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http://www.businessweek.com/small-business/the-real-reason-small-business-hiring-is-down-01132012.html

Commentary

The Real Reason Small Business Hiring Is Down


Entrepreneurs aren’t hiring like they used to. If the average business started in 2010 had the same first-year hiring as the average business started in 1994, new ventures would have produced an additional 1.3 million jobs in 2010. This is a substantial number considering that civilian employment is down 5.5 million jobs since the recession began in December 2007, according to figures from the Bureau of Labor Statistics.

While it might seem as if the Great Recession is responsible for this decline, it’s not the cause. The rising cost of providing employee health insurance is largely responsible. Sure, the recession didn’t help, but BLS data show that employment in new establishments has been in continuous decline since 1999.

Let’s look at what’s been happening to startup employment. First, few businesses actually have employees—and fewer do now than in the 1990s. Census figures show that more than 26 percent of businesses had employees in 1997, but by 2008, the share was down to 21 percent. Second, when new businesses have employees, they have fewer of them. According to BLS figures, the average establishment less than one year old in 2010 employed just under five people, compared with more than seven in 1994.

The slide in job creation appears linked to the rising cost of employee benefits. As the cost of providing for employees’ health care and retirement increases, hiring people becomes more expensive. The cost of employee benefits has been rising faster than businesses’ revenues since at least 2000. The BLS reports that from 2001 to 2010 the cost of employee benefits at private businesses rose faster than inflation, going up 13.6 percent in inflation-adjusted terms. The increase in benefit costs over the past decade suggests that benefit costs are eating into companies’ profits.

EQUIPMENT OVER LABOR

It is only natural that entrepreneurs try to reduce those costs. One way to do that is to hire fewer people. Equipment doesn’t need health insurance or retirement plans. So if a business can produce the same results by substituting investment in equipment for investment in labor, it can solve the rising benefit cost problem, albeit at the expense of employment. Therefore it’s not surprising that a smaller fraction of entrepreneurs hires employees, and those who do hire fewer people than they once did. The profit motive demands it.

So what’s the answer? Telling entrepreneurs that they should hire more people will do little if they have an economic incentive to trim the number of employees they hire. Entrepreneurs aren’t hiring fewer people because they are heartless; they’re hiring fewer people to ensure that they make money.

A solution requires taming rising benefit costs. And BLS analysis shows that most of that rise comes from increases in the cost of employee health insurance, not in the cost of retirement or other benefits. Boosting hiring by new companies depends on containing the cost of employee health insurance, which everyone knows has been rising faster than inflation for many years.

While much has been made of the new health-care law, it will do little to tame these costs. As Joseph Antos, the Wilson H. Taylor Scholar in Health Care & Retirement Policy at the right-leaning American Enterprise Institute, told Kaiser Health News back in July, the law “was about expanding coverage, not cutting costs.” In fact, the nonpartisan Medicare Office of the Actuary estimates that health-care spending will rise 0.1 percent more per year through 2020 as a result of the new law, increasing 5.8 percent annually.

If we don’t find a way to get health-care costs under control, we face a potentially frightening scenario in labor markets. New businesses may trim their hiring so much that they don’t hire enough to make up for jobs lost at existing businesses. That’s a situation I hope we never have to experience.

Scott_shane
Scott Shane is the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University.

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