Why small firms aren't the answer to recovery

Mitt Romney says they're "job creators" and vows to come to their aid as president. Newt Gingrich visited them on his "jobs and growth" bus tour. President Obama calls them "the engine of our economy."

If there is one thing Republicans and Democrats agree on, it is that small business is the answer to what ails the economy.

But the work of several economists suggests that most small businesses are not particularly adept at creating jobs, at least not the best jobs. The work also suggests their role in generating national wealth has been exaggerated.

The problem is that not all small businesses are created equal. Businesses just getting off the ground contribute most of the country's job growth, but older small businesses cut as many as they add.

"I don't want to pick on dry cleaners and restaurants and small manufacturing firms, but they're not a big source of job creation," said John Haltiwanger, an economist at the University of Maryland.

Politicians like to say that small companies create two of every three jobs in a given year. That's less impressive when you consider that almost all the six million companies in the United States - 99.9 percent of them - are small businesses with fewer than 500 workers.

What's more, "two out of three" masks the fact that most small businesses eliminate more jobs than they create in a given year, via layoffs, closings, or bankruptcy. And many of the rest do not offer much hope for the millions looking for jobs.

Many small companies - businesses such as florists, hardware stores, and barbershops - tend to grow with the population, not faster. So they do not speed the economic recovery the way an exploding new industry might.

According to an August study by two University of Chicago economists, most small-business owners just want to be their own boss and never expect to hire more than a few employees.

Haltiwanger and two other economists showed, in a study of millions of companies over 30 years, that small businesses no more than five years old - that is about 40 percent of them - are the only ones that create more jobs each year than they cut.

In 2005, for instance, more than 99 percent of the 2.5 million net new private-sector jobs in the United States came from these start-ups, according to the Census Bureau. But the 60 percent of small businesses that have been around more than five years act as a slight drag on the number of jobs available nationwide. They have cut about 0.5 percent more staff than they have added in a typical year, Haltiwanger said.

By contrast, big businesses have hired more than they have cut - about 0.1 percent in a typical year.

Economist Charles Kenny of the New America Foundation, a nonpartisan research group, goes as far as to suggest that Washington should stop offering certain incentives to small-business owners, such as loan guarantees and write-offs on taxes for home offices. He said the money would be better spent subsidizing research and development.

"If you want jobs, you have to focus on the innovative firms trying to provide something new and different," Kenny said.

Even the idea that small businesses play an outsize role in the economy has come under attack lately.

A study from the left-leaning Center for Economic and Policy Research shows that the self-employed worker accounted for less of the working population in the United States than in 20 other rich countries tracked, except for Luxembourg.

Another study by economists at Harvard and Dartmouth suggests that might not be such a bad thing because poorer countries are more likely to have a higher share of their workers self-employed.

Adding fuel to the argument, Kelly Edmiston, an economist at the Federal Reserve Bank of Kansas City, showed that workers at small businesses were more likely to lose their jobs and less likely to have vacation days, retirement plans, and benefits such as health care.

Myths about job creation aside, why isn't the United States launching more start-ups?

Haltiwanger thinks demographics may be at work. He said businesses were often started by people in their 30s and 40s. So as the population aged, the number of start-ups fell.

"We're a roll-the-dice economy. It has a lot of spillover effects," he said. "But we're not experimenting enough."