There's still a major entrepreneurship gap

The small-business creation rate falls short of the average for women, Hispanics and African Americans, notes a new Center for American Progress (CAP) report. On a per-capita basis, these groups own significantly fewer small businesses than white males. That news may not come as a surprise, but what does appear to be unexpected is this: The entrepreneur gap doesn’t vanish even after accounting for such factors as income, wealth and education. Kate Bahn is an economist at the CAP and lead researcher for the report, “A Progressive Agenda for Inclusive and Diverse Entrepreneurship.” She joined the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111 recently to discuss what can be done to reduce the inequality in this key economic segment.

An edited transcript of the conversation follows:

Knowledge@Wharton: Please explain what the numbers in the report tell you.

Kate Bahn: The numbers I found — similar to what other researchers have found looking at some of these racial and gender differences – show that it appears to be much harder for women and people of color to have a business…. I not only looked at those overall lower rates – that’s pretty well established – but I also looked at the likelihood of having a business in the household, even when we control for some of the things that are typically correlated with business ownership, like having high income, having high wealth, having more education. I found that even when you control for those things that tend to be correlated with having a business, women, African Americans and Hispanics are still less likely [to own one] Even with the same wealth, even with the same education, they’re still less likely to have a business in their household.

Knowledge@Wharton: The numbers I saw varied from between 2.5% to 8% less likely, depending on the demographic. And a lot of people might say, “Well, that’s not a big number.” But when you think about the sizes of those specific demographics, and the number of small businesses across the United States, it ends up being a fairly significant amount.

Bahn: Yes. For example, African American households are 5% less likely to own a business, even when we control for things. But what sounds like a small amount after controlling for the variables actually explains why they have business ownership rates that are only about a third of what they are for white households. So that actually ends up being a lot fewer businesses owned by people of color.

Knowledge@Wharton: What are some of the reasons why they own so many fewer businesses?

Bahn: Certainly, the recession did not help. But it seems as though the recession had a bigger negative impact on white male-owned businesses than on African American-owned businesses, Hispanic-owned businesses, or women-owned businesses. Those numbers were always low, and they stayed low after the recession.

What we’re finding is that some of it is caused by wealth gaps, in particular. If you have less wealth, it’s much harder to starts a business, not only because it’s hard to finance your own business, but also because you don’t have collateral to get other business financing. But what I really think I found in this report is that there seem to be some structural barriers.

Even if you have education and money, if you don’t have access to business networks, if you immediately are more likely to be discriminated against in the financial system, you can’t get as much informal mentoring and training from other business owners. These things are the softer structural issues that make it more difficult to start a business, even when you have what we generally consider are the tools — which are education and wealth.

Knowledge@Wharton: When people think “small business,” a lot of times they think startup or tech startup. But there are so many more small businesses that would fall into other categories.

Bahn: Yes. When we think of entrepreneurs, we often think of high-tech, high-gross Silicon Valley-type businesses, or even businesses in the Boston area. But what I tried to point out in this report is that really small businesses and Main Street small businesses, as well — these are also run by entrepreneurs. These are also people who are starting new businesses. When we think about our entrepreneurship policy, and we think about entrepreneurship issues, we should recognize Main Street small businesses as the backbone of American entrepreneurialism.

Knowledge@Wharton: You said this shift started back in the 1990s. Did something back then that set this pattern of declines over the last 25 years?

Bahn: Yes. I think it’s one of the big economic trends of our time: increasing inequality.

Not only income inequality, but also particularly wealth inequality, I think, explains the overall decline in entrepreneurialism.

Knowledge@Wharton: Is the level of security that people need before they can feel comfortable opening a business a big quality that’s lacking as well?

Bahn: Definitely. It’s pretty risky to open a business. So particularly if you’re lower income, that risk is going to be even starker, because if you don’t have income to fall back on, if you don’t have wealth to fall back on, or don’t have family support to fall back on, it’s much riskier for you to attempt to start your own business.

Some of those things we’re trying to think through here are, how we can support small business owners? There are a couple of different things we can do to make it less risky for them. Give them the sort of tools and education they need. Some of it might be stopping people from starting a business if they’re not ready, if they’re not able to take on that risk. Or some of it might be figuring out financial support so that they can support themselves while taking on this risk.

