Give New Businesses Some Credit

… if You Want Them to Grow and Help Put America Back to Work

Small businesses create more jobs than any other sector of America’s economy. So the fact that small business growth has been slowing down in recent years is worth investigating.

One reason appears to be an increasing difficulty in getting credit. A lot of factors are behind this trend, and not all the data is completely conclusive. But the evidence is strong enough that government and industry leaders would be short-sighted to ignore it.

Overall economic recovery from the Great Recession of 2008–2009 has been sluggish, but bank lending to large companies has managed to return to, and even exceed, prior levels. Lending to small businesses, however, has lagged well behind.

This exacerbates a trend that goes back considerably further. In 1980, new business startups comprised 13 percent of all companies. As of 2013, that figure had fallen to 8 percent, a drop of more than one-third.

That’s more than a statistic: it represents jobs that could have been created.

Or more to the point, people who could be working right now, but aren’t. The official U.S. unemployment rate is low, but it doesn’t include those who have tried unsuccessfully to find a job for so long that they have simply given up. Nor does it include those who can only find part-time work but would much rather be full time. Add in all of those people, and the underemployment rate is about one out of every 10 working-age Americans.

So it’s a big deal that there aren’t nearly as many new businesses around as there used to be. And even more so that the ones we do have aren’t hiring as many employees as they used to — an average of 4.4 people in 2011, compared to 7.3 in the 1990s.

That’s where credit comes into play. It is the means by which almost all small businesses expand their operations and hire more workers. Like most economic trends, small business health is influenced by many factors, but boil down to: just about every business wants to grow, and they need credit to do it.

The challenge is that most entrepreneurs only have access to a limited number of sources of capital. Many gather support from friends and family, but typically in small amounts. They can’t sell stock or issue bonds the way large companies do. Venture capital may be available for a handful of visionaries with groundbreaking new ideas, but less so for startups in more traditional industries. That generally leaves banks as the most realistic option to seek funding.

Small businesses have historically shown a preference for small community banks, and vice versa. Consolidation in the banking industry has reduced the number of banking institutions by two-thirds since the 1980s, and many banks report that new regulations have added cost, paperwork and delays to the loan approval process.

These and other developments have combined to make small business loans less profitable, and even led some banks to stop making them altogether. Meanwhile, small business borrowers are increasingly frustrated by cumbersome processes, long wait times, and the scarcity of options. These trends have pushed the latter away from traditional loans and toward credit cards and borrowing against their homes.

There may be potential in new sources of financing. Online lenders have emerged and are growing rapidly, though as yet they only account for a small portion of the credit market. Most use an advanced business model, incorporating algorithms to evaluate not just credit histories but also an applicant’s revenue patterns and even social media feedback. But there are privacy and other related concerns that will take time to work out, in addition to generally charging high interest rates. So where does that leave us? Getting more new businesses off the ground is one of the core economic challenges facing the United States, and entrepreneurs have consistently expressed in polls and studies that access to credit markets remains inadequate for their needs.

Congress can help by funding research by the Small Business Administration and other agencies that study how credit markets change over time. Supporting and strengthening the historical role of credit unions and community banks will help keep them as viable options for local start-ups, especially if federal agencies can find ways to reduce the paperwork burden for smaller loans.

There’s no silver bullet out there. But the great power of free markets is that they tend to solve such problems, often through innovation. Thoughtful policy initiatives can help support this process, and keep inadequate access to credit from suffocating our economy’s most potent engine for jobs and growth.

This document is a summary of To Grow New Businesses, Improve Access to Credit, by David Brown and Emily Liner, published by the centrist think-tank Third Way.