For the U.S. economy to make a comeback, the government must introduce smart policies to “put the customer back in the barber chair.”
Over the past several decades, small businesses have been credited with creating two-thirds of the new jobs in the United States. This is a statistic we see frequently cited during election season, when those who aspire to political office champion the small-business owner. But do policymakers and politicians really understand why small firms create such a big percentage of new jobs?
There’s really a very logical explanation for why small businesses are the engine of job growth: Jobs are created when the population grows and the need for more of the services and products that small businesses provide increases.
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A country with no population growth will not experience job growth over time – it will only experience job change as old products and services are replaced with new ones. Once a country’s culture and laws (like child labour laws that prohibit employment under the age of 16) are accounted for, there will be a fixed number of jobs available. But with population growth, more goods and services (barber shops, restaurants, doctors’ offices, etc.) are needed, and small firms provide most of these. Larger firms using relatively few workers produce most manufactured goods. According to William Strauss of the Federal Reserve Bank of Chicago, it only takes 177 manufacturing workers to produce what 1,000 workers produced in 1950. Consequently, most new jobs come from new small businesses that proliferate when the population expands.
Even a country with a stable population can experience a business cycle, as we do here in the U.S. About eight million workers lost their jobs in the recession, and – no surprise –large firms did not bear the bulk of those losses. In simple terms, the small businesses that were operating at capacity in 2007 are now operating with spare capacity (the five chairs in the barbershop are not fully used, and only three barbers are needed to meet demand).
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In the boom from 2003 to 2007, we created more new businesses than we could sustain, and too much inventory for consumers that decided to spend less and save more. The Bureau of Economic Analysis reports that, at the end of 2008, consumers cut their spending by half a trillion dollars per year. This plunged the economy into a steep decline, forcing small businesses to reduce employment and inventory in order to cut costs and stay afloat. That adjustment process has mostly run its course, with employment and inventories now adjusted to the reduced level of consumer spending and a weak economy.
Not much has changed in 2011. Today, nearly 30 per cent of small-business owners report “poor sales” as their top business problem. Normally, 600,000 new firms are formed each year and only 500,000 terminate operations. Right now, however, the number of terminations exceeds the number of startups as the “supply” of firms is adjusted to meet lower demand for services and products. 
When consumers start spending again, the “chairs will fill up at the barbershop” and population growth will once again produce a proliferation of new small firms (mostly in the labour-intensive service sector) to meet their needs. This will produce the bulk of “new” jobs. In the meantime, what we need is “re-hiring” in the firms that are already here.
Right now, small firms need customers. With nearly 40 per cent of small-business owners expecting business conditions to worsen over the next six months, gimmicky government offers of a temporary tax break (financed by permanent increases in income taxes) do not make a new employee a more attractive investment. If an owner does not feel a new hire could produce enough added value to justify the salary expense, a few thousand dollars for one year won’t balance the equation. And while a three-point reduction in the Social Security tax would be appreciated by owners who are trying to preserve current jobs, it does not change the expectation that, in a weak economy, the new employee could not add enough value to justify the hire.
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With a record percentage of consumers and small-firm owners unhappy with government policies and expressing uncertainty about the future, inspiring confidence in the economy is an uphill battle. The news is now full of stories about the consequences of overspending and over-borrowing here and around the world. If sensible policies to deal with the debt/deficit/spending problem were passed, confidence would change and 131 million currently employed consumers would spend more – a great stimulus that would lead small firms to start rehiring.
But simply spending more and increasing our debt will likely lead to more uncertainty and induce consumers to spend less, not more. Washington is our biggest source of uncertainty. Our politicians need to fix that.
