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<\/a>“I knew Dickens! And you, Curmudgeon are NO Charles Dickens!<\/p><\/div>\n
This article, \u00a0The Ghost of Christmas Past, is the first in\u00a0our \u00a0Small Business Holiday Trilogy. \u00a0The Ghost of Christmas Past describes how and why the Small Business Truism came to be, and how Evil Forces successfully questioned its validity. Is small business our best new net job creator? <\/span><\/strong><\/p>\n In subsequent issues over the Christmas and New Years holidays we shall send out The Ghosts of the Small Business\u00a0Present and Future which carry the research on Small Business job creation to the present day and into the future.<\/span><\/strong><\/p>\n Whether or not small business is the real job generator of the American economy is a question that probably doesn’t\u00a0need an answer. It is a FACT. For most economic developers that small business is creates the most jobs is a fact not to be questioned. Everybody says it, from the President of the United States (known in journalistic circles as POTUS) to the taxi cab driver from whom you get your stock tips (the Curmudgeon drove a cab for two years in Boston area back in the 1960’s: he didn’t play the stock market, THEN); it simply must be true. Frankly in the Curmudgeon’s mind, there is simply nothing that can compete within economic development circles with the notion that small business is the way to create the most jobs and revitalize your community. Even the media and politicians believe it. Indeed, the Curmudgeon himself must admit – he believed it himself in his time when he was at the helm of an economic development agency.<\/p>\n But, the Curmudgeon being the Curmudgeon, is the truism true? Where did this shibboleth come from? Is there any data to back it up? Is the data that exists based on job creation in the 1690’s? Worst of all worlds – is it partially true and partially false and therefore misleading?<\/p>\n To help and guide the reader to answer\u00a0these questions that for going on three decades\u00a0has bedeviled academics, economists (are they two different things?),\u00a0economic developers and practically everyone else, we offer for your Christmas time reading (who are we kidding?) a Lord of the Rings-style\u00a0Trilogy presented by\u00a0the Dickensian-like three ghosts of small business job creation. This article is the first in the Small Business Trilogy, The Ghost of\u00a0Truism’s Past,\u00a0and it purports to both describe how and why the Small Business Truism came to be, and how Evil Forces questioned its validity–almost from Day One. In subsequent issues over the Christmas and New Years holidays we shall send out The Ghosts of the Small Business Truism Present and Future which carry the research on Small Business job creation to the present day and into the Future.<\/p>\n Research since the 1980’s has linked small business as the single most important element in overall annual NET job creation in the American economy. But, this finding is controversial and has been consistently questioned in no small measure because the Truism\u00a0is near impossible to\u00a0measure and easily falls victim to serious methodological and statistical deficiencies. Scrooges abounded and they were right as often as they were wrong–and in their wake we were all confused. The methodological issues were, and are, complicated and the Truism’s\u00a0deficiencies were exaggerated by inadequate databases which previous to 2000, or so, were not up to the task at hand. This problem would plague the Truism until the turn of the century.<\/p>\n Well, we turn to\u00a0 David Birch, Job Creation in America: How our smallest companies put the most people to work, <\/strong>Free Press, New York. 1987, and with James Medoff, “Gazelles”, in Solomon and Levenson”s Labor, Employment Policy and Job Creation,<\/strong> Westview Press, Boulder, CO, 1994.\u00a0 To critique Dr. Birch we shall focus on a body of research centered around Steven J. Davis, John C. Haltiwanger, and Scott Schuh, especially, “Small Business and Job Creation: Dissecting the Myth and Reassessing the Facts”, Small Business Economics, Vol 8, 1996, pp. 297-315. In\u00a0 order to update and test both Birch and Davis, et al’s critique we will synopsized David Neumark<\/strong> (University of California, Irvine and California Public Policy Institute), Brandon Wall<\/strong> (Stanford University) and Junfu Zhang<\/strong> (Clark University and Institute for the Study of Labor (Bonn, Germany)) who, one dark and stormy night, apparently got together to write a research report which was published by NBER in December 2008. The review is entitled “Do Small Businesses Create More Jobs? New Evidence for the United States from the National Establishment Time Series<\/strong>“.