Where Will the Jobs Come From: Source - The Kauffman Foundation

8/14/2019 Where Will the Jobs Come From: Source - The Kauffman Foundation

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Dane Stangler and Robert E. LitanEwing Marion Kauffman Foundation

Kauffman Foundation Research Series:Firm Formation and Economic Growth

Where Will The JobsCome From?

November 2009


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2009 by the Ewing Marion Kauffman Foundation. All rights reserved.

Dane Stangler is a senior analyst at theKauffman Foundation. Robert E. Litan isvice president for Research and Policy atthe Kauffman Foundation. The authors aregrateful to Ron Jarmin and Javier Miranda

at the U.S. Census Bureau, Mike Horrell atthe Kauffman Foundation for excellent

research assistance, and Harold Bradley,Wendy Guillies, Paul Kedrosky, E.J. Reedy,

and Carl Schramm for their feedback.


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I n t r o d u c t i o n

Kauffman Foundation Research Series: Firm Formation and Economic Growth | Where Will The Jobs Come From2

IntroductionAt no time since 1945 have so many jobs

disappeared so rapidly in the United States.Compared to all prior recessions since the end ofWorld War II, the 2007-09 recession ranks worst interms of the number of jobs lost (over eight million),and second-worst in the percentage decline (6percent). 1 Still worse, the broadest unemploymentmeasure, U6, has touched ridiculously high levelsnearly one in five workersand the number ofhours worked per week has steadily decreased. 2 Putthese together with a rapidly falling employment-to-population ratio, and the U.S. employment situationhas not looked so bleak in several decades.Compounding this dreary picture, more than a few

forecasters see a long and slow recovery from this

declineand given that the last two employmentrecoveries were much longer than the postwaraverage, they could be right. 3

Naturally, then, everyone is asking: where will thenew jobs come from? The answerthough it hasmostly been missing from policy discussions, is thatwe will get new jobs from where we always have:new firms.

Prior work from the Ewing Marion KauffmanFoundation has shown that, since 1980, nearly allnet job creation in the United States has occurred infirms less than five years old. 4 This is an impressivefigure, but it doesnt convey the whole story of jobcreation in Americathe turmoil and churn of newfirm creation, young firm survival or failure, and the

scale growth of some firms. New data from the U.S.

1. See Floyd Norris, The Jobs News Gets Worse , NEW YORK TIMES, Oct. 3, 2009, at http://www.nytimes.com/2009/10/04/weekinreview/04norris.html.2. The U6 indicator captures the total number of unemployed workers (which is what is usually reported as the standard unemployment figure), plus all marginallyattached workers, plus total employed part time for economic reasons. That is, U6 includes people who have stopped looking for work and those who have had tofind part-time work instead. See Bureau of Labor Statistics, The Employment SituationSeptember 2009, Oct. 2, 2009, Table A-12, athttp://www.bls.gov/news.release/pdf/empsit.pdf.

3. Norris, supra note 2.4. See John Haltiwanger, Ron Jarmin, and Javier Miranda, Jobs Created from Business Startups in the United States, Kauffman Foundation, January 2009, athttp://www.kauffman.org/uploadedFiles/BDS_Jobs_Created_011209b.pdf.

AbstractCompared to all prior recessions since the end of World War II, the 2007-2009 recession ranks worst

in terms of the number of jobs lost (over eight million), and second worst in the percentage decline(6 percent). The key to economic recovery will come in the form of newly created jobs. But where willthese jobs come from?

Using United States Census Bureau data from 2006-2007, this paper examines net new job creation interms of firm age rather than firm size . Until 2005, we knew that from 1980-2005, nearly all net jobcreation in the United States occurred in firms less than five years old. This data set also shows that withoutstartups, net job creation for the American economy would be negative in all but a handful of years. If oneexcludes startups, an analysis of the 2007 Census data shows that young firms (defined as one to five yearsold) still account for roughly two-thirds of job creation, averaging nearly four new jobs per firm per year. Of the overall 12 million new jobs added in 2007, young firms were responsible for the creation of nearly8 million of those jobs.

Given this information, it is clear that new and young companies and the entrepreneurs that create themare the engines of job creation and eventual economic recovery. The distinction of firm age, not necessarilysize, as the driver of job creation has many implications, particularly for policymakers who are focusing onsmall business as the answer to a dire employment situation.


