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Small Employers: Too Numerous to Fail

Our federal policymakers need to recognize that they've gotten us into a bind when it comes to employment. When the economy tanked in 2008, they focused—rightly or wrongly—on what was happening on Wall Street, not Main Street. They bailed out the big banks and the big automakers and left small business owners to fend for themselves. Now they must learn a lesson for the next recession.

Maybe they were too busy putting out fires to worry about small companies. Maybe they didn't care about resource-strapped entrepreneurs who don't spend as much time wooing politicians as big business leaders do. Or maybe they naively believed models that showed that most companies would survive the recession, shedding jobs in the downturn and bringing them back when the economy recovered.

Whatever their reasons, our officials are now faced with a tough choice when it comes to private sector employment. They can suffer through high unemployment for a while as surviving small businesses and new entrepreneurs begin to create jobs, albeit at a slower pace than if established small businesses had gotten help to endure the recession. Alternatively, they can come up with policies, such as the payroll tax reduction, that are designed to stimulate employers to add jobs faster than normal—but without knowing the right recipe for those policies.

The Boom in Small Business Failures

I'm worried about the assumptions the federal government makes about small business job creation. Policymakers aren't acknowledging that employment at small businesses has been slow to rise in the recovery because a lot of small employers closed during the recession. But data recently released by the Small Business Administration shows that a far greater number of small businesses failed during the Great Recession than in normal years. So many, in fact, that the base of employers will struggle to generate the jobs we need as new companies start up and existing businesses begin to hire again.

The crux of the problem is that our policymakers seem to believe that employers of all sizes respond similarly to recessions and expansions—laying workers off when the economy sours and hiring them when good times return. While this characterizes big companies, it's much less appropriate for small businesses, particularly in harsh downturns. The Great Recession was obviously severe. With the business closure rate spiking just as the startup rate faltered, we ended 2009 with 146,000 fewer employers than we had in 2007, the first annual decline in the number of employers since 1991.

When jobs are lost because businesses have failed, they are harder to replace than when surviving businesses shed jobs; new businesses tend to employ fewer people than existing ones. The SBA has estimated that 5.9 people worked at the average venture that closed, compared with 5.2 in the average new business that opened in 2007, the latest year for which data are available. Assuming that the 2008 and 2009 numbers per business are similar to those 2007 figures, replacing the 7.8 million jobs lost from the 1.3 million employers that closed during the recession would require the creation of 1.5 million new businesses that employ people.

Small Startups Did not Keep Pace

That's a tall order. While entrepreneurs created 1.2 million businesses with employees in 2008 and 2009, that's well shy of what we needed. SBA numbers show that we created only 553,000 new businesses with employees in 2009—108,000 fewer than closed. Even if we return to the average, by which 41,000 more employers formed annually than closed over the past 20 years, it will take 3.5 years to make up for the drop of 146,000 businesses during 2008 and 2009.

Policymakers should be marking how difficult it is to put small businesses on job-creation steroids when we don't have the formula for the potion. The next time there's a big downturn, they should bear in mind how painfully slow it has been to rebuild the jobs lost in the Great Recession. They should step in to prevent so many small businesses from closing and thereby erasing jobs.

Government intervention to keep viable businesses from shutting down shouldn't depend on a company's size, as seems to have happened. Just as large businesses receive financial life support to keep from going under, so should small businesses. Instead of thinking a few businesses are too large to fail, policymakers should know that small employers are too numerous to fail.

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

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