<\/p>\n [A word about NBER (www.nber.org<\/a>). It was founded in 1920, and\u00a0called the National Bureau of Economic Research (hence NBER – who wouda guessed); it is a\u00a0private, nonpartisan nonprofit and is headquartered in Cambridge, Massachusetts (the Curmudgeon probably dropped people off there from his cab, economists are lousy tippers). It considers itself, and many others also consider it, as the “nation’s leading nonprofit economic research organization”. Twenty-two Nobel Economics prize winners\u00a0 and thirteen past Chairs of the President’s (POTUS, remember) Council of Economic Advisers have published in it over the years.\u00a0 In any case, Working Papers are published on a weekly basis and they represent the author’s current thinking and research – at the time of\u00a0 publication]<\/p>\n Birch’s bottom line message was the book’s title, the smallest companies put the most people to work, and he was arguably the first to quantify and support that position. Birch’s research demonstrated that companies with fewer than 20 employees-create 98% of all net new jobs.<\/span><\/p>\n Our approach is to use, when possible, the actual words\u00a0of the authors\u00a0(with page citation provided usually); we will\u00a0take occasional liberties with the original wording to facilitate readability, but we pledge to do our best to be faithful to the author’s message. Usually, but not always,\u00a0when the Curmudgeon wishes to distort, confuse\u00a0and blather, he will place his ravings within brackets []. When in doubt, if it sounds halfway intelligent, it will be a paraphrase of\u00a0the original authors, otherwise, it’s\u00a0the Curmudgeon.<\/p>\n So let’s begin. Anyone that’s been involved in the\u00a0economic development game longer than twenty-five minutes knows that the small business fixation started with David Birch who first published the idea in 1979 and then definitively proclaimed it in 1987 (Job Creation in America:\u00a0How\u00a0Our Smallest Companies Put the Most People to Work<\/strong><\/span>, Free Press, New York, 1987). Birch’s bottom line message was the book’s title, the smallest companies put the most people to work, and he was arguably the first to quantify and support that position. Birch’s earlier research demonstrated that “66% of all new jobs in the United States during the 1969-1976 period were created by firms with 20 or fewer employees, and 81.5% were created by firms with 100 or fewer employees.” (p.1) [The book jacket of the 1987 edition claims “that companies with fewer than 20 employees-create 98% of all net new jobs”].<\/p>\n This alleged importance of small business stood in marked contrast to the prevailing wisdom of the time which\u00a0was typified in J.K. Galbraith’s New Industrial State.\u00a0Galbraith indirectly\u00a0argued, or at least implied, indeed Birch himself quotes Galbraith by saying\u00a0that “this part [small business] of the economic system is not insignificant” … but Galbraith implies the reverse. Galbraith and others who think that big business is the American economy don’t seem to realize fully that the bubbly, yeasty, creative segment is the small businesses segment” (p. 8-9, Birch, 1987).<\/p>\n Further, in his 1987 book, Birch calls attention to the ongoing switch from manufacturing to the services sector which Birch believed to be the principal growth sector of the then current\u00a0American economy. Whatever the sector his data and analysis\u00a0observed and demonstrated that these growth\u00a0firms were predominately very small. “As we look through our microscope, we see economic growth being dominated by a relatively few highly innovative firms, most of which have started small and grew by creating a whole new way of making or doing something. We call them ‘high-innovation firms’ (p.4, Birch).<\/p>\n I”ve got a cat that looks more formidable than this gazelle!