There are nearly 5 million small businesses in America, firms with less than 500 employees.On average, they employ 11 workers each and produce $1 million of output annually.
They account for 60% of job creation, and nearly half of all employment and economic output.
But, says Citigroup, “the US small-firm sector is under substantial stress.” Small firm employment has declined about 20% relative to large firm employment versus its peak in the mid-1980s — including a 10% drop since the late 1990s.
And the small-firm share of output produced by the private sector has declined to 45% in 2010 versus 50% in 1998. And, as the chart at the top shows, the birth rate of new small firms – the number created in a given year relative to the total number of such firms – has fallen to around 8% vs. 10% before the financial crisis and 12% in the 1980s.
Photo: James Pethokoukis
Some of the decline can be blamed on short-term reasons. Small firms make up a good chunk of the construction and real estate sectors, both hard hit by the Great Recession and Not-So-Great Recovery. But longer-term, structural issues also play a role. Citigroup:
First, large firms account for the lion’s share of U.S. exports and, as such, have been better positioned to benefit from the rapid growth of emerging market economies and globalization trends more generally. Consistent with this observation, we find that a depreciation of the dollar systematically raises large-firm employment relative to that of small firms.
Second, we find that large firms tend to be in more capital-intensive industries, which means that these firms have likely benefited more directly from the decline in interest rates that has occurred over the past 30 years.
A third structural headwind appears to have been the ongoing consolidation of the U.S. banking system. This has brought with it a declining role for small banks, which traditionally have been major suppliers of credit to small firms.
Our sense is that such structural forces are likely to continue to favour large firms for some time to come.
The requirements of the new healthcare law may prove to be another structural headwind for the small-firm sector.
From a public policy perspective, the key would be to focus on entrepreneurship and the expansion of young firms — they’re the engine of job growth — rather than small firms in general.
Indeed, research from the Kauffman Foundation finds that the fastest-growing 1% of firms typically account for about 40% of US job creation. And of that group, three-quarters are less than six years old.
Given the Citigroup findings, an entrepreneurship agenda might include a) a less concentrated banking system and b) getting business out of the health care business through consumer-driven reform.
Beyond that, perhaps eliminating capital gains taxes on long-term investments and creating a more-skilled workforce. NGDP level targeting might also play a role, as Evan Soltas argues:
Economists believe that firms in the United States are risk-averse, and that’s not a bad thing in itself, but it does imply that nominal instability has real costs in the long run. In other words, if the economy is constantly swinging from boom to bust in NGDP, then if I run a business, I won’t invest as much as I would have if the economy grew with more stability, because I am afraid that if I invest (say, I open a new storefront) and a recession comes, then my investment will lose value.
Now expand this consideration of one firm to the entire economy: when NGDP growth is unstable, firms make fewer investments — factories buy fewer machines, merchants open fewer stores, companies hire and train fewer employees, etc. — and what this means is that, in the long run, the economy grows more slowly because productivity increases more slowly.
Alternatively, stable NGDP growth, which would be achieved by targeting NGDP, could increase the rate of long-run real growth because of the tendency of firms toward risk aversion when they invest.
More ideas welcome.
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