Knowledge@Wharton: Getting the financing to open a business is obviously a bit harder in the wake of the financial crisis.

Bahn: I might be downplaying the role of the Great Recession a bit too much. It’s true that the banking system is much less likely to lend to people right now. It seems really, really hard for people to get small business loans — both Small Business Administration loans and traditional small business loans. Banks just aren’t as able to lend out to people, which is not fault of the banks, per se, but we definitely need to start thinking about ways in which we can add a little bit more flexibility to the system, so people are able to actually get financial services to help them start a business.

Knowledge@Wharton: One thing being focused on is wage growth. It’s happening in the country in general, but obviously, it’s been slow. However, if we continue on this path of economic growth, do you have hope that in another few years, there would be a rising potential for this trend to change?

Bahn: Yes, that’s definitely true. What we’ve seen in the labor market for a while is a lot of jobless people. People aren’t really willing to move around between jobs, wages haven’t been going up, the labor market seems to just have a lot of slack in it.

But now finally, wages are starting to creep up, and what that means is that people are going to feel a little bit more secure. They’re more likely to be willing to transition into a new job or into business ownership in general, and that’s going to make the labor market much more dynamic. One thing I focus on in this report — and in my background as a labor economist – is that I see being a business owner as an occupational choice. It’s a job you choose to have. So when we have a labor market that is tighter, with more wage growth in it, we’re going to see people moving around, having more labor mobility. One of the things that they’re going to transition into is business ownership, in addition to better-matched jobs for themselves.

Knowledge@Wharton: There’s also the question of having the level of education required.

Bahn: That’s one of the things we think through — that part of having really good small business supports or supports for entrepreneurs includes stopping people from doing it, if they’re not ready to. That makes them less likely to fail and less likely to face the huge income or wealth drops that result if they try to start a business and aren’t successful.

Knowledge@Wharton: Where do you think that support needs to come from? Here at Wharton, we have the Wharton Small Business Development Center, which obviously does that type of work. But does that type of support need to come from the federal government, from institutions like the Wharton School and those types of like-minded entities, or elsewhere?

Bahn: The thing about trying to help people start businesses is it seems pretty unique to the local geography people are in, the local city, the local industries. It helps a lot to have policies that are very place-specific policies, focused on the local environment. Small Business Development Centers are operated traditionally out of universities in the local communities, so they do have a tie to the local community. I think there’s also space for federal policy to give the resources to municipalities or states to operate programs, but it really helps when they are spearheaded by a state or municipality or a local grassroots organization, because they’re really going to understand the needs of the local market and the culture of the local economy.

Knowledge@Wharton: Is it also possible that people generally — whether due to their personal situations or their financial situations — just don’t feel like they can pull it off right now, and that’s partly why we’ve seen the drop in entrepreneurship over the last 25 years?

Bahn: Yes, that could be a lot of it. There are sort of two different types of entrepreneurs. Generally, in the literature, there are “necessity entrepreneurs” and there are “opportunity entrepreneurs.”

Necessity entrepreneurs are more likely to be low-income folks who may not have other job opportunities, and so going into business for themselves might be the only job they can do. Then on the other side, there are opportunity entrepreneurs, who see these great opportunities, and they do it because they see a good investment opportunity, or they have a great idea. I think when the economy is a little bit more precarious, you’re going to see fewer people doing it for the good opportunities. They’re going to want to hunker down more, and not going to want to take that risk.

Knowledge@Wharton: What about small businesses that say too much regulation and increases in the minimum wage are putting some of them out of business?

Bahn: Well, what I’m looking at in this report are low-to-moderate income small business owners. I don’t want to say that the experience of a small business owner who is dealing with significant regulations isn’t true hardship, but I think for these low- and moderate-income people who want to start businesses, it’s not regulations that’s holding them back. It’s truly lack of access to capital, lack of access to training, lack of access to the resources they need to start a business. They’re not at the level yet where regulations are affecting them in a negative way.

Of course, regulations can be made a little bit more efficient, but I think when we’re seeing the overall decline of business dynamism, and to really decline among one-to-five person businesses – for low-to-moderate income people who might start businesses, I don’t think it’s regulations who are holding those folks back.