<\/p><\/div>\n This observation\u00a0is one of the very earliest\u00a0which called attention to what has since become a major, arguably paradigmatic, approach to economic growth and economic development: innovation, creativity and smallness. In the minds of many these forces became so intertwined as to become incorporated into our Truism. \u00a0[To be sure innovation economics had been dealing with the economic theory underlying\u00a0 all this for more than two decades. But\u00a0the discussion largely was in the bleachers of the economics profession and even as late as 1987 (1988-Buffalo conference was the real coming out party of Krugman, Romer and their mentors, Solow and Lucas) had not even penetrated mainstream economics. \u00a0Birch’s position in 1987 \u00a0impacted mainstream professional commentary and the academic literature much more than the early innovation economists had].But, we should also alert the reader that Birch continured writing after 1987. His 1987 work would be the foundation of our Truism but in 1994,\u00a0Birch radically amended his own approach (Birch and Medoff cited above). In his “gazelles” article he questioned whether size of the firm was itself\u00a0 the critical dynamic. Instead, he suggested that most net jobs are created by a small number of high impact firms which\u00a0he called gazelles<\/span> [now you know where that came from]:<\/p>\n “These gazelles move between small and large quickly–at various times in either direction–and to classify them by their size is to miss their unique characteristics: great innovation and rapid job growth”. (p. 163, Birch & Medoff)<\/p><\/blockquote>\n The “gazelles”\u00a0article concluded that these gazelles (about 4% of all firms) created\u00a0jobs at a rate far exceeding their proportion\u00a0of total firms. As cited in a 2008\u00a0study by Acs, Parsons, and Tracy (High-Impact Firms: Gazelles Revisited)\u00a0done for the SBA, (which we will describe in great detail in our Ghosts of Christmas Future issue)\u00a0, Birch, Haggerty and Parsons (1995) “concluded that gazelles account for all new jobs in the whole economy.” (p.5, Acs, Parsons, and Tracy). Birch had moved on and size, as we all know, doesn’t really matter.<\/p>\n In essence, Birch himself by 1995\u00a0had left his Truism behind and had moved on.<\/strong><\/span><\/p>\n [So there! We have answered a couple of our initial questions. It was Birch who gave birth to the truism and the data on which it was based was not 1690 but rather 1969-1986]<\/p>\n In his 1987 book, cited above, Birch\u00a0was quoted as proving that\u00a082%\u00a0“of employment growth via expansion and contraction”\u00a0in the 1981-1985 period were by firms with less than 20 employees, and that 88.1% “of overall employment growth” were created by these firms (as cited on p.1 of\u00a0Neumark et al-so forget about the bookjacket). These later\u00a0authors inject this last bit of precision, the Curmudgeon suspects, because from it’s outset\u00a0Birch’s numbers and\u00a0his methodology came under also immediate\u00a0attack. A literature was soon to develop over the next fifteen years\u00a0which questioned both the Truism and the methodology on which it was based. Birch, having moved on, did not participate in his own defense.<\/p>\n So how did we forge the Truism? Neumark et al observe (we are still on page one) that Birch’s central argument about the critical role of small business in job creation really dovetailed with “the U.S. government’s long tradition of supporting small business”. Pointing out that since the SBA was created in 1953 the Congress and the federal government consistently promoted and provided programmatic assistance to small business. “Birch’s findings fed into this thinking and quickly become conventional wisdom” (p.1) and ever since then Birch has been used by the federal government to justify a long string of loan programs, tax credits and incentives, favorable regulations, and support and assistance programs [such as a Curmudgeon fav, the Small Business Development (Counseling) Centers].<\/p>\n “Birch’s findings fed into this thinking and quickly become conventional wisdom” and ever since then Birch has been used by the federal government to justify a long string of loan programs, tax credits and incentives, favorable regulations, and support and assistance programs”<\/span><\/p>\n To this very day, the SBS’s Office of Advocacy “still trumpets Birch’s findings” (p.2) but, unfortunately for a quick and easy read on this topic,\u00a0the Bureau of the Census entered the fray in an effort to prove or disprove the Truism that small firms created the most jobs. With its vast array of databases the Census Bureau\u00a0added both sophistication and complexity into the equation of whether or not small business is indeed the greatest job creator in the American economy. The Truism had acquired a life of its own, and having been abandoned by its author, a new literature arose to critique, support, or disprove the Truism’s core principal that size of firm (small-less than 20 employees)\u00a0was the key factor underlying net job growth in America.