Why Things Aren't As Bad As They Seem
Even if David L. Birch's name isn't familiar to you, chances are his work is. He's the Massachusetts Institute of Technology researcher who two years ago established the fact that small companies, not big business, create most of the new jobs in the United States. Firms with fewer than 20 employees accounted for 66% of all new jobs between 1969 and 1976, according to Birch's findings. Companies less than five years old created fully 80% of all U.S. jobs during that period.
Those findings, based on computer analysis of 5.6 million companies, caught the fancy of the press and of politicians. "I didn't set out to prove any such thing," says Birch, "but that's how the numbers came out."
Since 1979, when he quietly submitted his results to the Department of Commerce, Birch's MIT Program on Neighborhood and Regional Change has extracted other startling conclusions from its very large data base. "Most researchers look at the economy and see scrambled eggs," Birch says. "We're the one group that's looked at 5.6 million businesses and can find out how the eggs got scrambled."
In other words, Birch's research methods tell him not just what has happened within industries and geographic regions, but how and to some extent why it happened. The results aren't always what you'd expect to hear, and neither are Birch's projections of trends. INC.'s Tom Richman spent an afternoon with the 44-year-old Birch in his Cambridge, Mass., office, which is sparsely furnished with only a coupld of chairs and a computer terminal.
INC: In your latest study you wrote that the trends in business location decisions show that "the future will not necessarily be like the past." You also said that it's no longer necessary for a company to make things in order to grow and to prosper. Could you explain?
Birch: Well, up to about 1820, most people in New England certainly thought of the world as agricultural one; we grew things. That changed dramatically when the Industrial Revolution hit, and for roughly 150 years we have been a nation of makers of things. But that, too, seems to have run its course. If you look at the 1970s, we created more jobs than ever before in history, something like 19 million new jobs, but only 5% of those jobs were in manufacturing and only 11% of them were in the goods-producing sector at all. So, just as New England no longer grows what it eats, as a nation we no longer make the goods we consume. To a great extent we now specialize worldwide rather than just regionally within the country. Most of what we consume is made for us by somebody else.
Take John De Lorean's car, for example. He conceived it while he was a General Motors executive, he designed it in America, he created all the production drawings in America, but he went to Northern Ireland to build it. He will sell it in America. Our market is a very good one. Our creative ability to design and conceptualize and invent is enormous. However, our relative skills at making things seem somewhat limited.
What seems to be happening is that worldwide we are working ourselves out of the manufacturing business and into the thinking business, out of hardware into software, out of physical capital into human capital, out of high-productivity sectors into low-productivity gain sectors. But in the process we're creating an extraordinary number of jobs. It isn't as though that's a bad part in the play. Indeed, it looks like it's pretty good part in the play. But it's different and that's what I meant by "the future will not be like the past." Furthermore, for individual regions of the country, the more a region was in manufacturing in the past, the more it's going into services today.
INC: If that's true, it isn't likely to be a very welcome truth in industrial areas of the country.
Birch: I can think of few changes in history that haven't been resisted. The fact is, however, that we're one of the most mobile nations in the world. Each area in the United States turns over from 8% to 12% of its population every year. People are free to move from one place to another. That's a plus, I think. The other thing is that the magnitude of the problem may be overstated. We may be reacting more to decibels than to reality. Only 13% of our labor force is engaged in manufacturing operations today. It isn't as though half our work force has this transition problem. It's relatively small percentage of our work force, and a declining one. We're not just thinking about moving out of manufacturing over the next 50 years. We've already done it.
INC: You're suggesting that regions, even the entire United States, can grow and prosper with a service-based economy. That's contrary to conventional wisdom.
Birch: There's no other conceivable way to explain how we created 19 million new jobs during the 1970s with only 5% of them in manufacturing. I think what's missing in the conventional wisdom is the notion of a world economy rather than a national economy or a regional economy. I'm not saying that somebody doesn't have to make things. They do. But it doesn't necessarily have to be Americans that make them.
INC: So what are we going to sell other people to pay our way?
Birch: This institution in which I sit sells 20% of its services to foreign students. We sell our medical facilities. I notice that magazines, including INC., do quite well all over the world. We sell all sorts of development services; much of the development in many European communities is now being done by developers from Texas. We sell new forms of insurance. We sell all different kinds of computer software. There's new hand-held computer that's about to be introduced by Quasar and Panasonic. The hardware itself is made in Japan. But the applications software, which is the key to it, is all manufactured here in the United States. It used to be that 90% of the cost of the computer installation was in hardware and 10% in software. Those percentages, I'm told, will reverse in the next 5 to 10 years. I'm told that 50% of the cost of a new automobile within 5 years will be in electronics. Providing the intelligence for those electronics, the whole chip revolution, will be an enormously important thing. That's a long list, and it could be much longer.
We seem to have an enormous advantage as a nation in producing those things I just described. We do not seem to have a very great advantage at producing other things. I, for one, would rather work for a magazine than assemble an automobile, and that seems to be the kind of choice that you and most Americans have made.
INC: You've said that in this new service-based economy that you foresee, economies of scale as we think of them in manufacturing will be less important and the need for independent thinking, creativity, and entrepreneurship will be greater. What should the government be doing to foster these changes, or is it necessary to have a public policy?
Birch: It isn't clear to me that you can make a policy to encourage creativity. Margaret Thatcher in England is trying desperately to have more of that kind of thing through policy. But that's because England's entrepreneurial climate is in terrible shape. The status of the entrepreneur in English society is very low. I mean, being an entrepreneur is not the fastest way to become a member of the House of Lords. The status of the entrepreneur in America is very high. We already have a tremendous creative climate that most nations of the world lack. And that's one of our great assets.
