When American Enterprise Institute (AEI) visiting scholar V?ronique de Rugy began looking at the long-held notion among entrepreneurs and policymakers that small businesses were the "fountainhead of job creation" and an important economic driver, she came to a radically different conclusion. A former analyst at the Cato Institute who earned her PhD. from George Mason University on the economics of tax revolt, de Rugy says that the policies predicated upon these deep-seated beliefs are not only wrong but actually damaging to small businesses and the economy at large.
BusinessWeek Online Staff Writer Stacy Perman recently spoke to de Rugy about her findings, which were published in an American Enterprise Institute for Public Policy Research study entitled Are Small Businesses the Engine of Growth? Edited excerpts of their conversation follow:
What led you to question the conventional wisdom of the significant role that small business plays in job creation and the economy?
I took for granted this number that 75% of new jobs are created by small businesses, etc. I wasn't even questioning that. I was looking at groups like women and minorities and seeing if there were liquid constraints and seeing if they were having problems accessing capital. And if so, was the Small Business Administration solving the problem?
I came across some literature by some labor economists written in the 1990s. The literature on this is thin, there isn't a lot of serious work done. I started looking at the data, and it took me a good month to see the fallacies. I looked at several different industries over the same period of time. I applied the same formula as the Small Business Administration (SBA) to come up with this 75% figure for each sector, and I came up with numbers that are completely random.
It showed me these numbers are correct, but they aren't an expression of a share of something. Then I realized that there was something wrong in the way people are looking at the data. They're seeing trends in the data that aren't there. This is actually a common phenomenon that labor economists call "the regression fallacy."
Is this the biggest misconception about small businesses?
This 75% number is a myth -- and everyone uses this number whether they're on the left or the right, an economist, a think-tank, or a journalist. Actually, it doesn't mean anything, and certainly not what people think it means.
What it means is that a lot of the policies and subsidies and incentives are implemented in the claim that they're needed to help small businesses because they're making 75% of all jobs, but in reality there's no legitimate claim for all that government spending. The thing people fail to see is that small businesses also destroy jobs much faster because the turn over rate is high. The life span of most small businesses is less than five years.
What, in your opinion is the upshot of basing policies on this figure?
It introduces a lot of distortions that can hurt small businesses. For example, if you offer subsidies and inducements for a company that has fewer than 20 or 50 employees, there's no incentive to grow.
Also, not all small businesses create a lot of jobs. We know that some of them do -- they're called "gazelles" -- they are highly entrepreneurial and create economic growth. The problem with targeting subsidies is that [they are] difficult to implement because the only way to identify the gazelles is after they have become successful, high-growth businesses.
Real job growth comes not from creating a small business but in building a big company. And most [new jobs] come from a few firms that start small and later grow big.
You advocate abolishing the SBA, why?
I actually think the SBA does a lot of damage. I find the idea behind the SBA reprehensible because it hinders economic growth more than anything. The SBA doesn't enlarge the natural pool of credit resources, for example. Its lending programs [assist] non-creditworthy firms, it intervenes and gives these firms access to resources.
[So] it's just shifting funds from [the] creditworthy to the less creditworthy, and that can't be a good thing by definition. Its programs reduce the marketplace efficiencies of job creation and economic growth by substituting policies and bureaucratic judgments of profit and risk for the market, and [the SBA] doesn't produce more credit, it's just shifting it.
The SBA is not only creating a lot of distortions by shifting money, on top of that it's not even accomplishing worthy goals. For instance, one of the things the SBA says is that women have difficulty accessing credit, but the data show that isn't true.
The literature does show, however, that there's a case to be made for helping minorities who do have a hard time accessing credit. Is the SBA helping these people that need help? The answer is no. [That's] because they're giving money to people who should already have access [to it], and if they don't [have access], there's a good reason why.
What do you recommend?
I would rather promote an environment that lowers tax rates and red tape for both big and small business and promotes an environment where small business can grow into midsize or large [companies] and then, whatever their size is, they can thrive. It's better than an environment that targets subsidies [that] usually aren't beneficial.
What has been the reaction to your conclusions?
I haven't heard from the Small Business Administration yet. Some people blogged [about] my study and are mad. They say things like, "Oh well, it's because she wants to promote big business." But that isn't true. In my paper, I make the same case for abolishing Big Business subsidies.
It's difficult to criticize this concept of small business, even I had a hard time. It's a very powerful concept. It seems like mother, apple pie, and small business is the trilogy of great things that everyone worships.