Small Business and the Knowledge-Based Economy

D avid Birch, the renowned economist and president of the research firm Cognetics, Inc., cemented his reputation for iconoclastic analyses in the mid-1970s, around the time that the United States Small Business Administration’s Office of Advocacy was getting started. His 1979 book, “The Job Generation Process,” showed the importance of small firms in creating jobs and helped give recognition and respectability to the field of small business research. Despite his considerable accomplishments since then, Birch expects that his epitaph will probably read, rightly or wrongly, “David Birch discovered that small firms create most of the jobs.”
Birch reflected on his research during Advocacy’s 25th anniversary symposium.

Small business and job creation

In 1979, when Birch published the idea that small businesses create most of the jobs, the reaction was a mixture of shock and disbelief. Large businesses were supposed to dominate the world, weren’t they? “Here was this nerd coming up with the idea that small firms were more important than large ones,” says Birch. “The huge corporations began aiming their cannons.” But others were reaching the same conclusions. The findings indicated that the United States was leading the charge.

Over the years since, other countries have been catching up: women business owners are now a major force in Sweden, for example. The United States was lucky–or perhaps particularly poised to be there first. Birch classified businesses in Wild Kingdom terms. The large, publicly traded firms that have shed millions of jobs over the past two decades are elephants. Small Main Street businesses that create jobs when they start up but then grow very little are mice. And fast-growing businesses that start small, then double in size and double again, are the gazelles. For the past 25 years, the most effective job creators have been the gazelles and the mice. And of those, the gazelles have been the prolific: some 350,000 of these fast-growing companies have created as many jobs in the recent past as the mice, which number in the millions.

Underlying this shift in economic vitality and the importance of small firms is the knowledge revolution of the past quarter century–the shift to a knowledge-based economy in which the source of value has shifted from factories and warehouses to knowledge.

Some years ago, Birch was discussing his small business job creation findings with a Canadian historian: “He took me through history, showing that restructurings like the one we’re in now happen every 200 years or so. The last was the Industrial Revolution in 1810-1820. ‘What you’re observing is the next revolution,’ he told me. ‘What happens during these revolutions is that the old order crumbles and the new one emerges.’”

Surviving in the knowledge-based economy

Small business has a key role here. In the current revolution, Birch says, the raw material is not steel or rail lines, but knowledge–brainpower. And it’s not just the high tech businesses that propel most of the growth–it’s the businesses that make efficient use of knowledge, including the tools of technology. The new order emerges through the experiments of thousands of companies–mostly small ones–that try out new ideas, new products, services, and processes in the changing marketplace. Some of the ideas that are particularly well adapted to the emerging market will make gazelles of the companies that capitalize on them–and will in turn shape the emerging order.

Evidence of this new era is in business statistics. Beginning in the 1975 to 1980 period, employment trends reversed themselves. “The Fortune 500 grew every year until 1980 and declined every year after,” Birch says. He also observed that the U.S. economy hasn’t added industrial jobs since 1953. While the work force has grown from 50 million workers to 123 million, all the net growth has been on the knowledge side.

Where are we now?

Birch sees the nation in a recession now, as has happened about every 10 years.“During the last two recessions in the 1980s and 1990s, we found that small firms do better in recessions than large firms,” Birch says. “Large firms do massive layoffs; small firms adjust earlier and more quickly and actually create growth while large firms are collapsing. Small firms are good shock absorbers in recessionary times, and it’s important that Congress get this message as they move to create economic stimulus packages.”

What of the future?

Over the long term, Birch thinks his historian friend is right. “We’re in the middle of a revolution, a transition period. These periods don’t go on forever. After 20 to 30 years, the new order will begin to establish itself. The successful upstarts will become the formidable firms.” Once the upstarts have become the established order, Birch says, it willagain be tough for the small firms to compete. They will be less dominant, although they will continue to be shock absorbers during recessions.
“I think this new order will hold until about the year 2200,” says Birch, “when all hell will break loose again.”

This article was excerpted from the December/January 2002 issue of The Small Business Advocate, a publication of the United States Small Business Administration’s Office of Advocacy.