What would make it better? The White House Commission on Small Business drafted a number of suggestions, which policy makers have been taking quite seriously. There's some interest in improving the tax structure at the margin to help entrepreneurs raise capital, to make it more attractive for Aunt Agatha to provide capital, because that's who provides most of it. Making the depreciation rules a little simpler, the regulations a little less burdensome -- those are all things at the margin that create a better climate. However, I see it as quite difficult for the federal government to get into the business of giving one-on-one assistance to 5 million or more small businesses.
INC: In a recent study you found that more jobs are lost every year in dynamic, faster-growing areas of the country than are lost in stable or declining areas. It sounds like a paradox.
Birch: Well, it's not a paradox because it's only looking at half the question. The number of jobs in an area is a balance between all the jobs being lost and all the jobs being gained. In the dynamic areas there are two or three times more replacement jobs than there are in the more slowly growing areas. As a result there tend to be more failures. There's more innovation, more risk taking, more entrepreneurship, and more failure in a place like Houston, say, than a place like New Haven. If you just look at the loss side, you see the losses as slightly greater in Houston and it seems like a paradox.
INC: And the positive consequences of that are what, aside from the net creation of jobs?
Birch: You have a much more vital economy. I was just talking to someone this morning who moved from Detroit to Dallas because there were more opportunities there. The bankers are more entrepreneurial. You can get your hands on capital more easily, and there are more people willing to gamble on you. There are more role models of gamblers -- entrepreneurs -- for younger people to see. You have just a much more dynamic, vital, vibrant economy.
INC: Okay, but the Sunbelt is gaining more jobs.
Birch: Absolutely, but it's not because companies move. It's because of people like the fellow who moved from Detroit to Dallas and has started three or four companies since he got down there. It's because people move down there to find a better opportunity in starting new companies. Or corporations, many of them based in the Northeast, open branches in the South.It's not the movement of firms, but the movement of capital that creates more jobs.
INC: Your study two years ago showed small business's capacity to create jobs. But we often hear the argument that the jobs big business creates tend to be more stable and higher paying.
Birch: The higher-paying part is true, but in an interesting way. The only break that I've been able to detect in the statistics is above and below 500 employees. And the number of businesses above 500 employees is only three-or four-tenths of a percent of the corporate population. Everybody else is below 500 employees and those companies seem to pay about the same wage rates up and down the scale. In other words, they all compete pretty effectively with each other for the labor dollar. So if you mean the Fortune 500 pay higher wages, I think the answer is yes. On the other hand the Fortune 500 have created virtually no new jobs in the last decade or so.
Now, in regard to stability, I don't know where the notion has come from that stable jobs are a good thing. I've never the much use for those systems that had the most stable employment. Civil Service, the tenure system within schools and universities -- those systems that guarantee employment are not noted for their efficiency. You can also look at stability as a form of exclusion. The stable job is by definition a job that doesn't enter the labor market very often. An if you're talking about poor people, if you're talking about young people, if you're talking about part-time people, or if you're talking about the vast majority, in a sense, of the work force in the United States, stable jobs are jobs they can't get their hands on.
We lose 8% of our jobs every year through contractions and layoffs, and I don't think that's all bad. I think that means that new things start up, old things decline, new job slots open up on a fairly regular basis. People can adjust and adapt and move to new locations. You can buy Dallas papers in Detroit, look at the want ads, and find a job there within two days. How likely would that be if all the jobs in Dallas were 10-year jobs?I think it's the very instability that creates much of the dynamism in our economy and most of the opportunities. The Dutch have very stable employment. Virtually everybody in Holland is guaranteed a job almost for life. And that system has meant that something like 25% of their labor force is in some way or another on permanent government subsidy.
INC: What do your findings about job creation in cities tell you about the future of American cities, and about their current decline?
Birch: We really have to talk about neighborhoods within cities. The more central the neighborhood, the older the neighborhood, the more minority a neighborhood, the more it's true that its job and employment growth is dependent upon smaller service-related business and the less it's true that employment growth will come from large manufacturing companies and large companies in general. The older, north central cities sometimes get 120%, 150%, or 180% of their net jobs from smaller service-based businesses, compensating for huge losses in their traditional industries.
But when cities go fishing for new businesses, they often set their hooks for whales. You may catch a whale but very few people do. On the other hand, if you set your hook for a tuna or a bass you may come home every night with something to eat. And the more central the neighborhood the more it's true that the chances of catching a whale are very, very small. A number of cities haven't caught a whale in a long time and they have spent, in many cases, hundreds of thousands of dollars baiting their hook for one. Whatever happens, northern cities must learn that their jobs are no longer coming from whales; they're coming from bass and tuna. And they better learn how to catch them.
INC: In none of these studies nor in our conversation this afternoon have I heard you proclaim doomsday. You've never said, "If we don't do this the future is bleak."
Birch: I guess the reason I don't get too discouraged is that I spend enough time in other countries in the world to realize how incredibly fortunate we are. The strengths of our system are enormous. The capabilities of our entrepreneurial climate let us set up 400,000 or 500,000 new businesses a year, tolerate 425,000 failures a year, and generate 19 million new jobs in the last decade, employing a higher percentage of our labor force than has ever been employed before in our history and probably in the history of any industrialized nation in the world. It's a rather extraordinary accomplishment.