Knowledge@Wharton: But if you’re trying to start that small business — maybe from one to 10 people — you’re going to have that problem with the financing to get it off the ground. Then, once you get it off the ground, then, potentially, those factors come into play. It’s a one-two punch that you’re having to deal with.

Bahn: Yes. I think that there are ways that you can try to make regulations easier to navigate, but of course a lot of these regulations are put into place with the best intentions of public safety, and we are able to finance our system through business taxes, and things like that. There are reasons we have those regulations.

There are ways you can make it easier for businesses to navigate it or to get relief from it, if it does become really too much of a burden for them. For example, some states like Michigan and Ohio have these one-stop shops, which are municipal-run business offices that you can go to, and one portal that you go to, to figure out how to navigate the regulations, navigate the business taxes, navigate the permitting, and any other zoning things you might need help with.

There are ways to make it easier for business owners to navigate the process, but we have those regulations for a reason.

Knowledge@Wharton: In terms of the dynamic between men and women, what are some of the reasons why you’re seeing those lower levels of ownership by women right now?

Bahn: Part of it is sort of the same thing that we’re seeing for people of color. The wealth gaps and inequality are going to affect women differently than men, because they’re likely to have less wealth. Also, sometimes business networks can be pretty hard to navigate for women. Any group of people that’s a minority among business ownership is going to have a harder time accessing those networks. I think sometimes female business owners have a hard time making connections, getting the mentoring they need, getting that really informal business education. Business networks tend to be old boys’ clubs.

Knowledge@Wharton: And if you do want to try and get the level of education you need, it can be hard to get that, sometimes.

Bahn: It can be hard to try to get it, and sometimes, even after you get the business education, it doesn’t necessarily help you get access to the networks you need to actually start businesses, or get jobs at entrepreneurial startup businesses after you have even the business education.

Knowledge@Wharton: If business lending was tweaked somehow, it could potentially really spur economic growth with a lot of these small businesses.

Bahn: There’s definitely evidence that if we had a more flexible business lending environment, particularly one that we can ensure is not being predatory, it could really help people who might not have access to other types of financial resources, whether it be their own wealth, or getting money from investors that they have a personal relationship with. If we had a more flexible business-lending environment, that would really help….

Knowledge@Wharton: I wanted to delve more into the fact that even at the same income level, the same wealth, the same education, the problems are significantly greater for African Americans and women compared to white males.

Bahn: Yes, that’s showing that it’s not as level a playing field as you might think. There are some other structural things going on. To look at really basic factors that we typically think are correlated with this ownership – like income wealth, education, age — business owners tend to be a little bit older than non-business owners.

That doesn’t explain it all. There’s something more going on here. This is a typical thing we do in economics: We try to control for everything we think might be correlated with a phenomenon, and if there’s anything left over, that shows us that there’s something else going on. A lot of times, we attribute that leftover, unexplained portion of a phenomenon like this for people of color and women, as discrimination

It could be overt discrimination in financial institutions, or it could be these structural things, like if you live in a community that has less access to high-quality financial services at large. It’s not only that you’re maybe being discriminated against in a bank office – though that certainly happens to people — but also, if you live in a community that doesn’t have a good community bank in it that can help you out. Those things are also structural issues that affect women and people of color differently.

Knowledge@Wharton: Is there a way to start thinking about some of the things that we really need to address now to improve this – such as the wage gap between men and women.

Bahn: Yes, I know. A lot of work that the Center for American Progress has done on entrepreneurship keeps coming to the conclusion that a lot of the things we need are broad-based progressive policies. Like policies that help address the gender wage gap. Policies that might help address education inequalities, particularly quality education for all people. These broad-based policies that just are good for all workers are also going to be good for business owners, and make it easier for people to start their own businesses.

But I do think that there are also some directed policies that we can do, like expanding the services that community banks do, because community banks do a better job of reaching out to these people who are underrepresented in business ownership.

Also, one of the provisions of Dodd-Frank that the CFPB is going to be undertaking involves starting to collect some demographic data based on business loans, so we can get an understanding about if and where discrimination is happening in business lending. There are both broad-based progressive policies we can enact, as well as some targeted analysis to try and figure out what’s actually happening in these communities that’s making it more difficult for people to get the support they need to start a business.