Size Matters When It Comes To Jobs

Size Matters When It Comes To Jobs
September 17, 2010
By John M. McClure 
www.profitscore.com

A Brief Performance Update
Here We Go Again
Paddling a Canoe up a Waterfall?
So Where Did We Go Wrong?
Is the 800-Pound Economic Gorilla Invisible?
Why Can't the Government Connect the Dots?
Updating the CMI Growth Index
Bronco Nation and the BCS

In last month's ProfitScore IQ, we looked at a number of forward-looking economic indicators and discussed the chances for a double dip. It was clear from the various factors we analyzed that trillions in government stimulus and bailouts have not worked, so far at least.

This month we'll take a look at the reasons why.  We will then discuss the latest programs being touted by many or our politicians, which have a high probability of failure.  Next we'll examine the sector that has historically generated all new jobs in our economy over the last quarter century and examine what the government is doing to help it. 

The bottom line is that our economy is at a tipping point and any major policy mistakes will almost certainly take us into a much more severe recession than we are currently in.  Increasing taxes or starting a trade war with China will almost certainly tip us over the edge.  At this point, there are few good choices so let's hope that cooler and wiser heads can prevail in Washington in this next political cycle.    

Quote of the Month
"In the first 19 months of the Obama administration, the federal debt held by the public increased by $2.5260 trillion, which is more than the cumulative total of the national debt held by the public that was amassed by all U.S. presidents from George Washington through Ronald Reagan." --- CBSNews.com September 8, 2010

A Brief Performance Update

August was a bad month for the markets but a great month for ProfitScore clients.  Below are some quick performance stats.  For more detailed performance analysis, click on the blue highlighted portfolio names listed in the table below.


Jan 08 to

YTD

MTD Aug

Sharpe

Name

Present

2010

2010

Ratio

Income Builder  (IB)

13.98%

5.37%

2.58%

1.33

The Guardian  (GRD)

5.71%

0.85%

4.37%

1.51

Harmony Plus  (HMY)

5.12%

-1.80%

5.11%

1.29

The Expedition  (EXP)

1.39%

-4.88%

6.33%

1.03

S&P 500  (SP500)

-28.54%

-5.90%

-4.74%

0.54

Important Performance Disclosure





Here We Go Again - Another Stimulus Program coming to a Tax Collector near You

Job creation has been the major focus of government policies, or at least that is what we have been led to believe.  Immediately after taking office, the new administration launched an aggressive spending program at a cost of more than $800 billion to keep unemployment, which at the time was below 8%, in check.  It was the beginning of an impressive plethora of multi-trillion dollar stimulus programs and bailouts aimed at ‘fixing' the economy.

Fast forward to today. We learned last week that the official unemployment rate (U-3) notched higher to 9.6% (from 9.5%) in July.  So with November mid-term elections rapidly approaching amid falling approval ratings, the Obama Administration is taking action again. This time it takes the form of a set of multi-billion dollar proposals, which the president has stressed is not another "stimulus" program, even though we all know that is exactly what he has planned.

The latest government program has three moving parts according to the White House.

1) A program to accelerate $200 billion in business tax write-offs which the White House has estimated will cost $30 billion.

2) A new infrastructure spending of at least another $50 billion.

3) A program to increase and extend a tax credit for research and development estimated to cost $100 billion over 10 years.

Not surprisingly, White House spokesman Dan Pfeiffer did his best this week to put a positive spin on the latest proposals. 

"These measures will help create jobs while building an American economy that is more competitive and productive over the long term," in a White House blog.

With a falling approval rating and increasing opposition to the rapidly ballooning budget deficit and long-term debt, the new Obama plan is a high stakes gamble. He has to do something.  With this latest iteration of Obamanomics, he is throwing everything he has left into slaying the economy's most stubborn nemesis - high unemployment. 

Come hell or high water, there is one promise he seems adamantly opposed to breaking. That is his pledge to let the Bush tax cuts expire in 2011.  This puts small business owners in the position of having to guess how this tax increase next year will impact them since their business profits in excess of $250,000 per year will get caught in the higher tax net.  Those with investments will also get hit with higher capital gains taxes aimed at the so-called "rich."

