The American financial system is failing small businesses. The Wall Street Journal has some eye-popping statistics:
The biggest banks in the U.S. are making far fewer loans to small businesses than they did a decade ago, ceding market share to alternative lenders that charge significantly higher rates.
Together, 10 of the largest banks issuing small loans to business lent $44.7 billion in 2014, down 38% from a peak of $72.5 billion in 2006, according to an analysis of the banks’ federal regulatory filings.
Through August, banks this year originated 43% of business loans of up to $1 million, down from 58% for all of 2009, according to PayNet Inc., a tracker of small business credit.
This matters much more than most people think.
New business start-ups are the lifeblood of the American economy, now more than ever. Even in normal times, small business is where most of the new jobs come from. It’s small businesses that revitalize neighborhoods, give poor people a chance to get ahead. And ultimately, it’s some of the small businesses of today that will become the innovative big firms of tomorrow.
But these aren’t normal times, and small business matters even more. We live in times when the old drivers of employment like big business, government, and the NGO sector are less and less effective at generating growth and prosperity. The collapse of employment in the manufacturing sector, and the steady pressure on white collar and clerical work driven by automation, means that established firms aren’t generating jobs as quickly. That’s driving wage stagnation and exacerbating inequality. And the new normal of slower job growth also means that many of the conventional career tracks in business and the professions aren’t as reliable a glide path to a comfortable middle class existence as they used to be.
Accelerating the formation of innovative new businesses is the only real way to address this problem in the long run. Millennials and their successors are going to have to create the jobs they want rather than hoping that corporate and government bureaucracies will provide them with lifelong careers.
This isn’t an impossible dream. Today labor costs are relatively low and information and communications technology are creating resources that smart and creative people can use to build new businesses. Harnessing the power of the internet and information technology to improve the lives of people around you is one of the greatest business opportunities of all time. But as a society, we are making it harder, not easier, for these creative new business ideas to emerge.
Part of the problem is that the natural response to the financial meltdown of 2008 has been to regulate against, rather than to regulate for. That is to say, the financial industry has been saddled with heavy costs and enormously complicated compliance regulations. And a greatly engorged bureaucracy in Washington continues to churn out new regulations in a cascading stream. Some regulation was clearly needed in the wake of the meltdown, but many of the consequences have been perverse. The higher regulatory overhead means that big banks (who can afford teams of lawyers, compliance officials and lobbyists) now enjoy even more advantages over small banks than they did before the crash. But the new policies also steer banks away from small loans to struggling new businesses. Those loans cost more to make than big loans to well known companies with long track records; the big banks want big loans to solid customers to help them bear the weight of the new regulatory superstructure the politicians and bureaucrats rigged up.
Again, some of this is inevitable, and the history of Western banking is in part the construction of more sophisticated forms of prudential regulation to allow financial systems to work at a greater scale in more complex environments. But what’s missing is a sense that the health of small business is essential to our economic well being, and that part of the work of effectively regulating the banking system is to ensure that small businesses and startups can access the credit they need under favorable conditions.
In past essays on the history of the American Dream, I’ve pointed out that in the 19th century the American ideal was the owner-occupied, single family farm. A substantial majority of Americans lived on their own farms during much of this time, enabling them to enjoy high living standards and personal independence and security. Throughout the first 125 years of American independence, government policy aimed to make it easier for Americans to achieve and live that dream. The Northwest Ordinance, the Louisiana Purchase, the Homestead Act, the promotion and regulation of railroads, the establishment of land grant colleges that taught scientific farming methods to the sons and daughters of farmers: all these polices (to say nothing of the use of federal troops in the Indian wars that opened land for settlers) were organized around the desire of ordinary Americans to own their own farm, and to escape the poverty and servile dependency of peasant life in Europe. America’s democratic aspirations expressed themselves in government policy aimed at enabling millions of ordinary Americans to live in their own way on their own land.
Late in the 19th century and continuing into the 20th, the advent of the industrial revolution made the family farm obsolete. Mechanized agriculture required larger investments than most single family farms could make, and farm prices fell to levels that depressed rural incomes. For decades American politics was rocked by the consequences of the decline of the family farm and the absence of an alternative version of the American Dream. Populists, socialists and anarchists assailed a rotten system; inequality grew. Many believed that the American system was doomed and that the Dream had vanished forever.
The crisis was resolved by the rise of the manufacturing and services economy of the 20th century, and a new version of the American Dream developed. In the 20th century, the single family home, lifetime employment and guaranteed retirement stood at the center of the American economy, American society and American politics. As is inevitable in a democratic society, government policy once again centered on assisting Americans who wanted to live the dream. From Social Security to the GI Bill and beyond, government policy shifted to meet the new realities. The financial system, with lots of prodding and support from government worked to inaugurate an era of cheap housing, rapid suburban expansion, and infrastructure for automobiles that got workers from their houses to their jobs.
We are now in what appears to be yet another transitional era. The old system works less and less well, but, as in the 1880s and 1890s, we aren’t yet sure what the new version of the Dream will be like.
Over time, we will start to get a clearer vision of what a prosperous information based economy will look like, but one thing is already clear: version 3.0 of the American Dream is going to depend much more on small business. The family owned business, perhaps operating out of the single family home, is likely to play a larger role in the new economy. As the ‘big box’ economy of traditional factory and big businesses continues to shed jobs as it becomes more efficient, more Americans are going to have to make their livings outside the old system. Even if the ‘single family firm’ does not replace the single family farm as the foundation of American national life, family owned businesses will need to play a major role in the information economy that is beginning to emerge.
We will need a credit system that is better at helping small businesses get launched, an educational system that builds entrepreneurial character rather than churning out bureaucratic functionaries and docile factory workers, and regulatory systems that encourage and support rather than discourage and inhibit the formation of new businesses—and new types of businesses.
Forward-thinking politicians, and the think tankers who want to help them, need to put the financial problems of small business at the top of their agenda. Just as the 19th century developed an agenda to help people own farms, and the 20th century developed ways of allowing more people to build homes and get higher education, the 21st century needs to develop regulatory fixes and policy initiatives that help people start and operate small businesses.
It’s a measure of how badly our priorities are out of whack that, as of now, things are headed in the wrong direction. It is easier than ever to borrow tens of thousands of dollars to fund a BA and graduate education program that will leave students with no marketable skills and a lifetime of debt. It was so easy to get home mortgages during the last bubble that flipping Miami condos became a national sport. But when it comes to financing the next wave of American growth and the future of the middle class, our financial system is coming up short.