Enterprise society

Leaking jobs in the Great Recession

The unemployment rate in the United States remains around 8.2% down from the peak of 10% it reached in 2009. If it remains high it will threaten President Barack Obama’s re-election prospects. Yet unemployment has been higher in the United States in past decades. For example, in 1982 it reached 10.8%, the rising unemployment rate of the previous year helping to bring President Ronald Regan to office.

In the 1980s the high unemployment triggered a strong interest in the role of small business and entrepreneurship to create new jobs. It was spurred on by the publication in 1979 of a study by Professor David Birch from Massachusetts Institute of Technology into job creation and destruction in the United States. This study suggested that it was small business start-ups rather than large firms that were creating the majority of new jobs.

Despite some controversy surrounding Birch’s report, the notion that small businesses are the major source of job generation led to governments around the world investing in small business start-up and entrepreneurship programs. This interest in entrepreneurship and small business formation continues today not only in the United States, but across many countries that currently struggle with the aftermath of the global financial crisis (GFC).

The dilemma of job leakage

Research undertaken by the Kauffman Foundation and published in 2011 suggests that small business start-ups are not creating the same level of new jobs that they traditionally have. Drawing on US Census data that tracks job creation and destruction over time, the Kauffman Foundation researchers E.J. Reedy and Robert Litan identified what they described as a “slow leaking” away of jobs from the US small business sector.

Of importance here is the number of new small businesses created each year that employ people other than the owner-manager, and those that are non-employing. This latter group employ only the owner via self-employment and therefore make a much lower impact on the overall employment rate.

According to Reedy and Litan’s study since 2006 the number of new employing businesses in the United States fell by around 27%. In 1999-2000 there were an estimated 4.6 million new jobs created in the small business sector in the United States as a result of new business start-ups. However, by 2009-2010 this figure had fallen to 2.5 million. This pattern is illustrated in the graph below.

Total aggregate employment of U.S. new business cohorts. Kauffman Foundation (2011)

The Kauffman study suggests that in the 1990s the average small business start-up employed about 7.5 people, but that this figure has now declined to 4.9 people per business. In attempting to explain this trend the researchers propose that small business start-ups today require only a smaller workforce, or are deliberately keeping their teams leaner.

Tracking the job creation trend amongst small firms over time indicates that while small businesses create new jobs as they grow, the rate of this job creation has been slowing. In their analysis they make the following observation:

“Summing up, one key undisputed finding emerges: The employment that a new business cohort is born with in the United States is likely the maximum employment that business cohort will experience in its lifetime”.

This trend is illustrated in the following graph that shows the steady decline in employment from the small firm’s sector over time from 1994 to 2008.

Total employment of cohort as percentage of base-year employment. Kauffman Foundation (2011)

According to Reedy and Litan the challenge for the US economy is to foster the creation of more new enterprises that are larger and employ more people, and to assist them in their growth. Of course this is more easily proposed than implemented.

The situation in Australia

Here in Australia the impact of the GFC was much milder than in the United States. In June the unemployment rate in Australia was 4.9%, up slightly from the 4.2% level it reached just before the GFC, but much better than the peak of 10.9% it hit in 1993 that posed a serious challenge to Prime Minister Paul Keating in his ultimately successful campaign against John Hewson’s “Fightback”.

However, since the GFC a two-speed economy has begun to develop in Australia. This has led to some high profile business closures resulting in job losses. As in the United States our small firms sector has a high proportion of non-employing micro-firms. Large firms (e.g. those with over 200 employees) comprise only 0.3% of all businesses in Australia, while non-employing firms make up 60% (see the following diagram).

Composition of the Australian business sector by size of firm. ABS (2010)

While comparable data to that used by the Kauffman Foundation is not available some indication of the churn over rate of Australian firms can be found within a study undertaken by the Australian Bureau of Statistics (ABS). This study examined the number of businesses that entered and exited the Australian economy over the period 2007 to 2009 at the height of the GFC.

As shown in the following diagram there was positive growth in the number of large firms with a net increase of 122 large firms in the economy in 2007-2008 and a net increase of 192 large firms in 2008-2009. By comparison the situation for medium sized (20 to 199 employees) and micro firms (1-4 employees) were one of a sharp decrease in numbers. Small firms (5-19 employees) increase slightly in the 2008-2009 period. However, for non-employing firms there was small decline of 0.5% in the second year.

Percentage change in number of Australian businesses by size of firm. ABS (2010)

On balance Australia lost an estimated 20,458 businesses in 2007-2008 and a further 20,704 businesses in 2009-2009. The majority of these were amongst the employing small firms. As small to medium sized businesses comprise around 65% of all employment in Australia, this net decline in the number small firms is a concern. This is particularly the case as the fall in business number was most pronounced amongst the employing micro-enterprises across both time periods.

The employing micro-business is usually the foundation upon which larger firms can grow. Such firms have demonstrated their desire and capacity to employ, as compared to their non-employing counterparts who primarily represent self-employment. Any future job creation is going to take place within the micro-business segment as such firms are typically new and therefore more likely to grow.

According to the OECD the proportion of people who are self-employed in Australia has declined from around 16% in 1993 to 11.6% in 2010. This follows similar declines in the United States from around 9% in the early 1990s to 7% in 2010. In fact the overall self-employment rate across the 34 countries in the OECD group has fallen from around 20% in the mid-1990s to 16% in 2010.

What does this all mean?

The trends identified by the Kauffman Foundation study suggest that small firms are not creating the same volume of jobs that they were once considered as being capable of. This has been an accepted view since David Birch published his report in 1979. However, as with most things the matter is complex.

For the small business sector to be a real engine of economic growth and job creation it must be comprised of the right kind of business. Business start-ups that are undertaken out of necessity rather than opportunity are often non-employing. Self-employment is typically undertaken by people who cannot secure paid employment, or who are seeking an alternative to working within a large organisation but do not wish to take on the stress and challenge of building a company.

Hiring employees creates numerous administrative and managerial issues for small business owners. The compliance cost of dealing with employees means that many small business owners will think carefully before taking on staff. Further, as the number of employees within a business expands from one or two to more than 5 and then more than 20 the management skills and administrative systems requirements within the business increase.

The recommendation of the Kauffman Foundation study that the key challenge is to create new ventures that employ from an early stage and then assist them to grow is one that should also resonate here in Australia. However, to achieve this will require mechanisms that can allow this type of business to succeed.

The creation of a new business that can employ from an early stage and grow sustainably over time is not easily achieved. Such firms require strong financial foundations and senior management teams that are both entrepreneurial and experienced. This type of business is often best created by a team of individuals rather than a sole trader. They are also usually found to have within the start-up team a good balance of skills and the backing of some significant financial resources.

In summary we might say that it is not the number of business start-ups that matters but the quality of these start-ups.