Paddling a Canoe up a Waterfall?

Republican House leader John Boehner believes that extending the Bush tax cuts would at least give certainty to small businesses but critics say that the government can't afford to do so in the wake of trillions in recent stimulus spending.  He has a point and small business owners are listening.  Without certainty, small businesses, which account for the lion's share of new jobs in our economy, will put off hiring until they can assess the added tax costs.

There are other challenges to the latest Obama proposals.  Harvard economics professor, Greg Mankiw, described the limitations of the new government business tax breaks.

"The impact will be relatively modest.  Notice that expensing merely accelerates deductions.  Thus, the value to the firm depends on interest rates.  With interest rates near zero, the impetus to investment is small.  Put another way, this policy can be seen as giving firms a zero-interest loan if they invest in equipment.  But with interest rates near zero anyway, the value of the loan is not that great."

One of the biggest job creation agendas since the latest recession began was the government census program.  At its apex in May 2010, it accounted for 564,000 workers according to the U.S. Census Bureau.   To put that in perspective, there are approximately 2 million federal government full-time workers (including postal employees) according to the latest BLS data.  Census hiring was a big deal.

That is now over and those jobs, most of which were temporary, are disappearing.  Another 121,000 census jobs were lost in August.  As the next chart shows, it provided at best a temporary blip.  At worst, it may have provided a false sense of demand along with the mistaken impression that unemployment was finally on the mend.   As the chart also shows, we are in the process of suffering through the worst recovery since World War II in terms of jobs lost.  Now that the census hiring is over, joblosses look set to increase again.


Chart 1 - A chart comparing the recovery in employment in recessions from World War II on. Courtesy of CalculatedRiskBlog.com


Chart 2 - As this chart shows, this recession has resulted in the biggest jump in the length of unemployment in the last five decades - with little improvement in sight.  Courtesy of CalculatedRiskBlog.com

So Where Did We Go Wrong?

There is scant evidence that stimulus programs have had anything other than a short-term effect, especially when it comes to helping the group hardest hit by the recession - the long-term unemployed.  This recession is like no other in recent history - the length of time people have remained unemployed is unparalleled in the last 50 years and is likely as bad as the Great Depression. Unfortunately, the big changes in how unemployment figures are now calculated make realistic comparisons difficult at best.  Certainly the attempts by government today are eerily similar to those like the New Deal by FDR in the 1930's. Unfortunately, the outcome we've experienced is also more similar than any current politicians in power are prepared to admit.


Chart 3 - This time is different!  As we see from this chart, the number of long-term unemployed is at a 60-year high and more than 50% above that the second most severe recession in 1981-1982.  Courtesy of dshort.com

Is the 800-Pound Economic Gorilla Invisible?

We have discussed the importance that small businesses play in generating new jobs.  But how important are small businesses, and specifically new businesses, in driving jobs growth?

It may surprise you to learn that the government, under the auspices of the U.S. Census Bureau, has released data, called the Business Dynamics Statistics (BDS), in an attempt to address this question.  One aspect of the program is to track business startups of U.S. private, non-agricultural companies.

According to a Census report entitled Jobs Created from Startups in the United States,

"The fraction of employment accounted for by U.S. private-sector business startups over the 1980-2005 period is about 3 percent per year... While this is a small fraction of overall employment, all of this employment from startups reflects new jobs. As such, 3 percent is large compared to the average annual net employment growth of the U.S. private sector for the same period (about 1.8 percent).  This pattern implies that, excluding the jobs from new firms, the U.S. net employment growth rate is negative on average.  This simple comparison highlights the importance of business startups to job creation in the United States."  (U.S. Census Bureau report - Jobs Created from Business Startups in the United States)

Hold on a minute!  There is a lot to consider in that last paragraph. If I understand this correctly, it is saying that startups accounted for ALL of the new private-sector jobs created in our economy from 1980 through 2005! 