<\/p>\n Scrooge-like, bah humbug,\u00a0criticism of Birch was soon in coming. A couple of years after Job Creation in America,<\/strong><\/span> (1990 to be exact), a fellow, believe it or not,\u00a0named Charles Brown (and James Hamilton and James Medoff) in\u00a0Employers Large and Small<\/strong><\/span> (Harvard University Press, 1990) attacked the quality of the jobs which small business created. Comparing the small business jobs to those created by large firms, Brown et al found the former (small business) created rather lousy jobs,\u00a0 with less pay, less job stability, poor fringe benefits, inferior working conditions, less job training and exhibited higher turnover rates (p.2). This was a serious concern and it remains to this day “an important” concern but given that\u00a0these concerns affected real people\u00a0in their real lives it would not be of significant professional concern . The quality of small business jobs, however, is NOT Neumark et al’s primary focus.<\/p>\n For Neumark et al, the\u00a0core critique of Birch’s numbers and his methodology\u00a0originated from two 1996 works by Steven J. Davis, John Haltiwanger, and Scott Schuh, “Small Business and Job Creation: Dissecting the Myth and Reassessing the Facts” (Small Business Economics, Vol 8, 1996).<\/p>\n [Before discussing specifics about Davis’s critique of Birch, the Curmudgeon would offer that Davis’s works\u00a0do seem to\u00a0possess a bit of apples to oranges aspect. The two studies use (1) overlapping, but different time periods, (2) different data sets, and (3) and Davis studies only one sector, manufacturing, which Neumark footnotes may well follow different growth patterns than other sectors and it is, after all, a sector which has been in serious job decline since the 1950’s. Neumark cites a number of other researchers who also have concerns with a critique based on manufacturing during this period of time. So as we understand Davis et al’s critique of Birch\u00a0we should realize it too was under almost immediate attact by others who were defending Birch, who, if you remember, had moved onto hunting gazelles]<\/p>\n Davis’s analysis refutes much of Birch’s Truism, pointing out several important and potentially serious concerns principally with Birch’s database and methodology. It is these additional concerns which, if held to be substantially correct, would damage the Truism and the pivotal role of small business in job creation. The reader ought to keep in mind that Birch’s original study represented then and still remains\u00a0the core defense of the small business job creation Truism to this day. If Birch’s study\u00a0could\u00a0be successfully questioned, we\u00a0would be\u00a0back to “square one”.<\/p>\n The first bottom line problem with Birch’s methodology was that he classifies small business firms into size classes (i.e. less than twenty, twenty to fifty, etc) and then “examines the variation in job growth across the size classes”[which means a firm’s jobs in one year is contrasted to the same firm’s jobs in a second year, etc]. To Davis et al this size classification scheme is flawed and leads to a “regression fallacy” which, Curmudegon’s words, leads to an overestimation in the number of jobs created by small firms. (p.2) Subsequent research, cited by Neumark, suggests this has proven not to be a major concern with Birch’s work (p.5-6) but Neumark et al themselves will conduct research to assess the extent to which the regression fallacy does or does not exist.[Not to keep you in suspense, they conclude there is a regression fallacy and they will design a methodology to correct for it].<\/p>\n [In essence Davis et al, are attacking the “quality”\u00a0 and integrity of\u00a0Birch’s old-style Dunn & Bradstreet data, implying that\u00a0D&B is error-prone and far too imprecise to support \u00a0Birch’s far-reaching conclusions]<\/span><\/p>\n Other problems alleged to be part of the size classification approach to estimating small business job are that two types of firms “will accidentally fall into the smaller size category: firms that are not small but have just experienced a transitory negative shock to their employment …; and firms that are not small but are mistakenly classified as small due to random measurement [error from the D&B database]. Both types of firms allegedly will ‘grow’ fast from one year to the next only because [they will return to their former size] of regression to the mean (p.4).