South By North Strategies, Ltd.

On The New York Times’ small business blog, Scott Shane of Case Western Reserve explains how start-up firms actually generate job growth and why business creation alone is unlikely to pull the labor market out of the recession.

Shane argues that the proper way to understand small business job creation is to look at both the jobs created by new small firms and those destroyed by small firms that fail in a given year. Explains Shane:

… Analysis of the data indicates that the annual cohorts of start-ups founded between 1977 and 2000 employed only 81 percent of the people in their sixth year that they employed in their first year. In other words, after the first year, the firms that failed destroyed more jobs than were created by the firms that survived. In fact, in no year did the sixth year employment of a cohort of firms equal its first year employment.

This point may seem a little abstract. So let me give you numbers from a particular year to make it clearer. In 2000, 487,000 new establishments were founded and created jobs for 3.1 million people. By 2005, those businesses only employed 2.4 million workers. That means the growing businesses founded in 2000 didn’t add jobs at a fast enough pace to make up for the shrinking and dying businesses started in that year.

So what does this mean for new business job creation? It means that new businesses are important to job creation primarily because they get founded, not because most of them tend to grow. Even though each cohort of new firms ends up shedding more jobs that it creates as it ages, the initial formation of new businesses creates jobs. And because a crop of new firms is born every year, jobs are continually created.

Shane then notes how policy efforts designed to promote business creation by themselves will fail to generate adequate numbers of jobs. Business support and retention services also are needed. Writes Shane:

To get back to pre-recession employment levels, we need entrepreneurs to start new businesses. But we also need more existing businesses — including the young small ones — to grow rather than stay stagnant, shrink, or die. If we could get each cohort of businesses to employ the same number of people at age six that they employ at founding (or better yet employ more people), we would have a much better employment picture than we currently have.