Why Small Businesses Aren't Fueling Job Creation in This Recovery

A crisis in confidence is holding back the most important job powerhouse of the past two decades.

By + More

The recession may have officially ended two years ago, but unemployment is still painfully high, and the squeeze on small businesses might be to blame.

Historically, small businesses have led the country out of recessions, generating nearly 65 percent of net new private-sector jobs over the past decade, according to the Small Business Administration.

But that engine of job creation has been sputtering as the economy claws its way out of one the deepest recessions in U.S. history. Net gains totaled just 18,000 jobs in June, and the national unemployment rate ticked up to 9.2 percent according to Bureau of Labor Statistics, reaffirming a worrisome slowdown after a string of more encouraging reports earlier this year.

"Small businesses have added some jobs, but it's a lot less than you would have seen in previous recoveries," says Todd McCracken, president of the National Small Business Association. "It's a very different pattern this time. Smaller businesses really aren't growing at a [more] rapid pace than their larger counterparts."

[See How 15 U.S. Firms Depend on Foreign Sales.]

This year, the private sector has added about 200,000 jobs a month on average, but economists say businesses need to add somewhere between 350,000 to 400,000 jobs each month over the next three years to bring unemployment down to a more normalized level of around 6 percent.

Without a boost in hiring from small businesses, that goal may remain out of reach and prolong an economic recovery that's already been painfully slow. "When you're not feeding the economy with smaller-business growth, that's really a danger," says Doug Arms, senior vice president at Ajilon, a professional staffing firm. "When you have your small businesses contributing, en masse it really does spark the economy."

Particularly troubling is the large drop-off in the number of start-ups since the beginning of the recession. The number of new establishments for the year ending in March 2010 was lower than any year since the Bureau of Labor Statistics began collecting the data in 1994, a worrying trend that has put a significant dent in job creation. Jobs created by start-ups sank to just under 2.5 million in 2010, down from a peak of 4.7 million in 1999.

[See 4 Bright Spots for the U.S. Economy.]

"The shortfall in this job market in this recovery is [because] small business formation has been very weak. I think that's the key problem," says Mark Zandi, chief economist at Moody's Analytics.

Stagnant consumer spending and tight credit have also put financial pressure on small businesses. While experts say credit markets aren't as tight as they were a year ago, getting a loan is still tough. That's especially true against the grim backdrop of the housing slump, given that many small business owners rely on home equity as collateral for loans.

"You need capital and credit to grow or start up [a small business]," says Steve Smits, associate administrator in the Small Business Administration's Office of Capital Access. The agency has tried to bridge the gap in lending by offering loan guarantees to banks that lend to small businesses, facilitating more than $42 billion in financing since February 2009. "Lenders are eventually going to need to lend. They are looking for ways to say 'yes,' [and] the credit enhancements is a way to get you a 'yes.' It's a crutch," he adds.

[See Why Europe's Debt Crisis Will Keep Coming Back.]

But it's not just a matter of encouraging banks to lend, it's nudging small businesses to borrow and invest in their companies, too. That's been a tough sell lately as confidence in the economy among small-business owners has sunk to its lowest level since September, primarily due to low consumer demand and poor sales. "Those challenges translate into a continued decline in confidence," Smits adds. "There's a pullback. You go into survival mode."

The Index of Small Business Optimism fell for the third consecutive month in May, reflecting persistent pessimism among small-business owners about the outlook for the economy. Perhaps the most sobering statistic for the jobs outlook: The net share of firms reporting that they plan to hire moved into negative territory for the first time in eight months.

business growth
small business