Fixing the Broken Economy

Why Small Business Matters

We've been doing a little thinking about how helping the small business economy can save the economy in general. It's armchair economics to be sure, but it makes sense.

If Barack Obama knows what is good for the economy, he has a dedicated economic team in place working to figure out how to stimulate the small business economy.

Why Small Business Matters

Think about it. There are two economies in the United States that are very different from each other.

On the one hand, we have large public companies. We invest all of our money in these firms through our stock markets and our retirement savings vehicles. As such, in addition to home equity, they play a large role in defining our net worth.

We track the health of these firms through the Dow Jones Industrial Average. This simple calculation tracks the health of the largest 30 stocks on the New York Stock Exchange. If the Dow falters, we view it as an indictment of the entire economy.

On the other hand, in juxtaposition to the large companies, we have small businesses. You see them on the street as you drive around your neighborhood. You might work at one. You probably frequently buy goods and services for them.

So, let's say I make you Economy Czar. I give you $500 billion and I ask you a simple question:

You can either spend this to stimulate large businesses or you can spend it to stimulate small businesses. Which do you choose?

It's the Small Business Economy, Stupid

If you chose to stimulate small businesses, you've made the correct choice.

Let's say you split the United States into two separate countries, Large Business USA and Small Business USA.

In Large Business USA, you have all the businesses that employ 500 or more people and you have all the people who directly work for those large companies.

In Small Business USA, you place all the businesses that employ fewer than 500 employees.

It turns out that Small Business USA is a bigger country than Large Business USA.

It has a higher population.

It produces more goods and services.

It creates jobs at a faster pace.

Indeed, small businesses account for 60 percent of U.S. GDP and they have created 93 percent, or 21.9 million, of the new jobs in America since 1989.

So, given that it's a bigger part of the overall economy, your best choice is to stimulate the small business economy.

Is Small Business Chicken or Egg?

Of course, your counterargument might be that many small businesses exists only to meet the needs of larger businesses.

For example, would a small PR firm that has IBM as its largest account survive if there were no IBM?

The counterargument to the counterargument is to ask whether IBM could survive if there were no small or mid-sized businesses buying its wares? If the consumers who work at small businesses never bought a thing from IBM, would IBM survive?

At the end of the day, economies exist to serve human needs. Large companies are not in the business of serving large the end of what can be a very long chain there is a human getting some good or service. In this respect, each human is the ultimate very, very small business. (Indeed, three quarters of U.S. businesses have no employees at all.)

So it's a chicken and egg scenario. Which is more important to the economy? No economist has an answer to that one.

Why Small Business Comes First

But what truly drives economic growth is the rate at which currency circulates through an economy. When currency sits idle, economies stagnate at best and fail in the worst case. It's like a car with no oil.

You can bailout the banks but if they sit on the money, there is no economic stimulus. In order to resuscitate an economy, dollars need to move from wallet to wallet, from cash register to cash register, from checking account to checking account. The faster that movement, the better the economy does.

It's called the velocity of money, if you want to use the economics lingo. If velocity is high, money is circulating quickly, and a relatively small money supply can fund a relatively large amount of purchases and economic growth.

So who puts dollars back into circulation faster? Large companies or small companies?

That's the key question to answer.

The answer is that small companies circulate money at a much faster rate than large companies.

A dollar that comes into a small business leaves the business at a much faster pace than a dollar that lands at a big business.

So, if you want to stimulate the overall economy, you have to stimulate the small business economy first.

Another Way to Look At It

Here's another way to examine whether small businesses are more important than large businesses in reviving an economy.

Consider two firms. One is the small PR firm that serves IBM. The other is IBM.

Let's say the PR firm has 5 people. IBM has 390,000 employees worldwide.

How much NEW revenue does the PR firm need to hire a $40,000-per-year employee? It of course varies from firm to firm, but if they got another $100,000 in cash flow, you can bet they would hire a new employee to get the work done.

How about IBM, our token large company for this discussion? If they got an extra $100,000 in cash flow would they need to hire an additional employee?

Probably not. That's because they already have infrastructure and economies of scale in place that allow them to accept that additional revenue without hiring more people.

If anything, they are getting more and more productive over time because they have the resources to do so. So, in theory, they can even drop an employee when that additional $100,000 in cash flow comes in the door. (Not because of the new money but simply because they are getting more efficient.)

So, again, if you are looking at job creation as being something that can help turnaround an economy, you get more bang for your buck by stimulating small companies, rather than large companies.

So, Obama, if you Top 10 To Do List for 2009 does not include "Figure out how to stimulate small businesses and help them to grow," then you are getting some bad advice from your economic team.

By the way, Obama, you absolutely should restore the SBA to a Cabinet position. Send a message to Main Street America that you care about small business, and you may be pleasantly surprised at what happens after that.

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Do you agree that the small business economy should be a higher priority than the large business economy? If not, what's your reasoning? How about any ideas on how to stimulate the small business economy? Share your thoughts below.

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