the camera loves them)? They have all promoted the notion that small businesses are the engine of America’s economic growth. But new research shows that the role of small businesses has been overstated.

The Small Business Administration (SBA), an independent agency of the federal government, highlights the contributions that small businesses (defined as firms with fewer than 500 employees) make to the overall economy. According to an SBApublication, a major part of private-sector job generation takes place in the small-firm sector.

But according to recent studies, small-business employment has been misinterpreted for decades due to one critical issue: firm age. Newly formed firms have a disproportionate effect on net job growth, and many new companies are small.

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But even that important distinction does not tell the whole story. Large firms play a key role in creating jobs and retaining employees.

A report by Goldman Sachs economist Kris Dawsey explains that comprehensive data tracking to account for firm age is now feasible. This data reveals “the process of young firms (which do tend to start out small) growing into larger firms is the true contributor to job growth.” Dawsey states that controlling for firm age also proves that “the vast majority of small firms start small and do not grow significantly.”

I will begin by explaining why small businesses have been and continue to be credited for contributing disproportionately to job growth. I will then look at the typical lifecycle of new, small firms and compare their economic value in terms of job creation to that of large mature, firms.

What started the misconception?

More than 30 years ago, academic David Birch became the first to publish a study1 that labeled small businesses as the engine of economic growth. Politicians and the business press have embraced this finding ever since. The SBA, in its publication noted above, goes as far as to praise Birch for discovering “that the end result of small businesses’ creative destruction was a net increase in employment.” Moreov