Business Economics

Small Business Role in Economic Recovery

New research from the SBA suggests that small businesses are poised to play a big role in economic recovery. Economist Brian Headd explains why small businesses may be the key to new job creation.

During the last year the media has begun to pay close attention to the role small business plays in job generation.

That is because amid the mountain of previously disappointing economic statistics, small businesses provide some interesting contrasts.

While recent job losses are widespread, small businesses' historical overall rate of net job creation makes them a key player in solving our labor market woes.

And the number of newly self-employed, whether by choice or not, still offer glimmers of hope.

Lost Jobs

Unless your age is measured in single digits, you probably have direct knowledge that the labor market has had its ups and downs.

The U.S. Bureau of Labor Statistics (BLS) reports that nonfarm, private sector employment peaked in December 2007 at 115.8 million then fell to 109.5 million by May 2009.

During this period, job losses from mass layoffs (more than 50 layoffs from one location) numbered 3.6 million, up 66 percent over the preceding 18 months.

The loss of over 6 million net jobs is a problem that needs a solution.

Creating New Jobs

Where will the new jobs come from?

There may be clues in the recoveries from the two most recent economic downturns, in 1991 and 2001.

When considering small business employment, remember that there are two kinds of small businesses: those without employees (or non-employer businesses), and those with paid employees (or employer businesses).

The Office of Advocacy estimates that in 2008 there were 23.1 million nonemployer and 6.1 million employer businesses.

When the economy struggles, the number of nonemployers tends to increase at higher rates, while the number of employer businesses stagnates or declines.

For example, when the economy was humming along during the late 1990s, non-employers had annual increases in the 2 to 3 percent range; as the economy limped along from 2007 to 2008, they increased an estimated 8.1 percent or 1.7 million.

The change in the number of employers is not nearly as sharp. Employers have tended to have annual increases of 0.75 percent to 1.5 percent when the economy has done well and negative to flat when the economy struggles. Employer firms contracted by -0.5 percent during the 1991 downturn and grew 0.1 percent in the 2001 period.

Nonemployer growth is not simply a response to economic factors; many personal factors cause people to go into business for themselves too. For instance, self-employment rates increase with age, income, and generally with education.

The number of employer business start-ups is affected by the economy, but again, probably less so than one might guess.

BLS's Business Employment Dynamics data show that the business startup rate (percent of businesses that were new in the quarter) for the first three quarters of 2008 averaged 2.8 percent, versus 3.0 percent in 2007 and 3.2 percent in 2006.

But new businesses are only part of the job creation story. Employment created by start-ups (minus the job losses from firm exits) accounted for 30 percent of the private-sector net employment increase from 1993 to 2007, while continuing businesses provided the remaining 70 percent.

The 1.7 million increase in nonemployers is a lifesaver for many individuals and families. But since a large portion of nonemployers work less than full-time, when we talk about expanding the job market, we are most interested in employer firms.

In the aftermath of the 1991 downturn, firms with 20-499 employees led the employment expansion, while the smaller and larger size classes struggled.

During the 2001 downturn, larger firms (500 or more employees) experienced the greatest net employment losses, followed by firms with 20-499 employees.

The smallest firms, with fewer than 20 employees, weathered that storm.

The current downturn is shaping up more like 1991 than 2001. Data from the Bureau of Labor Statistics attributed 35 percent of the net job loss during the first three quarters of 2008 to firms with fewer than 20 employees, whereas in 2001 through 2002 they accounted for less than one percent of the net loss.

So a labor solution is more likely to be found by studying the 1991 downturn rather than the 2001 dip.

Our best hope for job creation may shape up to be expansion of existing firms with 20-499 employees.

Article written by by Brian Headd, Economist at the U.S. Small Business Administration Office of Advocacy. This article was originally published in the July 2009 issue of The Small Business Advocate.

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