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Monday, August 23, 2010

"Who Creates Jobs? Small vs. Large vs. Young"

Those who argue that "small businesses create the most jobs" have it partly right, but they also destroy the most jobs so that the net contribution of small firms isn't so clear.

What is the relationship between firm size and job growth? It turns out the age of a firm is important independent of size. The paper finds that "once we add controls for firm age, we find no systematic relationship between net growth rates and firm size. The paper does find, however, that conditional on survival, young firms (who tend to be small) grow faster than older firms. Thus, there is a sort of risk-return tradeoff. Startups, who tend to be small, do grow fastest if they survive, but they also have high rates of failure and job destruction.

This is one reason why the relationship between social insurance and job growth may not be negative as many on the right would have you believe. Would you be more likely to start a new business if you were sure that, if the business failed despite your best efforts, you would still have health insurance, still be able to feed your family, still be able to send your kids to college, etc. etc. I think people are more likely to start a new business and create new jobs when they know the downside is limited by social protections:

Who Creates Jobs? Small vs. Large vs. Young, by John C. Haltiwanger, Ron S. Jarmin, and Javier Miranda, NBER Working Paper No. 16300, August 2010: 1. Introduction An enduring notion about the U.S. economy is that small businesses create most private sector jobs. The notion of an inverse relationship between firm size and growth, while popular among politicians[1] and small business advocates, runs counter to that described by Gibrat’s Law (see Sutton 1997) that states the firm growth rates are independent of firm size. Attempts to definitively describe the firm size – firm growth relationship empirically have yielded mixed results.
Early empirical support for small firm dominance in net job creation comes from the studies by Birch (1979, 1981, and 1987) finding that growth is inversely related to firm size. In the years since Birch’s early work, a number of studies have demonstrated that empirical analyses of the firm size – firm growth relationship are subject to a host of statistical and measurement issues that affect how they are interpreted. For example, Davis, Haltiwanger and Schuh (1996) (hereafter DHS) highlight several issues that, once accounted for, break the inverse relationship (at least for U.S. manufacturing firms) between firm size and job creation that Birch described. ...
In this paper, we demonstrate there is an additional critical issue that clouds the interpretation of previous analyses of the relationship between firm size and growth. Datasets traditionally employed to examine this relationship contain limited or no information about firm age. Our analysis emphasizes the role of firm age and especially firm births in this debate[3] using comprehensive data tracking all firms and establishments in the U.S. non-farm business sector for the period 1976 to 2005 from the Census Bureau’s Longitudinal Business Database (LBD). We are the first to use the comprehensive LBD to study these issues. ...
Our main findings are summarized as follows. First,... when we only control for industry and year effects, we find an inverse relationship between net growth rates and firm size, although we find this relationship is quite sensitive to regression to the mean effects. Second, once we add controls for firm age, we find no systematic relationship between net growth rates and firm size. A key role for firm age is associated with firm births. We find that firm births contribute substantially to both gross and net job creation. Importantly, because new firms tend to be small, the finding of a systematic inverse relationship between firm size and net growth rates in prior analyses is entirely attributable to most new firms being classified in small size classes.
Our findings emphasize the critical role played by startups in U.S. employment growth dynamics. We document a rich “up or out” dynamic of young firms in the U.S. That is, conditional on survival, young firms grow more rapidly than their more mature counterparts. However, young firms have a much higher likelihood of exit so that the job destruction from exit is also disproportionately high among young firms. More generally, young firms are more volatile and exhibit higher rates of gross job creation and destruction.
These findings highlight the importance of theoretical models and empirical analyses that focus on the startup process – both the process of entry itself but also post-entry dynamics especially in the first ten years or so of a firm’s existence. This is not to deny the importance of understanding and quantifying the ongoing dynamics of more mature firms but to highlight that business startups and young firms are inherently different. ...

5. Concluding Remarks There is a widespread popular perception that small businesses create more or even most jobs in the U.S. We argue, as has the earlier literature, that the popular question of “what fraction of net new jobs is created by small businesses?” is not well posed. In addition, until the Census Bureau’s Business Dynamic Statistics (BDS) became available, publicly available data on firm size and growth tended to confirm the popular perception. ... As we showed..., BDS data demonstrate that, in addition to previous concerns about measurement issues, not accounting for firm age can lead to misleading inferences about the role of firm size in job creation. ...

We find that once we control for firm age, the negative relationship between firm size and net growth disappears and may even reverse sign as a result of relatively high rates of exit amongst the smallest firms. Our findings suggest that it is particularly important to account for business startups. Business startups account for roughly 3 percent of U.S. total employment in any given year. While this is a reasonably small share of the stock, it is large relative to the net flow which averages around 2.2 percent per year. Startups tend to be small so most of the truth to the popular perception is driven by the contribution of startups, which are primarily small, to net growth. ...

Most of our focus in the analysis is on the net growth rate patterns by firm size and firm age (along with the underlying different margins of adjustment). However, we also show that large, mature businesses account for a large fraction of jobs. Firms over 10 years old and have more than 500 workers account for about 45 percent of all jobs in the U.S. private sector. In turn, we show that these large, mature firms account for almost 40 percent of job creation and destruction..., the share of jobs created and destroyed by different groups of firms is roughly their share of total employment. However, this is hardly the whole story as much of the analysis in the paper shows that some groups disproportionately create and destroy jobs. For example, firm startups account for only 3 percent of employment but almost 20 percent of gross job creation. Young and small businesses disproportionately create and destroy jobs and large mature firms exhibit robust adjustments along the establishment entry and exit margins.

In closing, we think our findings help interpret the popular perception of the role of small businesses as job creators in a manner that is consistent with theories that highlight the role of business formation, experimentation, selection and learning as important features of the U.S. economy.[27] Viewed from this perspective, the role of business startups and young firms is part of an ongoing dynamic of U.S. businesses that needs to be accurately tracked and measured on an ongoing basis. Measuring and understanding the activities of startups and young businesses, the frictions they face, their role in innovation and productivity growth, how they fare in economic downturns and credit crunches all are clearly interesting areas of inquiry given our findings of the important contribution of startups and young businesses.

In a related manner, it is important to not focus only on jobs per se but also on the role of these dynamics in the patterns of productivity and earnings behavior in the U.S. We also need to develop the data and associated analyses that will permit investigating the complex relationships between young and mature (as well as small and large) businesses. It may be, for example, that the volatility and apparent experimentation of young businesses that we have identified is critical for the development of new products and processes that are in turn used by (and perhaps acquired by) the large and mature businesses that account for most economic activity. ...

    Posted by on Monday, August 23, 2010 at 10:47 AM in Economics, Unemployment | Permalink  Comments (69)


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