<\/p>\n [In essence Davis et al, are attacking the “quality” of the old-style D&B data, implying that it is error-prone and far too imprecise to be pushed to justify Birch’s far-reaching conclusions. The Curmudgeon can himself testify that his personal experience with D&B data in this time period, used as a mailing list only, almost always had error rates exceeding twenty-five per cent. Birch no doubt cleaned this up somewhat, but how much is somewhat? At the time of original publication, these weaknesses, which are fundamental, were discounted or ignored]<\/p>\n Using a different method of calculation, Davis et al believes removes the regression fallacy,\u00a0Davis then analyzes firms in the manufacturing sector from the Longitudinal Research Database for the period 1973-1988. They conclude “that employment growth appears to have ‘no systematic relationship to average plant size'” (p.3). Size does not matter!<\/p>\n The second bottom-line deficiency with which Davis et al were concerned was the database used by Birch (a derivative of Dunn & Bradstreet data) and they alleged that Birch’s data “were not particularly suitable for studying job creation-destruction dynamics for two reasons. First, early D&B data suggested a much higher total employment number than alternative data sources such as those from the Census or the BLS (larger denominator). Secondly, the early D&B data did a poor job in terms of capturing new businesses (p.8) and establishing if they were true “stand alone” business independent of a larger firm. [In the Curmudgeon’s underpowered mind, and, to the extent they are valid, these are serious criticisms and do impact negatively on the original research of Birch. They call into question the validity of Birch’s findings, and therefore would\u00a0invalidate our small business Truism apart from the regression fallacy]<\/p>\n Neumark et al decide to review Davis et al’s critique and test both Birch and Davis et al methodology and conclusions. To this end they develop with the Bureau of the Census a new database, the National Establishment Time Series (NETS) [which is also a sophisticated derivative of Dunn&Bradstreet data]. NTES includes ALL US business establishments since 1989 (although Neumark only uses data from 1992-2004). This database allows for the clear identification of branch or subsidiary firms, and therefore permits researchers to isolate “stand alone” firms in all sectors, not just manufacturing, a total of about 13.1 million firms annually (p.7)<\/p>\n The purpose of Neumark et al’s Working Paper is to test, using a new database, whether Birch or Davis is correct. Neumark et al are concerned with the numbers of jobs created by small business and the methodology by which those numbers are derived. [Neumark et al assert that the earlier cited deficiencies of D&B data have since been corrected and Neumark et al have taken great pains to validate the data and assess for its reliability. They feel they have corrected additional deficiencies associated with rounding, and in particular they have refined and enhanced\u00a0the “capture” of births by new firms significantly (p.9) For specific details how they accomplished this feat, the reader should consult the article itself]<\/p>\n Still, after all these refinements, adjustments, and sensitivity to data deficiencies, Neumark et al “find the NETS database, like all others, is not without its flaws, and has both advantages and limitations (p.10), but Neumark does believe the deficiencies associated with the earlier Birch data sets have been remedied quite well and in particular, NTES, constructed with more recent D&B data, has corrected\u00a0the NTES and Census\/BLS gap in number of firms so that\u00a0issue \u00a0“is not a serious concern”, and the capture criticism has been made “largely invalid” (p. 10).<\/p>\n [I don’t know about you, the reader, but all this data and methodology stuff has got me bored. So, it’s time for a mandatory three minute reflection on an interesting\u00a0 (which precludes economics and databases) topic\u00a0of your choosing]<\/p>\n\u00a0The Ghost of Small Business Job Creation Past: David Birch<\/h3>\n
<\/a>Scrooge Questions the Ghost of Small Business Job Creation<\/h3>\n
Neumark’s Review<\/h3>\n