Wednesday, October 5, 2011

Is Small Business the Engine of Growth?

It is common for politicians and others to say that small businesses account for most job creation. This is somewhat misleading though. Many small businesses go out of business after a year or two, so that they are also responsible for a lost of job loss. A new working paper by Erik Hurst and Benjamin Wild Pugsley suggests that small businesses are small and do not account for a lot of new employment. They note that most small business owners are not the entrepreneurs that provide the "creative destruction" Schumpeter wrote about. Instead, most small business owners do not bring a new idea to the market and do not have a desire to grow large. Instead, many are starting small construction firms, a legal practice or small retail store or restaurant. The motive is often being one's own boss rather than starting the next Apple Corporation.

Most small businesses have no paid employees. For the state of Michigan, over half of all business establishments have fewer than five employees. The Small Business Administration provides regulations that determine the size limits for "small" businesses. A table of these limits for industries can be found here. The limits are given in revenues for some industries and in number of employees for some. For example, establishments in mining have employee limits of 500, while those in transportation manufacturing have limits of 1,000 employees.

Simple explanations of the economy or job growth generally miss the mark. But politicians often look for simple explanations and simple solutions. Promoting small business will not solve the employment problem. A better solution is to provide an environment that supports business activity regardless of the size of the firm.

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