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Small-Business Research--Job Detection

An urban economist offers a way to identifying start-ups and counting the jobs they create.
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What's the state-of-the-art method of identifying start-ups and counting the jobs they create? You do it the old-fashioned way: one company at a time

The people and companies creating America's new economy are a mystery to even the most ardent observers. The media and the nation's political elite focus stubbornly on the now rapidly decaying world of mammoth enterprises -- defense contractors in California, automakers in the Midwest, lumbering computer manufacturers in Boston, or struggling national retailers. As the transformation of America from the New Deal-era economy picked up steam over the past decade, the gap between official statistics and shop-floor realities has reached staggering proportions.

Take California, for example, where the inadequacy of conventional market measures has repeatedly forced officials to reinvent their views to an almost comic degree. Because California's employment data were historically derived from surveys of only a few large firms, the state Employment Development Department (EDD) recently discovered that it had wildly overestimated the state's job losses since 1989. When smaller, more robust firms were factored into the data, California's job loss totals declined dramatically from the 1.2 million initially reported to approximately 500,000 -- a result that sent banks and investment analysts scurrying to upgrade their appraisals of the state's future prospects.

Further evidence of how the state's new economy was not registering in official data came in October 1994, when an unprecedented disparity emerged between EDD surveys and employment figures compiled by the state Department of Finance. Once highly complementary, the two databases showed either that California had lost 17,000 jobs for the month or that it had gained an incredible 229,000 positions. Few could deny that something was going on that official statistics simply couldn't grasp.

In an effort to overcome such problems, then Los Angeles Economic Development Deputy Mayor Linda Griego -- now the head of Southern California's postriot recovery organization, Rebuild L.A. (RLA) -- commissioned a pilot project in 1992 to re-examine the region's new economy in six sectors: entertainment, textiles, environmental engineering, biomedical, computers, and metalworking. Completed in 1994 with the support of the city of Los Angeles and AT&T, the New Economy Project provided a startling glimpse of how, even in recession-wracked Southern California, the new economy was silently fashioning dynamic industries from the old.

Defying the conventional wisdom that industry had either fled or died out in the region, the project recorded an astounding 18,000 companies in the six sectors, employing more than 376,000 people and generating revenues of close to $54 billion. Average start-up rates in the 1990s kept pace with those of the 1980s -- a period of record expansion for greater Los Angeles. Wage rates in all of the focus industries, except textiles, vastly exceeded the California mean and were among the highest in the country.

Learning about what was happening to the companies and individuals involved in the new economy proved remarkably difficult. As in other parts of the country, official industry directories, employment data, and prevailing economic perspectives obscured industrial reality. Furthermore, many key players didn't want to be discovered. Finding the new economy required novel ideas about how and where to look for industrial activity.

* * *

One-Dimensional Thinking, Multidimensional Firms
The chief lesson of the New Economy Project is that understanding complex regional industries requires abandoning conventional notions about industrial organization. Politicians and academics, for example, routinely speak of "high" and "low" technology and "service" or "manufacturing" businesses, and they use broad classifications such as "defense," "electronics," or "computer" industries. Vast state and national bureaucracies compile economic statistics to reflect those categories.

Those time-honored notions are dangerously misleading in the new economy. In the more stable New Deal era, larger companies housed the most sophisticated equipment and technology, and smaller firms provided labor-intensive, uncomplicated products or services. The boundaries of entire industries seemed self-evident.

But the turbulent markets of the '80s and '90s put a premium on firms that were developing particular skills and adapting knowledge to as many uses as possible. Smaller firms mastered particular tasks and applications to a degree few others could match. They then learned to educate a growing number of customers about how to profit from their specialized capabilities in an enormously diverse range of markets and industries.

The result is an economy that defies standardized industrial classifications. Constantly shifting alliances of specialized vendors, designers, and marketing experts increasingly blur once-inviolate industry lines.

From the start, researchers in the New Economy Project observed how this new economy had transformed the structure of U.S. industry. They found, for example, entertainment-prop or high-resolution-lighting manufacturers officially coded as "motion-picture-service" providers that were actually far more involved in advising global retailers on how to create shopper-friendly in-store environments or in designing architectural lighting schemes for major metropolitan areas. Seemingly mundane "printed-circuit-board" producers turned out to be sophisticated engineering consultants, teaching mammoth supercomputer makers how to construct CPUs to increase reliability.

"Food-processing companies" -- typically portrayed as low-tech, low-skill sweatshops -- in fact fed worldwide demand for the automated baking and packaging machinery they designed. And seemingly low-tech "welding-machinery" producers actually were training the most sophisticated biomedical, food-processing, aerospace, and electronics users to operate the advanced, automated equipment they designed and built.

Then there were enterprises for which no official statistics were kept. Those included new industries such as the region's aggressive blood-products wholesalers, who exploited their knowledge of the social makeup of their donor populations to isolate unique antibodies for use by global pharmaceutical giants -- using fractionation techniques and medical devices that they themselves designed. Project researchers found far more companies and employees in this industry than anyone had previously suspected -- close to 900 companies, 44,000 employees, and $5 billion in revenues in Los Angeles County alone.

Existing economic models and statistics therefore overlooked much of how industries had evolved in the past decade, and directed official attention to what were often the least interesting, most rapidly declining companies and practices in the region.

* * *

Business? What Business? The Stealth Economy
Compounding the difficulties of tracking the new economy was the surprisingly strong antipathy many firms displayed toward any activity even slightly associated with the government. Mistrusting the project's motives, many executives, upon hearing the barest outline of the effort, slammed down the telephone. Those who agreed to interviews would often start out by venting their frustrations with government before apologizing and discussing their businesses.

