Government should foster innovation and entrepreneurship instead of focusing on companies' sizes.
Now we're told that small companies don't create the most jobs after all. So what? This is one debate that's missing the mark by a mile and leading to bad economic policy as a result
Every academic learns one important lesson at the knee of his or her Ph.D. adviser, namely, that you can get your name in lights by challenging the hoary truths of your field. So it should be no surprise that scholars are now mounting an attack on that most conventional of new-economy wisdoms, "Small businesses create the most jobs."
Harvard economist James Medoff has been arguing that contrarian case for a while, beginning with coauthorship of a 1990 book ( Employers Large and Small) and continuing through op-ed pieces and interviews with the press. (Small business's alleged job-generating power is a "PR job," he scoffed to a National Public Radio interviewer not long ago.) Medoff's brief got a boost from a recent study by Steven J. Davis of the University of Chicago and two associates. The Davis group examined Census Bureau data on manufacturing companies from 1972 to 1988 and found that small companies do indeed add a lot of people to their payrolls. But they also let a lot of people go -- and when you add up net rather than gross job creation, the small-company advantage disappears. "The job-creating prowess of small business is a myth," announced the Wall Street Journal in a front-page summary of the Davis study this past November.
So far, contrarians such as Medoff and Davis haven't silenced their intellectual opponents. David Birch, for example -- the grandfather of the small-companies-create-jobs argument -- released a new report last May. From 1987 to 1992, contend Birch and his Cognetics Inc. colleagues, companies with fewer than 100 employees accounted for virtually all the new jobs.
Who's right? Sorting out these statistical disputes can be a dizzying task. Davis and his colleagues accuse the Birch side of various scholarly sins: using unreliable data, falling into logical traps such as the "regression fallacy." (Don't ask.) Probably the disparities can be traced to less nefarious differences. As Birch has noted elsewhere, researchers' conclusions in this field depend heavily on what time period they're studying and on their choice of methodology. Davis, for instance, was looking only at manufacturing. But it's the service sector that's creating the most jobs these days, so the big picture could be markedly different from the corner he studied. Birch, for his part, focuses on the most recent data available. But there's no way to know how many of those new small-company jobs will be around five years from now.
Academically, the debate is no big deal. The scholars are argumentative but not pigheaded; eventually, they'll come to some sort of consensus on methods and data. Politically, however, it's a big deal indeed. Lobbyists for small companies regularly clothe themselves in the virtuous robes of job creators -- useful attire, they figure, for seeking special treatment from policymakers. Contrarians then accuse those lobbyists of duping taxpayers. "If there is fault to be found in the president's job-creating strategy," wrote Medoff in the Washington Post, "it may lie in his emphasis . . . on small business." Small companies' record, he added, is "far from the spectacular success that the hyperactive small business lobby maintains."
In the political arena, alas, the debate misses the mark by a wide margin; it obscures rather than clarifies what's happening in today's new economy. By dividing everything up into "big" and "small," it lumps together companies that are utterly unlike one another, and so leads to silly policy choices. Worse, it misstates the real source of the new economy's dynamism, thereby fixing policymakers' gaze squarely in the wrong direction.
Look first at the small-business side of the ledger. A lot of small companies, even today, are like the little grocery store down the street from my home. It's a sleepy, single-location enterprise that hasn't yet discovered checkout scanners. This business could get all the tax breaks in the world, and it still wouldn't create any new jobs.
Other small companies are savvy, sophisticated, and oriented toward growth. Coldwater Creek, a mail-order merchant in Sandpoint, Idaho, uses state-of-the-art computers and telecommunications systems to track buying patterns, inventory trends, and quality levels. In the past six years Coldwater Creek has increased its payroll 25-fold, from 6 employees to 150. Find the thousands of other companies that look like Coldwater Creek and you'll have a pretty good idea where many of the new jobs are coming from. But most of those fast growers are doing fine, thank you. They neither need nor want any special help from the government.
The big-business side is a similar jumble. Some giant corporations -- the IBMs of the world -- are facing calamity. Others, like General Electric, are growing and prospering but are cutting their payrolls anyway. (GE employs 100,000 fewer today than it did 10 years ago.) Still others are newly arrived in the big-business category. Five years ago Cabletron Systems, in Rochester, N.H., had 300 employees. Today it has more than 3,000. Was it a small company or a large one that created those jobs?
The point here is that innovation and entrepreneurship, not company size, determine an industry's health in the new economy. Look at retailing, for example, a sector that accounted for nearly 5 million new jobs during the 1980s. Ten or 15 years ago, modest Main Street merchants coexisted with a few big department stores and chains like Sears. Today a thousand flowers have bloomed -- huge upstarts such as Wal-Mart and Target, "category killers" such as Toys 'R' Us, specialty chains such as the Gap, mail-order houses such as Lands' End (and Coldwater Creek), plus any number of new local and regional retailers.
The numbers show that "big companies" outstripped "small companies" in creating retail jobs, at least until the recent recession. But what does that tell us? That Sears and the old-line department stores were thriving? That would-be retail entrepreneurs were barking up the wrong business? Hardly. Retailing is like all fast-changing industries: the companies that succeed are the ones with the new ideas. Most of the innovators start small. Some of the successful ones grow big and hire a lot of people.
How much the government can or should do to stimulate economic growth and job creation is a matter for continuing debate. But the debate should at least focus on the right issues. The right focus is how to foster innovation and entrepreneurship. The wrong one is how to help the companies that happen to fit into one of those tattered file folders marked "big" and "small."* * *
John Case, an Inc. senior writer, is the author of From the Ground Up: The Resurgence of American Entrepreneurship and writes a syndicated weekly newspaper column called "The Inc. Report."