The growth of small firm jobs by state, 1984-88

Business Economics, April, 1993 by Bruce D. Phillipa

DURING THE 1980s, there was ample documentation of the growing importance of small firms in creating new jobs, new products and increasing income. A portion of this research also emphasized the major role played by new small firm births, particularly births of new firms with fewer than twenty employees.(1) New and expanding small firms with fewer than twenty employees provided about 19 percent of total employment in 1988 but created more than twice their expected share of new jobs (39.5 percent) between 1984 and 1988. Clearly the smallest firms have become recognized as the most dynamic growers in the economy.

Much of the literature on job creation has, in fact, centered on these rapid growers with fewer than twenty employees, and many state programs have been designed to aid in their formation.(2) In spite of these state programs, however, the share of new jobs created by these smallest firms has also shown great variation. For example, job creation by the smallest firms ranged from 8 percent in Delaware to well over 100 percent in Texas (where large firms lost jobs) between 1984 and 1988.(3) Therefore it is of interest from both a state policy perspective, as well as a national growth perspective, to understand how job creation varies geographically by firms with fewer than twenty employees.

This paper will explain how and why the share of jobs created by very small firms varied among the states between 1984 and 1988. Because per-capita income growth is associated with increased small firm births and expansions of existing small firms, we attempt to quantify the optimal spatial environment in which this activity flourishes.(4) The model below examines the role many of the presumed determinants of growth play on a state-by-state (e.g., cross section) basis in influencing the share of new jobs created by small firms with fewer than twenty employees.

This paper is also of particular interest to larger firms because small firms provide growing markets for the largest companies. In particular, from computers and fax machines in home-based firms to banking services in new firms, small businesses function as both suppliers and purchasers in many newly emerging markets.

ARE SMALL FIRMS ATTRACTED TO GROWING SECTORS?

There has been considerable disagreement about whether small firms are more likely to enter growing industries or declining industries. Apparently the answer depends upon the life cycle of the industry, and whether the industry is initially dominated by small firms or large firms. For example, as segments of the service sector matured during the 1980s, small firms, while growing absolutely, lost market shares in subsectors that also grew during the 1980s, such as business services. On the other hand, gains in employment and sales shares were recorded by small firms in declining industries, such as the primary metal sector.(5) The former sector, business services, was initially dominated by small firms, while primary metal was historically a big business industry. Some of this recent growth has therefore been counterintuitive.

Other studies have gone further in trying to generalize the relationship between industry growth and small firm growth, on both an absolute and share basis. In a paper recently prepared for the Office of Advocacy of the SBA, David Evans (1991) observed "that there is a weak tendency for industries in which the small business share has increased to be industries in which total employment is declining, and that there is a weak to moderate relationship between increases in the number of small firms and industry expansions." Evans used data from the Small Business Data Base from 1976 to 1986 and found these generalizations lacked significance.(6) Apparently, Schumpeter aside, it is quite difficult to predict empirically how the small firm employment share will change in specific industries based upon historical generalizations.

A MODEL OF JOB CREATION

The following factors are hypothesized to have influenced the share of jobs created by state between 1984 and 1988 (PCTJOBS). The source of data for the dependent variables are the state job creation data based upon the 1984-88 Small Business Data Base (USEEM) files.(7)

The Presence of Large Firms. As summarized above, the presence of large employers is assumed to exert a negative influence on the birth of new small firms; large organizations generally exert a negative influence on entrepreneurial spinoffs, e.g., new firm births. The variable tested in our model below is LFEMP, the percentage of the labor force employed by firms with 500 employees in 1988, by state. Source: USEEM files.

Small Firm Births. A continuing supply of new small firms is generally a prerequisite for a growing small business sector with continuing employment generation, In addition, a continuing supply of new enterpreneurs is generally assumed to emanate from the births of new small firms, further increasing the share of new jobs created by these smallest firms.(8)

Rather than use the share of jobs contributed by births of all small firms with under twenty employees, we instead chose to use the birth and death rates of small high-technology firms, principally because we expected a stronger relationship between job growth and this rapidly increasing segment of the small firm sector.(9) In addition, using high-tech birth and death rates acts as a proxy to measure the influence of innovation by state. Because almost all new high-technology firms are based upon a new product or process, or a more efficient method of doing an established task, this variable acts as an indirect test of the state innovation rate.