Despite recent stock market turmoil, everywhere you looked this year someone was heralding the strength of the economy, which grew at 3.5 percent in the third quarter. However, not all economic growth favors small businesses, and some even detracts from it. The Inc. Entrepreneurship Index, which measures the quarterly health of the U.S. startup economy, currently sits at 83 out of 100 for the third quarter of 2018. This is down two points from the second quarter and a full nine points from the first quarter of 2017, when our Index peaked. Our indicator sees one factor in particular still dragging like an anchor on the startup economy: job growth.

Even though overall economic conditions have been largely favorable, small businesses have hit a growth ceiling as larger companies--bolstered by generally strong market conditions, favorable tax policies, support from local governments, and easing federal regulations--have been gobbling up talent. This is why, for the past year, the Index has shown a startup economy that is strong but slowing. 

The over-the-year job growth rate for small businesses dropped from almost 4 percent in the first quarter of 2017 to 2.5 percent in the third quarter of 2018. (In Q3, headcount growth--that is, the number of jobs added by small and medium-size businesses--declined for every region in the U.S., except for the West.) In fact, job growth by small businesses is the lowest it's been since early 2008.

This can in part be attributed to our location in economic cycles. Late in an economic cycle, as we are now, small businesses predictably tend to create fewer jobs relative to large businesses. This is occurring now in this cycle for the following two reasons.  

A People Problem

One, talent is quitting small businesses at higher rates than employees are leaving larger firms. Data from the Bureau of Labor Statistics shows that small businesses (10 to 50 employees) saw an average of 2.8 percent of their employees quit between January and August of 2018. Meanwhile, establishments with 1,000 to 5,000 employees lost talent at a rate of about 2.1 percent, and businesses with more than 5,000 employees had a quitting rate of just 1 percent.

Moreover, Bank of America's biannual Small Business Owner Report states that 24 percent of small-business owners have lost at least one employee this year, while roughly 10 percent of the field lost 10 percent or more of their entire workforce. It's far harder for a company of 20 souls to lose one or two key staffers than it is for a company of several thousand to shed 50 people. 

Two, small businesses are having a harder time hiring. Twenty-two percent of small-business owners cited the difficulty of finding qualified workers as their single most important business problem, and almost four out of every 10 small businesses have at least one unfilled opening. That's the highest level for this metric in the past decade. According to Bank of America's report, plans to hire are up more than 10 percentage points from last fall, even as 58 percent of business owners report difficulty finding qualified candidates.

Ostensibly, small businesses' loss has been big businesses' gain: People have been flocking to the greater security bigger companies can provide, and hiring has become more difficult for small businesses as a result.

Losing more talent than their much larger counterparts while having to work harder to attract new talent, small businesses feel the headcount crunch from both sides. Competition from big businesses has become a major concern, according to a recently surveyed sample of the 200,000 monthly users of work platform Thumbtack.com. To win attention, small businesses have employed a series of new strategies, from becoming more creative with flexible office culture to upgrading their social media appearances.

Despite the slowdown in job creation, small-business owners are experiencing record high levels of optimism, and their wages continue to grow, as the Inc. Entrepreneurship Index shows. When founders have more work coming their way than their companies can handle, they tend to see this as a windfall, especially when they have increasing access to capital. When coffers are full, it's hard for business owners to mourn the loss of work they don't have for want of a larger payroll. (Also, if the prediction of a looming recession proves accurate, no companies will mind having fewer salaries to pay.) 

The Downstream Effect

However, when startups fail to scale, the impacts are felt downstream and most often at the local level. Younger or smaller businesses consistently provide an opportunity for people at the margins of the labor force. A younger company or a smaller business is more likely than a big business to take a chance on employees with nontraditional backgrounds, including younger people, workers with gaps in their résumé​s, and those lacking educational credentials. This creates a ladder for fringe employees to gain the skills and experience necessary to travel throughout the workforce and grow their careers. 

Without this pipeline, a chicken-and-egg problem results: SMBs can't find sufficient talent, because other SMBs aren't taking the time to groom it. And these other SMBs aren't grooming it, because they can't find it, and so on. Today, Steph Curry is one of the greatest players in the history of the NBA. But he played college ball at Davidson College, a small school in North Carolina, where only 2,000 students had the chance to watch him from the stands. If the Davidson Colleges fail to thrive, the Steph Currys may never get their shot. The same is true in private industry. When new and small companies are not hiring, it's not hard to imagine a country where workers who do not fit a well-defined corporate mold experience a failure to thrive.

Published on: Dec 20, 2018