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Small Thinking About Small Business: A Rebuttal to Jared Bernstein

AcornsIn his 1974 opinion in Geduldig vs. Aeillo, Supreme Court Justice William Rehnquist asserted that discrimination on the basis of pregnancy was not tantamount to discrimination on the basis of sex. His classic sentence expressing this tortured logic was: “Pregnancy is of course confined to women, but it is in other ways significantly different from the typical covered disease or disability.” 

It is a similar twisting logic that leads Jared Bernstein to conclude, in a New York Times op-ed (“Small Isn’t Always Beautiful,” 23 October 2011), that even though start-up businesses critical to job growth tend to be small, small businesses themselves do not matter. Come again?

I like and admire much of Jared Bernstein’s work, but he really doesn’t understand the case for small business. Having spent much of his professional life in the labor-funded Economic Policy Institute, Bernstein comes to most economic discussions with a visceral skepticism about small businesses generally (because many have historically supported Republican policy agendas) and a comfort with large businesses generally (because they are more likely to be unionized). He appears to be largely unaware of new small-business groups like the Business Alliance for Local Living Economies (BALLE) that favor progressive change and embrace labor rights. 
 
Bernstein’s piece is valuable for two reasons. It’s a nice summary of a common skeptical view of small business to which small-business supporters like us need to respond. Second, it’s clear evidence that our arguments – about the importance of small businesses in economic development – are gaining strength and therefore, from Bernstein’s standpoint, need to be rebutted.
 
Over the last year, research funded by the Kauffmann Foundation (among others) has proven that small businesses are the “engine of job growth.” According to one widely circulated paper by E.J. Reedy and Robert Litan, entitled “Starting Smaller; Staying Smaller; America’s Slow Leak in Job Creation”: “Conventional wisdom about job growth tends to focus on the jobs that are being created at existing (typically big) companies. But as a wealth of new research has shown, new businesses are vital contributors to a health jobs market.”
 
Bernstein attempts to debunk this: “In fact, according to path-breaking work by the economist John C. Haltiwanger and his colleagues, once they accounted for the outsize contributions by new and young companies, they found ‘no systematic relationship between net job growth and company size.’”
 
Weirdly, the Kauffmann researchers based their conclusions on the exact same paper. Does the Haltiwanger paper actually say the opposite of what Reedy and Litan claim? Hardly. Here’s one of its conclusion:
 
“We find some evidence in support of the popular perception that small businesses create more jobs along the following lines. If one looks at the simple relationship between firm size and net growth rates, there is evidence that net growth rates tend to be higher for smaller as opposed to larger businesses….Using our preferred firm size classification ….the inverse relationship between net growth rates and size remains but is not overwhelming.” (p. 29) 
 
In other words, small businesses are superior job creators, just not quite as superior as some advocates have previously suggested. The key finding of the paper – which Kauffmann made its own headline – is that the age of the firm is a more robust variable than size.
 
“Our findings suggest that it is particularly important to account for business startups. Business startups account for roughly 3% of the U.S. total employment in a given year. While this is a reasonably small share of the stock, it is large relative to the net flow….Startups tend to be small so much of the truth to the popular perception is driven by the contribution of startups, which are primarily small, to net growth.” (p. 30)
 
The research doesn’t negate the role of small business, it sharpens it. It underscores that small start-up companies are the key to job growth in our economy.
 
So what about the line in Haltiwanger’s paper, which Bernstein highlights, that there’s no ‘no systematic relationship’ between net job growth and company size? What it means is that if, through statistical analysis, you subtract the impact of “new and young firms,” there is no relationship between firm size and job creation. But that doesn’t change the fact that most “new and young firms” also happen to be small. Bernstein is implying a conclusion that’s the opposite of the evidence.
 
Bernstein next says, accurately, that “57% of total compenstation is paid out by companies of 500 or more employees, with most of that coming from the largest, those with at least 10,000 employees.” Since small businesses pay less, he seems to be implying that they are less relevant to national prosperity. 
 
It is true that larger businesses pay more in wages – about 29% more in the 2008 data Bernstein is using.  But the following facts suggest caution in how one interprets the wage differential:
 
-          The spread between larger and small business pay and benefits has been steadily shrinking, as U.S. manufacturers move overseas and large Wal-Mart stores paying minimum wage spread across the U.S. interior. This difference could well end in the coming decade.
 
-          There’s huge variation within each size class. Many small businesses, like law firms and hedge funds, certainly pay way-above-average compensation.
 
-          Small business proprietors tend to pay themselves very low wages as they are building up the company. “Annual payroll” does not take into account non-pay equity accumulation. Likewise, people working for small businesses tend to be thinking about the growth potential as they forego their full salary potential.
 
-          One explanation of the differences between large and small businesses is how they match labor to capital. Larger businesses apply more capital, less labor; smaller businesses apply more labor, less capital. Is it really a benefit to society to have more capital intensive businesses? Is it a pro-labor position to suggest that the higher unemployment that arises from replacing labor with capital is a virtue?
 
Bernstein then tries to belittle the role of small businesses by reporting that “new research by the Treasury Department finds that small businesses…account for just 17% of business income, and only 23 percent of them pay any wages at all.”
 
In fact, this research – “Methodology to Identify Small Business and Their Owners” by Matthew Knittel et al. – is not about the economic potential of small businesses, it’s about new ways to identify them. It’s an effort to develop a new methodology that the authors readily admit “will differ [from the definitions used by the SBA] because they are based on different data sources and concepts and used for different purposes.” (pp. 2-3) So, sure, if you define the universe of small businesses more narrowly, their income and payroll fractions of the economy will be smaller. Big deal. It’s not that the Treasury Department has in fact discovered that the existing universe of small businesses contributes less to the economy.
 
Even within this narrower universe of small businesses, the Treasury Department report shows that net income rate per dollar of receipts of small business is roughly equal to all businesses (p. 26), which underscores the yet unrealized potential of investing in small businesses.
 
It’s worth noting, finally, that Bernstein doesn’t review or engage with the studies most familiar to local business advocates. He may not even know about them These studies show:
 
-          That communities with a higher density of small businesses tend to have higher income growth, more equality, better voting participation, more entrepreneurship, more tourism, and more smart growth. (See, e.g., Edward L. Glaeser and William R. Kerr, “The Secret to Job Growth: Think Small,” Harvard Business Review, July–August 2010.)
 
-          That from the perspective of communities, a local business (typically small) contributes two to four times more to local economic development than do nonlocal businesses. (See, e.g.,  various studies at www.civiceconomics.com )
 
-          That from the perspective of government-led economic development, small businesses produce more jobs per unit dollar than do larger nonlocal businesses. (See my 2006 book The Small-Mart Revolution.)
 
If one adds the lessons of these studies to those of the Kauffmann Foundation, government agencies at all levels would be smart to focus economic-development efforts on companies that were small, local, and young.  Bernstein’s position that small businesses do not matter, driven by a Rehnquist-like logic to avoid admitting the obvious, sadly prevailed within the Obama Administration in its big-business stimulus policies, and is one reason why the President’s job creation record has been so disappointing and our economy continues to stagnate. 
 
Michael Shuman is director of research for Cutting Edge Capital, director of research and economic development at the Business Alliance for Local Living Economies, and a Fellow of the Post Carbon Institute. He is the author of 'Local Dollars, Local Sense: How to Shift Your Money from Wall Street to Main Street and Achieve Real Prosperity', forthcoming in 2012 from Chelsea Green and Post Carbon Institute.

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