The Best Government Investments in Small Business?

Photograph by Oskar/Corbis

When our elected officials advocate small business policies, they invariably invoke the concept of an economic multiplier. One of the most recent examples: House Democrat Nydia M. Velazquez (D-N.Y.) used the idea at Small Business Committee hearings on the role of American entrepreneurs in economic recovery. “By creating brand new markets and sparking competition,” she said, “these firms often have a multiplier effect on job creation.”

Of course they do. Almost any economic activity has a multiplier. The question is whether investments in startups generate more jobs, create more new markets, or produce more competition than the same amount invested in something else. What matters is not how much bigger a policy’s impact is once the multiplier is factored in, but what its return on investment is in comparison to other uses of the money.

While multiplier effects are used as political rhetoric for virtually all government investments (and some private ones), I’ve noticed that they are often used—and abused—to argue for small business policy. Job creation, it seems, is the justification for most policies to support startups and established small businesses.

The supporters of proposed policies use multipliers to show that their programs have a large effect on economic growth or job creation. For instance, hole-digging advocates will tell you that hiring people to dig holes and then fill them back in doesn’t just generate jobs for hole-diggers, it also creates jobs for shovel manufacturers, the supermarkets where hole-diggers shop, and so on. Because multipliers incorporate the indirect effects of policies as well as the direct effects, policies invariably look better once multipliers are considered.

Consider a 2009 proposal (PDF) by the Ecosystem Resource Program at the University of Oregon to use stimulus funds for ecological restoration, which they estimated would create 15 jobs for every $1 million spent. That sounds good, right? But the report doesn’t compare the projects to others that would generate more jobs for your $1 million.

If you built child-care facilities in San Mateo County, Calif., your $1 million would yield 23 jobs, according to this organization’s report (PDF). If you put the money into academic research in Wisconsin instead, you’d generate 36 jobs for each $1 million invested, the Wisconsin Angel network estimates (PDF). Of course, if you really want to create jobs, you should establish energy efficiency programs for low income people. The utility Entergy estimates (PDF) that those programs create 216 jobs per $1 million invested.

Even if you compare policies after factoring in their employment multipliers, you still need to understand that some will create more jobs than others because of the industries they are in or the places where the investment will occur. The Bureau of Economic Analysis, which since the 1970s has been using its data to create the standard regional input-output multipliers that most people use, explains (PDF) that “the employment multiplier is particularly sensitive to hours worked in each industry. Industries with a larger number of part-time workers will necessarily have a larger jobs multiplier.”

Moreover, the same change in an industry’s output can affect many more jobs in one place than another. For instance, consulting firm Batelle estimates (PDF) that a $3 billion increase in output in the advanced medical technology industry will generate 7,287 jobs in California, but only 18 in North Dakota.

Finally, employment multipliers inflate the job-creation potential of all policies. Because employment multipliers consider both direct and indirect job creation, they double- and triple-count jobs. As the former vice president for research at the Minneapolis Fed, Art Rolnick, calculates, you will probably get a figure equaling 10 times the actual job creation that occurs if you add up the number of jobs estimated by factoring in employment multipliers for all companies.

Instead of invoking job-creation multipliers to make every proposal they favor look attractive, policy makers should focus on evaluating the direct impact of different projects and then pick the ones that have the best cost-benefit trade-offs.

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