Small Firms to Keep Lagging Back in U.S. Expansion: Economy

Small Firms to Remain Missing Link in U.S. Expansion
After peaking at 55 percent in 1987, small-businesses’ share of the U.S. workforce began declining in the 1990s. Photographer: Daniel Acker/Bloomberg

Small companies will probably remain a missing element of the current U.S. expansion as their role in driving growth continues to wane, according to economists at Citigroup Inc.

Payrolls at firms with fewer than 500 employees accounted for less than 50 percent of the total workforce for the first time in 2008 during the recession and have barely recovered, according to their research. After hovering close to 50 percent, small businesses’ share of gross domestic product began dropping in 2001 to reach about 45 percent in the latest available data.

In contrast to the gains in confidence for their larger counterparts, sentiment among smaller companies remains at recessionary levels, reflecting a confluence of obstacles, including globalization and a lack of credit as local banks consolidate. That means the world’s largest economy will lose support from the businesses that helped boost growth and productivity through innovation.

“Small businesses are going to be under pressure for quite some time to come,” Nathan Sheets, the New York-based global head of international economics at Citigroup, who conducted the research, said in a telephone interview. “Competing globally means establishing networks of distribution, communication, transportation, and it’s easier to do that as a large firm.”

Most U.S. shares fell today as Apple Inc. tumbled amid a report it cut orders for iPhone components. The Standard & Poor’s 500 Index dropped 0.1 percent to 1,470.68 at the close in New York after trading last week near the highest level in five years.

European Production

Elsewhere today, euro-area industrial production unexpectedly fell in November, adding to signs the 17-nation currency bloc’s recession deepened in the fourth quarter.

After peaking at 55 percent in 1987, small-businesses’ share of the U.S. workforce began declining in the 1990s. Citigroup’s analysis of Census Bureau data shows the slump was exacerbated by the 2007-2009 recession, the deepest and longest in the post-World War II era. The figures cover the period through 2010, the latest available.

Hiring by small companies still accounts for the lion’s share of gains in payrolls. Nonetheless, even that dominance is fading as the jobs they created accounted for 61 percent of the total in the 10 years through 2007, down from 65 percent in the decade ended in 1997 and 77 percent in the similar period to 1987, according to Citigroup’s research.

The total number of small businesses is also falling, decreasing to 4.9 million in 2010 from a peak of 5.3 million three years earlier.

Sentiment Slumps

More recent figures from the National Federation of Independent Business indicate little has changed since 2010. The group’s small-business sentiment index in December hovered around an almost three-year low reached the previous month, according to a report last week. The net share of respondents projecting the economy will improve over the next six months held at the lowest level since monthly records began in 1999.

“The environment for small businesses is not good,” said William Dunkelberg, NFIB’s chief economist and a professor at Temple University in Philadelphia. “Sales are weak, there’s regulatory bombardment, tax changes, all the uncertainty about the economy. People are thinking the odds are not as good as they might have been at other times, and so they’re not going to put their money on the table.”

A survey of 1,482 small businesses by the U.S. Chamber of Commerce confirmed the bleak outlook. More than half of respondents in the fourth quarter projected the economic climate for their firms will worsen over the next two years, according to a report last week. Less than 20 percent said they added employees last year, and the same share said they planned to hire in 2013.

Larger Companies

Conversely, a survey of chief executive officers’ outlooks conducted by the Business Roundtable, which represents larger companies like Chevron Corp. and Cisco Systems Inc., showed its index rose above its pre-recession peak in 2011 and continued to show expansion as of December, even as it cooled in the second half of last year.

To combat the small-business slump, Sheets said policy should aim to spur entrepreneurship, which he says is the real source of job creation and invention.

The Small Business Administration under President Barack Obama has made strides, said Karen Mills, the agency’s head. SBA initiatives include providing more access to capital, supporting innovation through research programs and simplifying application processes, she said. Her group has focused on manufacturers, helping small businesses become exporters and prompting American multinational corporations to use home-grown suppliers.

SBA Initiatives

“As the economy now has momentum and small businesses are looking at growth opportunities, we have a really rigorous and dynamic agenda going forward to drive small business success,” Mills said in an interview.

Citigroup’s Sheets isn’t as optimistic. Large firms account for about 66 percent of U.S. exports, which means they benefit more from global growth and a cheaper dollar, he said.

Matt Crooks, chief executive officer of Carbi-Tech Inc., which specializes in die design, tool building and production stamping for manufacturers, knows the situation well. His company, based in Vandergrift, Pennsylvania, about 35 miles east of Pittsburgh, employs 20 people and has been in business since 1995.

Less Competitive

“We face larger competitors, 10 to 100 times our size,” said Crooks, who said that even as his company would benefit by having some work done by firms in Canada and Mexico, like some larger competitors, he’d still rather keep it in-house. He said the pressures from globalization and larger companies’ ability to mass produce can make competing difficult. “We lose the economies of scale.”

Becoming an exporter requires overcoming “frictions,” like learning to navigate cultural differences and setting communications, said Therese Flaherty, director of the Wharton Small Business Development Center at the University of Pennsylvania. While that doesn’t mean small companies will not be able to export, the initial costs for a small business are larger relative to its sales, she said.

The next challenge comes as small companies try to secure financing. The value of commercial and industrial loans for less than $1 million, which the Federal Deposit Insurance Corp. counts as borrowing by small businesses, has changed little since 2004, data show. Loans for larger amounts are up 75 percent.

Local Lenders

The share of lending by small banks, the traditional funders of small firms, has simultaneously shrunk. Around 20 percent of loans under $100,000 come from institutions with less than $1 billion in assets, down from 40 percent a decade ago, according to Sheets, who attributed the slide to the consolidation of the U.S. banking system.

The recession also made it more difficult for small companies to borrow as banks feared taking additional losses.

“One of the after-effects was the tightening of lending standards,” said James Kunkel, executive director of the Small Business Development Center at St. Vincent College in Latrobe, Pennsylvania. “Small businesses struggle with cash flow. They just aren’t as well capitalized.”

Data on startups confirm Americans are reluctant to begin new companies, which represent the biggest share of job creation among small firms.

Fewer Startups

The number of establishments less than 1 year old has declined each year to about 505,000 in 2010 from a peak near 665,000 in 2006, according to the most current data available from the Labor Department. Citigroup found that the birth rate, or number of new small firms created in a given year relative to the total number of such firms, has dropped from 12 percent in the mid-1980s to around 8 percent.

Citigroup’s Sheets says that’s where policy makers should focus their efforts to boost the economy. Research by economists Teresa Fort, John Haltiwanger, Ron Jarmin and Javier Miranda found that while employment at startups accounts for 3 percent of the workforce, hiring by these firms represents 20 percent of total job creation, according to a November paper.

“I would prefer to focus on the start-ups, on making sure the U.S. is an attractive place to start business,” Sheets said.