Allison Schrager on the Future of Small Business Job Creation in the U.S.

by Reihan Salam

Allison Schrager, who wrote a defense of financial innovation for National Review last fall, has a new article in Quartz on how the U.S. small business sector is evolving, drawing on the work of the University of Florida economist Jay Ritter:

[Ritter] believes a structural change has occurred in the economy which he calls “economies of scope.”  Technology and globalization have shrunk the time a start-up has to commercialize its innovation. Previously, firms had more time to grow organically and with it the capacity to execute their innovation on a large scale. But now markets move faster and are more competitive. Commercializing an innovation successfully requires the infrastructure large firms already have in place.  In this new world he says it’s “eat or be eaten.”

To test economies of scope Mr. Ritter looked at firm profitability. If it has become harder for small firms to compete, then fewer of them would be turning a profit.  Mr. Ritter did observe that the percentage of profitable, small, public firms has been declining. Meanwhile profitability among large companies did not decrease as much.

Given that a great deal of U.S. job growth is attributable to the expansion of young high-growth firms the Kauffman Foundation has referred to as “gazelles,” what might this evolution mean for economy-wide job creation? 

Historically, fast-growing small firms created many new jobs, according to research from George Mason University professor Zoltan Acs, who studies firm size, age and job creation. These job-creating companies are called high-impact firms.  Only about 6.3% of firms are high-impact, but they are responsible for nearly all net job growth. They are remarkable, not only because of the number of jobs they create, but how fast they grow. About 94% of high-impact firms have fewer than 20 employees when they entered the job-creating phase. If small firms are bought out early instead of growing large will they create the same amount of new jobs?

Mr. Acs is concerned they won’t. He believes that if small firms don’t have the time to grow organically it will inhibit job growth. A start-up successful grows quickly, but it can take several years to reach the high-impact phase. According to Mr. Acs job-creating firms are usually not over-night sensations.

Schrager’s article is noteworthy because, as she notes early in the piece, it runs counter to the valorization of small business that can be found across the U.S. political spectrum. During Wednesday night’s debate, for example, both candidates — but particularly Mitt Romney — made numerous references to the central importance of small businesses.