Wall Street's Hollow Boom: With Small Business And Startups Lagging, Job Recovery Unlikely

On Wall Street, even as layoffs mount, the upper echelons are clinking champagne glasses for good reason. The stock market is hitting new highs, propelled largely by Bernanke dollars and strong corporate profits. Big financial institutions like Wells Fargo and JPMorgan have announced record profits.

But on Main Street, for the most part, the mood is far more subdued. Big business may be flourishing, but small business is still in recession. The number of startup jobs per 1,000 Americans over the past four years fell a full 30% below the levels of the Bush and Clinton eras. The Ewing Marion Kauffman Foundation, a nonprofit that studies startups, estimates that the rate of new business formation in the U.S. has fallen to a record low. The number of startups in 2011 was lower than in 1994, when the economy was smaller, as was the workforce and population.

According to the BLS, smaller firms accounted for two thirds of all net jobs added between 1992 and 2007, a figure much cited by small business advocates. (This is hotly disputed by labor-backed economists, who have traditionally downplayed entrepreneurial ventures since they are not amenable to organizing.)

But whatever the actual percentages, the weakness of smaller, and particularly newer firms, is one key reason for our current, persistent job shortfall. This time around, as a recent Brookings study reveals, larger businesses came out of the recovery stronger, not their beleaguered smaller counterparts.

Big businesses often drive the economy but newer, smaller ones, historically, have created the jobs. If the U.S. had come out of the recession maintaining the same rate of startup formation as in 2007, notes McKinsey, we would today have almost 2.5 million more jobs.

The problem is that in many ways, the recession never ended for small business. The reductions in small business employment during the fourth quarter of 2008 and in 2009 were the largest ever recorded in the history of the National Federation of Independent Business data series. And now, as we enter the sixth year since the onset of the Great Recession, more than four years after the “recovery” officially began, small business remains in a largely defensive mode. Hiring and startup rates have been far less dynamic than in the aftermath of the downturns of 1976 and 1983.

Since big companies largely have recovered, and government employment has grown, at least at the federal level, clearly the real problem lies with the poor performance of smaller, and most critically newer, firms. In the past, young businesses bailed out the economy and spurred innovation. Yet today fewer than 8% of U.S. companies are five years old or younger, down from between 12% and 13% in the early 1980s, another period following a deep recession.

It’s difficult to predict a rapid turnaround. In sharp contrast to the Fed-inspired boomlet on Wall Street, Gallup polling has found that one in five small firms expect to drop their employee count, one in three expect to decrease capital spending and almost as many expect to be in more severe cash flow troubles by the end of the year.

Why is this small business recession persisting? The causes are diverse. Certainly the prospect of Obamacare scares some smaller firms, who lack the resources of larger companies to deal with the new health regime. This is leading some to reduce full-time staff to avoid new mandates. In states such as California, New York, Massachusetts, Minnesota and Illinois, higher taxes on incomes directly threatens the cash flow of smaller firms.

Another source of trouble could be the decline of community banks, which traditionally have focused on smaller businesses. New regulations and Federal Reserve giveaways to “too big to fail” financial institutions have fostered an unprecedented concentration of financial assets in the hands of a few banks. In 2013 the top four banks controlled over 40% of the credit markets in the top 10 states, up 10% from 2009 and roughly twice their share in 2000. At the same time, since the passage of Dodd-Frank, there are some 330 fewer small banks. In the four years following June 2007, the volume of business loans under $1 million fell 13%.

But perhaps most important has been the weak GDP growth that has kept consumer spending at a low level, a particularly rough condition for smaller, start-up businesses. A growing economy and marketplace is critical for newer firms; without a sustained economic expansion many will suffer or never even come into existence.

Small business’ future is further obscured by political shifts. The Obama years have been golden for “crony” capitalists with good connections in Washington or in the various statehouses. As larger firms readjust to the realities of the Obama-Bernanke regime, they seem more willing to accommodate themselves, for example, to the new health care law, and also have better opportunities to feed off the federal trough; federal subsidies for renewable energy , for example, largely benefit bigger firms or well-heeled investors. Absent real tax reform, they also have less to fear from higher income taxes than smaller businesses, which are often sole proprietorships.

The emerging alliance of the “bigs” — big business, government and labor — represents a return to a kind of dirigiste economy not well suited to smaller firms. Former Clinton Administration advisor Bill Galston openly urges Democrats to cement what he considers a a natural alliance with larger firms, including the financial industry, while denouncing small business lobbies as “a building-block of the Republican base.”

In the long run, this new corporatism threatens not only small business — less able to lobby for itself and adjust to regulations than giant firms – it also also represents something of a threat to the very justification for a capitalist economy. Today large banks and big companies have public approval ratings down around 20%, according to Gallup. In contrast, small business has retained positive ratings of over 60%, as it has for decades. Another survey, conducted by Frank Magid and Associates, found large businesses approaching “the netherworld” inhabited by Congress — almost two-to-one unfavorable. Wall Street fared even worse. Small business, in contrast, was viewed positively 10 times as much as unfavorably.

This is not just entrepreneurial romanticism. The notion of reasonably widespread entrepreneurial opportunity underpins basic faith in the free-market system. Small enterprises, and expanded business ownership, justify capitalism by showing it is still open to competition, and that anyone, however humble, can participate and gain from the system. “Wherever there is small business and freedom of trade,” noted V.I. Lenin, founder of the Soviet Union, “capitalism appears.”

Without the innovative and job-creating potential of new small businesses, capitalism devolves into a fixed game dominated by big money and insider influence, as long portrayed by socialists, before Lenin and since. And, if the economic picture does not change soon, they will have been proven right, at least about that.

Joel Kotkin is executive editor of NewGeography.com and a distinguished presidential fellow in urban futures at Chapman University, and a member of the editorial board of the Orange County Register. He is author of The City: A Global History and The Next Hundred Million: America in 2050. His most recent study, The Rise of Postfamilialism, has been widely discussed and distributed internationally. He lives in Los Angeles, CA.

This piece originally appeared at Forbes.com.

Wall Street photo by flickr user Manu_H.