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Economics: Small Business & Job Creation

Michael Pakko
Written by Michael Pakko

April/May 2016 Issue

Does Size Really Matter?

When it comes to economic development and employment growth, news about large employers often grabs the headlines. Politicians and economic developers are eager to share the credit when big companies set up shop locally or expand existing operations. Similarly, the departure of a large employer is duly noted by the press as newsworthy, if not cataclysmic event. Small-business advocates, on the other hand, argue that it is the smaller firms that really drive the dynamics of growth and employment in our economy.

They Say Smaller Is Better

The role of small business in job creation has been an active topic of economic research. A seminal 1979 study found that firms with 20 or fewer employees accounted for two-thirds of new job creation, and firms with 100 or fewer employees accounted for 82 percent of new jobs. Subsequent research challenged the magnitude of those figures, pointing out that although small businesses do create a huge number of jobs, they are more likely than large firms to go out of business. In other words, while job-creation is high at smaller firms, so is job destruction.

Some recent U.S. figures from the Bureau of Labor Statistics’ Business Employment Dynamics dataset bear this out. From 2010 to the second quarter of 2015, firms with one to 19 employees generated 32 percent of total new jobs created nationwide, but after accounting for job losses, the net contribution was only 18.4 percent. On the other hand, companies with more than 500 employees accounted for gross job creation of 19.1 percent of all new jobs, yet 34.3 percent of net new jobs were created at these larger employers.

Nevertheless, even taking account of the distinction between gross and net job creation, businesses with fewer than 500 employees accounted for more than 62 percent of net new jobs created. Small business contributes significant net job growth — in spite of the volatility generated by business failures and their consequent job-losses.

The table below compares the distribution of employer sizes for Arkansas and the U.S. These numbers are not job flows, but reflect total employment levels at a specific point in time. While larger firms, with 100 or more employees, constitute a much higher proportion in our state than in the U.S., these firms do not account for a higher share of total employment in Arkansas. It would appear, therefore, that the engine of small-business job creation is active in Arkansas, but the impact of having relatively more large firms does not translate into higher employment from that segment of the employer base.

But Is It Really Size That Matters?

Research has shown that the net job creation by small firms might not be as substantial as early estimates had suggested, but it is significant nonetheless. A consensus had emerged indicating an inverse relationship between firm size and growth, which implied that small firms contribute disproportionately to net job growth.

But more recent research has brought even this fundamental relationship into question. It turns out that after controlling for the age of the firm, the relationship between size and growth disappears. That is, expansion and job growth tends to take place at younger firms and young firms also tend to be small. But it is the age of the business, not the size, that matters. These more recent findings suggest that policies targeted to help businesses of a certain size — small or large — are poorly focused.  Rather, it is the youth and innovation of business startups that generate the job growth that has typically been associated with “small business.”

This is not to say that businesses should be targeted for assistance based on their tenure. There are plenty of new ideas that should and do fail, as evidenced by the data. So a policy of picking winners and losers would be fraught with peril. It would make more sense to help entrepreneurs by facilitating opportunities to get new businesses going, and then let the marketplace sort out the value of their new ideas.

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About the author

Michael Pakko

Michael Pakko

Michael Pakko is chief economist and state economic forecaster at the University of Arkansas at Little Rock’s Institute for Economic Advancement.

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