Here is a chart from the report that should help clarify the jobs picture.  Take a close look because there is a lot of information presented.  Also note that Micro Startups (small businesses with 1 to 4 employees) accounted for a far bigger percentage of jobs than larger firms, in fact nearly one in five (19%).  This compares to an average of 3% of jobs for all startups.  Unfortunately, as the next chart shows, Micro Startups have lost ground in the number of employees since the late 1980's.  According to Business Dynamics Statistics, this may "reflect compositional changes in sectors such as retail trade, where there is ample evidence of substantial shifts away from small, single-establishment firms to large, national firms [box stores]."

Given the complex and diverse nature of the business market, this unfortunately oversimplifies the situation. However, there are some valuable lessons to be learned.


Chart 4 - Chart comparing the percentage of jobs created by small and large businesses.

Next we took a look at the data contained in the Census Bureau's Business Dynamics Statistics (BDS).  The data dates back to 1977, but the first years that the data was collected it was incomplete.  We therefore compiled data from 1995 through 2005, to try to get a more accurate picture of the impact of startups on job creation.

We've charted the results below.  There is one caveat, the data for companies in the last two categories (cohorts), namely companies that are 21-25 years old and companies that are 26 years and older are incomplete, so figures represent rough estimates.  Since these companies accounted for just 10% of the total number of companies, they were not a major factor in overall job creation.


Chart 5 - Chart constructed from U.S. Census Bureau Business Dynamics Statistics data compiled for the years 1995 through 2005 showing the importance of startups compared to more established companies.  Only startups created new jobs.  Older companies lost jobs as they matured with year 2 accounting for the single greatest annual jobs lost.

Total Net Job Creation 1995 - 2005
Firm Age (Years)
Net Job Creation
0
34,635,485
1
-260,658
2
-1,553,616
3
-1,256,543
4
-1,091,159
5
-866,540
6-10
-3,120,470
11-15
-1,344,354
16-20
-853,981
21-25*
-450,000
26+*
135,136
TOTAL
22,752,489

US Census Bureau

Table 1 - The total number of jobs created by firms from startups to mature companies older than 26 years.  * Incomplete data for these cohorts for this period.

The takeaway is that in their first year of business, U.S. startups were indeed responsible for all new private sector jobs - a total of 34,635,485 jobs were created between 1995 and 2005 according to the Census Bureau.  As the chart and table show, companies shed jobs as they aged.  Year 2 accounted for the greatest single-year loss at 1,553,616 jobs.  Even though businesses from 1 to 26+ years lost 11,882,996 jobs, net job growth was more than +22 million for the period thanks to the huge contribution by startups.

The big picture is that on average between 1995 and 2005, startups created an average of 3,148,680 new jobs per year.  That compares to an average loss for companies in the other age categories of 1,080,272 jobs per year.

Tim Kane, author of a July 2010 report entitled, The Importance of Startups in Job Creation and Job Destruction for the Kauffman Foundation summed up the BDS data succinctly.

"Startups aren't everything when it comes to job growth. They're the only thing... Wilted FlowerWithout startups, there would be no net job growth in the U.S. economy."

Easy to Connect the Dots, So Why Can't the Government?

There are 154.2 million workers in the civilian workforce according to the CIA World Factbook.  Add another 2 million Federal government employees and 1.5 million in the military.  Lump all the government employees together at the municipal, state and federal levels and there are roughly 22 million for a total of approximately 175 million employees.

According to the BLS, there were 14.9 million unemployed as of August at the stated U-3 unemployment rate of 9.6%.  That number drastically understates the real situation.  A more realistic estimate is the U-6 unemployment rate which was 16.7% in August. That includes discouraged workers who have given up looking for a job as well as those that took part-time jobs after being let go.  That means there are nearly 26 million civilians currently unemployed.

Can you smell what I'm cooking here?  Given that new companies have been responsible for all of the hiring over the last few decades, why is so little being done in various stimulus and incentive programs to spur new businesses?  Are you aware of any programs specifically aimed at encouraging new business startups?  I'm not.

