Here's the truth about employment growth--and how the government can stop hindering it and start helping.
Every four years about this time, political pandering reaches a crescendo, and this year no constituency has been pandered to more than small business. As different as the two candidates’ economic philosophies may be, both President Barack Obama and former Governor Mitt Romney agree that job creation is one of the central issues of the campaign, that small businesses are the biggest job creators, and that federal policy should be geared toward helping them. “They are the anchors of our main streets,” says the President in a video on his campaign website, which notes that small businesses are responsible for two out of every three new jobs in the United States. “Small business, entrepreneurs and innovators, mom and pop businesses, little shops and stores—they’ve always created most of the jobs in this country and they will again,” said Lou Dobbs in a recent Fox News special, nicely summing up the conventional wisdom.
The problem is, this conventional wisdom is wrong. Or rather it’s only half-right: Small businesses may create the majority of jobs, but they also lose most of the jobs. What counts is not job creation, but net job generation. And if you were to group together the vast majority of small companies, their net job generation would add up to zero.For economists and policymakers who research job creation, this is not a major news flash. No one who has done a serious study of the subject in the past 15 years believes that small companies as a whole generate the 60 to 70 percent of the net new jobs they are credited with by, among others, the Small Business Administration. Indeed, the claim has been debunked so often by so many people of all political persuasions that I’d be piling on to debunk it yet again. It survives by virtue of repetition, the SBA, and the Tip O’Neill Rule that all politics is local. When members of Congress want to check on the economic climate back home, or raise money for their campaigns, the people they talk to are business owners. Supporting small business is thus a guaranteed political winner.And you might ask, “Where’s the harm in that?” Job generation aside, we know that small businesses play a vital role in our economy and our society. They form the backbone of communities from Barrow, Alaska, to Key West, Florida. They also employ between 60 million and 95 million people (depending on who’s counting), or 50 percent to 65 percent of the workforce. So what if they don’t add a lot of new jobs to the economy every year? Shouldn’t the government be doing all it can to help them anyway?There’s an interesting debate to be had on that subject. But it would be a distraction from the policy discussion we should be having—particularly now, when jobs are in such short supply. That’s actually where the myth of small-business job generation has done its harm: It has diverted our attention from the most important questions we face when it comes to economic growth. There are three of them: Which companies really are the job creators? What can be done to enhance their ability to survive and prosper? And how can we get more of them?
The search for answers to all three begins with one word: gazelles.
For most of the 20th century, everyone believed that big companies created almost all new jobs. Then, in the late 1970s, a researcher at the Massachusetts Institute of Technology, David L. Birch, made a remarkable discovery. He’d come to MIT from Harvard to work in the Center for Urban Studies and there had developed a particular interest in jobs—how they were created, why they moved from place to place, what role they played in regional development. The government databases weren’t much help in his research, since they didn’t break out employment at individual companies and therefore didn’t allow him to track changes in the numbers and locations of jobs over time. So he hit on the idea of using data from Dun & Bradstreet, which recorded the job numbers and locations of specific firms and establishments in the course of preparing its annual credit reports. He got hold of the complete D&B files for four years—1969, 1972, 1974, and 1976. When he examined the data, he was surprised to find that, in that period, businesses with fewer than 20 workers created four times as many new jobs as companies with more than 500 employees.In 1979, Birch published the results of his research in a 52-page report titled The Job Generation Process. Appearing as it did just as entrepreneurs were beginning to remake the economy, the report had a huge impact on policymakers. Equally important, it demonstrated the need to study job creation and destruction on the micro level, thereby opening up a whole new field of research.To be sure, not everyone accepted Birch’s findings. One research team tried to duplicate his results using D&B data from different years and found that small companies grew no faster than large ones. Others claimed he’d made statistical errors that had skewed the results and invalidated his conclusions. Still others argued that Birch’s conclusions were beside the point: Jobs in small companies were worse than those in big companies in terms of working conditions, compensation, fringe benefits, and employment security, and therefore it was no great shakes to have more of them.But Birch also had defenders who conducted independent studies that produced similar results—not only for the United States, but for other countries, including Canada, the United Kingdom, Holland, and Greece. Over the next decade, Birch continued his research into the job-generation process. (Some of his findings were presented in columns he wrote for Inc.) As time went along, he developed new insights into where jobs came from. In 1994, he co-authored an essay with one of his chief critics, Harvard professor James Medoff, for a book called Labor Markets, Employment Policy, and Job Creation. The idea was to see what they could agree on. The title of the essay was "Gazelles."
"Gazelles" is a term Birch coined to describe the small percentage of companies that accounted for virtually all the net job growth he had observed in his research. As such, the concept represented a significant shift in his thinking. In an interview many years later, he said that he needed “a simple, almost naïve way of explaining what was going on in the economy.” His solution was a business taxonomy consisting of elephants, mice, and gazelles. “The big companies, elephants, are slow and not very innovative,” he said. “Then there are a large number of very small firms—mice—that run around but fail to develop. And then the gazelles...small firms that grow quickly and create employment.”He defined gazelles as companies that, beginning with at least $100,000 in sales, grow 20 percent or more annually for four years, at least doubling their revenue in the process. In the period the essay covered—1989 to 1992—there were about 350,000 of them, or just 4 percent of all firms, and yet they accounted for about 60 percent of the net new jobs in the economy. (Of the remaining 40 percent, about half came from start-ups, and half from large companies.)The following year, Birch doubled down on his analysis. In a paper published by his consulting firm, Cognetics, he and two colleagues presented the results of a study they’d done using their D&B-based dataset to analyze job generation from 1990 to 1994. They concluded that gazelles were responsible for all net job generation during that time. They also added a significant twist. At the beginning of the period, some 82 percent of the gazelles had had fewer than 19 employees, while just 3.6 percent had had 100 or more. That contingent of larger companies proved to be “superstars,” generating 53 percent of the net new jobs created by the entire group during the five years studied. Some of the superstars were already Fortune 500 companies in 1990. Others would join that list later.These findings turned Birch’s earlier conclusions upside down. He was now saying, in effect, that size didn’t matter. Although most gazelles were small companies, only a tiny percentage of small companies were gazelles, and the most prolific job-creators among them weren’t particularly small at all. The private sector got the message: Birch’s firm did a booming business helping companies identify and market to gazelles. But these startling findings had no discernible effect on elected officials and policy makers, who continued to promote as enthusiastically as ever the myth that small businesses as a group created the lion’s share of new jobs.
Bo Burlingham: Burlingham joined Inc. in 1983. An editor at large, he is the author of Small Giants. Burlingham is also the co-author with Norm Brodsky of The Knack; and the co-author with Jack Stack of The Great Game of Business. @boburlingham