RealClearMarkets - Small Business Is The Key To US Growth

In proclaiming May 15-21 National Small Business Week in the United States, President Obama emphasized the contributions of small businesses to the economic well-being of America:

"Our country started as an idea, and it took hard-working, dedicated, and visionary patriots to make it a reality. A successful business starts much the same way-ideas realized by entrepreneurs who dream of a better world and work until they see it through. From the family businesses that anchor Main Street to the high-tech startups that keep America on the cutting edge, small businesses are the backbone of our economy and the cornerstones of America's promise."

The President added that indeed, small businesses are the embodiment of America's promise, which, he said, is "the idea that if you have a good idea and are willing to work hard enough, you can succeed in our country." A brief examination of the role of small businesses in the U.S. economy shows how correct Mr. Obama is, and offers hope for a more prosperous future if policies out of Washington once again come to reflect the primal importance of his statement.

As an institution in the U.S. economy, small business is a critical part of the whole. According to the Small Business Administration, 99 percent of all independent enterprises in the country employ fewer than 500 people. These enterprises employ 80 million Americans, or over 60% of America's workforce; among this percentage, more than 20 million are employees of companies with fewer than 20 workers. Even more telling is the "creative destruction" that occurs among small businesses, in the aggregate: in the last 40 years, there have been 45 million jobs created in the United States, but this number breaks down into approximately 400 million created jobs, and 355 million lost or eliminated. This dynamism occurs almost exclusively in smaller businesses: total employment in the Fortune 500 is unchanged since the mid-1980s and up only slightly across that entire period.

That this is so is due to the remarkable productivity of capital in corporate America, which makes the workforce ever more efficient: other things equal, as the scale of a business increases, it becomes more capital- (and less labor-) intensive. For example, in 1984, IBM had $50 billion in revenue and 425,000 workers; last year, including recent acquisitions, IBM had 399,000 employees on $109 billion in revenue, with the real price of computing falling dramatically in that time. Even more telling are those industries for which capital investment and new technology has displaced workers in some companies and industries, and spawned new ones. In 1970, for example, there were 400,000 telephone switchboard operators employed by AT&T, while today more than 99% of those jobs are gone. Of course in 1970, Microsoft, Google, and a host of other of today's Fortune 500 companies did not yet exist.

Economists Carl Schramm and Robert Litan of the Kauffman Foundation have tried to quantify the precise impact of new job creation from start-up companies on macroeconomic growth. In recently-published findings, they estimate that across time, innovators from start-ups receive approximately 4% of the financial value from new inventions or technologies. This implies that in a $15 trillion U.S. economy seeking a 1% increase (or $150 billion) in GDP entirely from innovative new firms, $6 billion in real wealth must flow to the inventors. Depending on how one models ownership splits, that comes out to 10-30 firms each year that eventually reach what Litan calls "home run" status, e.g., Google-type success. Or, equivalently and more likely, 30-90 firms that are eventually a third the size and scale of a Google. This, from among the tens of thousands of new enterprises that are formed each year in the United States.

While Schramm and Litan's work is a construct based on some rough assumptions, their point is critical to understanding how, from the vantage point of the individual entrepreneur or small business, economic growth and progress are induced at the "macro" level. Small businesses, usually without the benefit of resources such as market research or a deep capital reserve, are engaged in daily acts of entrepreneurship, that is to say, in constant decision-making and judgment about an uncertain future fraught with financial and operating risk. If these judgments, usually about currently-unmet market needs, are proven correct, small business owners reap the benefit in increased revenue and operating profits. If incorrect, the firm suffers losses, and must retrench or, as is often the case, liquidate. It is quintessentially a trial-and-error process, with one critical feature of which policymakers need to be aware: knowledge, about the best use of resources, about what "the market" (consisting of human beings) needs or wants (and does not want), and about how the productive process itself is best effectuated, is created in this process.

And it is important to understand two aspects of this knowledge about products, production processes, technology, people, and marketing methods: first, that it is created as much during circumstances leading to losses as those leading to profit, and secondly, that it is dispersed among thousands, if not millions, of individual people and firms (and not, therefore, either resident in one convenient place such as Washington, D.C. for collection, or even collectible by anyone in Washington). The implication for policymakers is axiomatic: because it is this continual trial-and-error process (conducted in such large measure by entrepreneurial start-ups as well as established small businesses) that leads directly to the dynamism and growth of the U.S. economy, any burdens placed on small business that impede this continual trial-and-error, whether financial or operating, will harm economic growth. Further, because this knowledge that is so seminal to the process of economic growth is so truly (and radically) dispersed, across tens of millions of people, it is folly to place hope in effective "one-size-fits-all" dictates coming out of Washington, D.C.

Rather, policy should point to maximal degrees of freedom for small business to operate, in order to make best use of the continual knowledge and feedback that comes from experimentation, risky new offerings, promising new methods, and new hires to exploit perceived opportunities. Practically speaking, what this translates to in terms of policies are, most of all, competitive and incentive-inducing tax rates on income, profits, and capital investment; and, a sound monetary framework that both preserves the currency's value as well as permits rational calculation of profits and losses, both of which encourage risk-taking in the face of an uncertain future. Additionally, free and open trade with partners abroad that affords the widest possible markets for both export businesses as well as goods and services needed here, along with a reasonable regulatory environment that does not burden small business with needless operating costs, all serve to maximize economic growth.

In spite of the recent period of recession and slow growth, the U.S. economy has been the marvel of the world for the better part of 150 years. It is appropriate that, per an annual tradition in this country dating to 1963, President Obama has declared this week as a time to recognize and hail the importance of small business owners and employees to this remarkable history. Moving forward, to ensure continued progress and the vibrant dynamism of our economy, it will be important to return to a policy mix per the above that is nothing less than completely supportive to this crucial institution.

John L. Chapman is Chief Economist at Hill & Cutler Co., an advisor to Alhambra Investment Partners and a?consultant to the George W. Bush Institute on economic growth. The Bush Institute has recently commenced a project to promote long term annual growth of 4% in the United States by highlighting the policy mix that will approach this target.

Source: http://www.realclearmarkets.com/articles/2011/05/21/small_business_is_the_key_to_us_growth.html

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