The new economy had become a "stealth" economy, difficult to find and implacably alienated from public entities. Project researchers found many companies lurking unnoticed in the back of anonymous industrial parks, unlisted in official industry guides and databases. Viewing government as hostile to their concerns and responsive only to larger enterprises with more political clout, smaller companies resisted the idea of contributing to any effort that might shed light on the true nature of their industries.

Companies learned to keep key attributes such as work-force and gross-income levels just below legal thresholds that would trigger additional regulatory or reporting requirements, often by spreading work among newly created "independent" entities as their business grew. In some industries it was common to open and close companies on timetables that coincided with the date that state-unemployment-insurance or other government paperwork could be expected to arrive for the first time in the mail.

The ability of those companies to minimize their public profile is unquestionably a big reason why official economic data are now so wildly inaccurate. In California's bellwether entertainment sector, for example, the project found that because state statistics largely ignored nonpayroll contract labor, they undercounted the true employment generated by the industry by an astonishing 260,000 people -- or 66% of the work force.

Complicated new company alliances also fuel the stealth economy because many companies now find themselves in the dual roles of suppliers to key industry players and direct competitors of those customers. Textile companies, for instance, produce fabric for Los Angeles's clothing designers and manufacturers. At the same time they are also forming long-term relationships with some customers by directly investing in a particular clothing line or brand name, or by starting manufacturing operations of their own. Few want this potential conflict of interest to be widely publicized.

To circumvent the stealth economy's defenses, project researchers had to find cooperative industry insiders with a comprehensive understanding of the six focus sectors. Yarn vendors supplying raw materials to regional textile companies or entertainment production coordinators provided researchers with a road map for an industrial terrain that was daily changing the structure of business enterprise.

The Victims Strike Back
Another challenge for the researchers was the ethnic stereotype problem. Like all urban areas, Los Angeles suffers from the near-reflexive belief, nurtured by the media and academics, that ethnic groups are the victims of, rather than participants in, the regional economy.

Although years of repetition had imbued such views with seemingly unchallengeable authority, even a cursory look at the official data suggested otherwise. An RLA survey of Los Angeles's neglected areas -- typically those with the highest ethnic populations -- revealed a concentration of more than 15,000 companies employing 357,000 people, with annual sales of $54 billion, in manufacturing sectors alone. Census data showed that Asians and Latinos, who collectively accounted for virtually all of the region's massive population growth from 1980 through 1990, recorded household-income increases of four to five times the statewide averages and had attained levels of income that were among the highest in the country. Another study showed that an incredible 70% of all businesses in greater Los Angeles were owned by Latinos or Asians.

Plainly, the new economy was doing something other than creating victims, but catching even a glimpse of the real progress being made was a daunting task. Some groups, such as Southeast Asians active in regional electronics and assembly industries, bore suspicion toward government and government-sponsored projects because of experiences they had had in their native countries. Others, weary of patronizing attitudes toward ethnic business, recoiled at what they thought would be yet another "victim" study.

Learning about ethnic business networks therefore required even more circuitous strategies than had other parts of the project. Dimly aware that Chinese computer manufacturers were flourishing in greater Los Angeles, for example, project researchers sought help from a University of California-Berkeley professor with Chinese graduate students who could help the team secure interviews with companies that normally shied from outside contact. Researchers were then able to compile extensive information about the hundreds of Chinese companies and the thousands of employees who make up Los Angeles's "Silicon Valley South."

To learn about the Koreans and Persians who were investing millions in the textile industry, researchers courted similar informants. Inside contacts led researchers to a number of Latino companies owned by entrepreneurs who had started as shop-floor assistants in the oil- machinery business or in tortilla factories. Exploiting what they had learned on the job, they built multimillion-dollar firms exporting high-priced products to Europe, Latin America, and Japan.

* *

New Economic Growth, Old Political Barriers
The staggering gap between the perceptions that animate official perspectives and the realities they fail to grasp suggests at least three troubling conclusions about the future of the new economy:

1. Old economic tools don't work. If firms in the new economy are constantly redefining their skills, markets, and goals, then surveys, statistics, and policies based on the more static industries of the past are inherently flawed. Understanding today's industries requires ongoing communication between data compilers and the companies they are trying to measure. Public officials in Pennsylvania, Ohio, and Michigan, for example, have incorporated continuous bottom-up industry input into their economic-monitoring efforts, an innovation that many credit with producing far more effective business policies than those in less-enlightened regions.

2. Government-business alienation cripples the new economy. A region's business enterprises flourish today to the extent that they specialize and share information about their skills, form alliances, and expand the boundaries of older industries. But profound mistrust of the government and the existence of "stealth" firms erode the most important foundation of the new economy -- open, collaborative information exchange.

3. Public policies are ineffective. If the economic perspectives that guide how the government spends billions of dollars each year on business "support" -- training schemes, loan programs, technology assistance, tax subsidies, minority set-asides, and the like -- are grossly misleading, it is small wonder that businesses see little of value in government initiatives. Erroneous information about regional economies like Southern California's or the role of ethnic groups and the nature of high-skill, high-wage development virtually guarantees ineffective public policies.

Avoiding such outcomes is why learning to find the new economy is crucial for businesses and public officials. It is only from seeing things as they really are, not as some might wish they could be, that it is possible to create policies that will help new businesses thrive and continue to generate jobs in the future.

* * *

David Friedman is an urban economist, a research fellow at the Massachusetts Institute of Technology Japan Program, and an attorney with Tuttle & Taylor in Los Angeles. He was the director and author of the New Economy Project.

Last updated: May 15, 1995




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