The high importance of small firms in job creation is a very popular and “politically correct idea” between policy makers. But once again it is misleading.
Haltiwanger and colleagues used a large set of data, from 1976 to 2005 (equivalent to 70 million firm-year observations) and they show that small companies are not the job creators. However start-ups, new entries, make important contributions to job creation - and indeed also to job destruction during their (usually) short life. But net job creation by start ups makes a significant contribution to net employment.
Typically a new entry (start up) begins small and grows. This paper gives evidence for a “up and out” dynamic of young firms: new firms begin small, and they grow or they disappear (exit). They either grow fast or they disappear. But in manufacturing sectors the exit pattern during early stages is much stronger.
From young to mature, along time (age), usually firms go from small to larger - may be medium size and, in some (rare) cases, they become very large corporations.
In early stages, firms are small and they have small, incremental, effects on job creation and destruction. But lots of them can create a sizable effect. While they are small, even small absolute changes in size can give high relative rates of change. Usually they are financially weak and dependent of external sources of funds (venture capital, equity). They often have an high R&D intensity, but their share of total R&D activities is marginal.
Later, in the mature phase, if they survive, firms are larger, their relative rates of change are smaller, but their share of total employment is larger, their contribution for job destruction is also larger when they collapse, and they make substantial contributions to R&D activities (even if their R&D intensity is smaller).
It is easy to chart these important changes in business behavior as firms go from young / small to mature / large. But starting point also influences firm behavior (path dependency): technologies used and related operational / organizational aspects are different for a start up today and for a start up, in a similar business and environment, twenty years ago (for instance).
Mortality is high for small firms, including start ups in early stages: a robust finding from the authors is that small firms are more likely to exit than large firms, even controlling for age.
Business start ups have a small contribution for total employment in any given year: roughly 3%. But these new jobs become significant in the overall net changes in employment, from job creation and destruction. They account for almost 20% of gross job creation.
Young firms exhibit high rates of job creation and destruction. They have very high job destruction rates from exit (closing of firms). After five years, around 40% of the jobs initially created by start ups have been eliminated by exit of the firms. But if the firm survives this initial and testing period, young (then small) firms will grow more rapidly than their more mature counterparts. Anyway - large, mature firms account for a large fraction of the jobs.
The authors make some relevant conclusions:
- We think our findings help interpret the popular perception of the role of small businesses as job creators in a manner that is consistent with theories that highlight the role of business formation, experimentation, selection and learning as important features of the U.S. economy. Viewed from this perspective, the role of business startups and young firms is part of an ongoing dynamic of U.S. businesses that needs to be accurately tracked and measured on an ongoing basis.
- Our findings suggest that policies targeting firms based on size without taking account of the role firm age are unlikely to have the desired impact on overall job creation.
- It may be, for example, that the volatility and apparent experimentation of young businesses that we have identified is critical for the development of new products and processes that are in turn used by (and perhaps acquired by) the large and mature businesses that account for most economic activity.
- Analyzing dynamic data about firms by isolation of age cohorts gives new insights. Overlapping of different dynamic behaviours (firms of different ages) can create a misleading “confounding” effect (well known in statistics) that can easily induce wrong conclusions from time series data about firms.
- Young companies role is very important in economy change (innovation), so is entrepreneurship. But young companies do not mean young people. Young companies by mature people are specially important (see previous post).
- Small and large firms have different roles in the innovation ecosystem (as predicted by William Baumol, and also recognized by Joseph Schumpeter in his later phase).