Small businesses and jobs

Here's a (partial) headline from earlier this week: "Small businesses keep fueling the economy." The notion that small businesses account for most job growth is politically ubiquitous; while it is technically true, it can be pretty misleading since the effect is driven by young firms. This was shown definitively in this paper (ungated here), but it's not catching on as much as it should.

Figure 1 breaks firms into four categories: large/young, large/old, small/young, and small/old (click for larger image).

Figure 1

As a group, small businesses that have been operating for 5 years or more typically destroy jobs on net. They are outpaced in job creation by both kinds of large firms (young and old) and by young small firms. Government programs that throw money at old, small businesses based on the notion that "small businesses" are big job creators strike me as a little misguided.

Figure 2 is similar, but it draws the line for "young" at startups (click for larger image).

Figure 2

I like this chart because it shows that startups were really hammered in the Great Recession (and even before it), a fact I've mentioned before. In an arithmetic sense, we "need" a lot of startups for net job growth. Firm entry is the setting for a huge amount of experimentation; startups exhibit an "up-or-out" dynamic, with some growing rapidly and others failing in short order (I did some simple cohort charts here and here). Still others reach a small "optimal" size, like your local dentist office, and won't grow again. We need more startups both to absorb the jobs destroyed by previous failed startups and to supplement the very slow job growth of incumbent firms generally. In any case, the small business meme is a good example of how aggregation can sometimes get you into trouble.

We need a better understanding of firm dynamics, in both our public dialogue and the study of macroeconomics.