So is it any wonder that economic stimulus programs have so far failed to have the desired result?  All government and Federal Reserve efforts introduced so far, including new proposals, essentially ignore the entrepreneur who has been responsible for all new jobs.  Private employers are finding it difficult, if not impossible, to borrow money for new companies given the stricter lending rules by banks.  It's pretty hard to start a new business without any support.

The government is not helping either.  However, they have thrown trillions of taxpayer dollars into supporting moribund, money-bleeding entities Fanny Mae and Freddy Mac?

Something that many voters will hopefully consider when they head to the polls in November...

Last but Not Least...

I know there has been a lot to digest this month but I wanted to update the Consumer Metrics Institute's Daily Growth Index, which has been a good leading economic indicator.  In the final chart this month we see what the latest CMI data is saying.  The economy is still contracting and the index is pointing to a double dip recession.  Let's hope it's wrong this time around, but based on past performance, I'm not holding my breath.


Chart 6 - Chart courtesy of the Consumer Metrics Institute showing the latest data for the CMI Growth Index.

More Reading...

Obama pitches road spending and tax incentives
http://www.reuters.com/article/idUSTRE67O4WF20100908

Why Obama's Stimulus Failed
http://blog.heritage.org/2010/06/07/morning-bell-why-obamas-stimulus-failed/

Why the Stimulus Failed
http://www.ncpa.org/sub/dpd/index.php?Article_ID=18404

Employers on Strike
http://online.wsj.com/article/SB10001424052748704764404575286831965692578.html

Obama's Offensive May not Charm Business of GOP
http://blogs.reuters.com/columns/2010/09/07/obamas-offensive-may-not-charm-business-or-gop/

Obama Proposes Massive Business Tax Cuts
http://www.tax.com/taxcom/taxblog.nsf/Permalink/MSUN-89343B?OpenDocument

A Small Step in the Right Direction
http://gregmankiw.blogspot.com/2010/09/small-step-in-right-direction.html

The Importance of Startups in Job Creation and Job Destruction
https://docs.google.com/viewer?url=http://www.kauffman.org/uploadedFiles/firm_formation_importance_of_startups.pdf

Jobs Created from Business Startups in the United States
https://docs.google.com/viewer?url=http://www.ces.census.gov/docs/bds/BDS_Jobs_Created_ces.pdf

BLS Employment Data
https://docs.google.com/viewer?url=http://www.bls.gov/news.release/pdf/empsit.pdf

CIA World Fact Book - United States
https://www.cia.gov/library/publications/the-world-factbook/geos/us.html

Consumer Metrics Institute
http://www.consumerindexes.com/


Bronco Nation and the BCS

I mentioned in our last letter that the Boise State Broncos were playing Virginia Tech in the ESPN game of the week.  They beat them in Boise State fashion.  America loves an underdog, and there has never been a football underdog as small as the Boise State Broncos.  I was born and raised in east Tennessee which is located in the heart of SEC football country.  Tennessee's stadium sits over 107k screaming fans and getting a ticket is not an easy thing to do - even during the bad years. 

Boise State's football stadium sits 30k and change, and the full-time student population is under 10k.  Boise State University is a tiny school with limited resources that has been slapping the college football world in the back of the head for the last 10 years. 

This year they are ranked so high that they risk being picked to compete for the BCS championship game.  If this happens, they will more than likely be the catalyst that turns the BCS ranking system on its head and forces the system to weight schools/conferences similar to larger programs.  ESPN is doing everything in its power to make this a reality by bringing the Broncos as much TV coverage as possible.  ESPN college game day is coming to Boise for the Oregon State game on September 25th.  Prepare to see the blue field on game day.

In one fail swoop, Boise State could win the national championship and defeat the unfair BCS ranking system in the same year!  If you like underdogs, then the Boise State Broncos are your team. 


Working to grow your wealth,


John M. McClure
President & CEO
ProfitScore Capital Management, Inc.


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Posted 09-20-2010 11:23 AM by John M. McClure