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E m p l o y m e n t i n t h e U n i t e d S t a t e s

Kauffman Foundation Research Series: Firm Formation and Economic Growth | Where Will The Jobs Come From

Census Bureau now allow us to peer under theeconomic hood, as it were, and tell a morecomprehensive story about job creation. And it isthis storythat new firms have been and are likelyto continue to be the real engines of job growth inAmericathat should occupy the attention ofpolicymakers and perhaps provide some cause foroptimism amidst the continuing gloom about jobs.

Employment in theUnited States

A commonly heard statement in any employmentdiscussion is that small businesses account for halfof the labor force and are therefore the key tofuture generation of jobs. This is roughly true: firmswith fewer than 500 employees (the somewhatquestionable cutoff between small and largecompanies used by the Small BusinessAdministration) employed 50.2 percent of workersin employer firms in 2006. 5 Sensibly enough,employer firms are those companies that haveemployees, as distinguished from nonemployerfirms, which are companies comprised of only thefounder. If we take the entire workforce, firms withfewer than 500 employees accounted for about42 percent in 2006. Not everyone would define asmall business this way, so we can drill down a bitmore to two smaller firm size classes: those

employing fewer than 20 employees, and thoseemploying 20-99 employees.

As shown in Table 1, whereas the smallestcompanies (fewer than twenty employees)account for an enormous share of all companies

(89 percent), they also account for only a smallfraction (less than 20 percent) of total employment.In fact, those companies that account for only asliver of the population of companies employ theother half of American workers. Firms with morethan 500 employees represent only 0.3 percent ofemployer firms, yet account for just under half ofemployment within firms, and over half of firmpayroll. This makes sense, of courselargercompanies, even when there are fewer of them,will account for an outsized share of employmentsimply by virtue of their size. But the discrepancieshere are quite noticeable, and belie the conventionalnarrative about small businesses and jobs. Thisbecomes even more apparent when we look atthe most detailed classifications of firm sizeand employment.

Across these standard categories, the largest shareof employment is in firms with more than 10,000employees, followed by companies with 20-499employees; likewise with payroll. In general, then,the U.S. economy is comprised of a very largenumber of small companies, accounting for a smallshare of employment; a relatively small number ofmedium-sized companies, accounting for about athird of employment; and a tiny handful of verylarge firms, accounting for a relatively sizeableportion (about a quarter) of employment. We have anone-too-surprising inverse relationship among firm

size, number of firms, and overall employment.6

The point of this is not to belittle the employmentcontributions of small businesses or to laud those oflarge companies, but instead to underscore thatanalyzing employment in terms of firm size actually

Share of Employer Share of Employment Share of ShareSize Class of Firm Firms in Firms Labor Force of Firm Payroll


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W h e r e t h e J o b C r e a t o r s A r e


Share of Firms

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Share of Payroll

Figure 1: Di stribu tion of Em ploymen t and Payroll Acro ss Firm Sizes

hare of Firms

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Figure 1: Di stribu tion of Em ploymen t and Payroll Acro ss Firm Sizes

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tells us very little about job creation. It would bemore accurate, and much more revealing, to discussemployment in terms of firm age. 7

The dynamics of firm age, moreover, point usaway from a discussion on the existing distributionof employment and toward a focus on the annualchanges in jobs. Lets ask not where people work,but where each additional increment in net jobcreation occurs. This approach immediately forcesone to recognize that companies in a given size classare not necessarily homogenous: a company withfifteen employees that is twenty-five years old willbehave differently than one that is only two yearsold (differences that will multiply if we classify firmsaccording to economic sector). To answer thepressing question of where new jobs will comefrom, therefore, we need to understand theceaseless dynamic of new firm entry and exit, and

the behavior of existing firms and the subsequentimpact in terms of net job creation.

Where the JobCreators AreAs we have noted, nearly all net job creation since1980 has occurred in firms less than five years old. Ifwe want to know more about the dynamics ofyoung companies and how they affect existingcompaniesand perhaps the sectoral distribution ofnew companieswe need to look at the data a littlemore closely. Fortunately, a recent Special Tabulationdone by the Census Bureau for the KauffmanFoundation has provided a wealth of information onthese very issues, and we will now present some ofthese findings.

7. Other research funded by the Kauffman Foundation and conducted by Census Bureau researchers clearly establishes this general principle, but has not yet beenpublished. Historically, the United States statistical infrastructure, like those in most of the world, has not been equipped to track changes in business composition.Dynamics of businesses, particularly new and young companies, were not of much concern. This has recently been changing, in the United States and elsewhere.

Figure 1. Source: U.S. Census Bureau, Statistics of U.S. Business, at http://www.census.gov/econ/susb/.


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In general, the net addition of jobs from year toyear (i.e. job creation) comes from three sources:startups; young firms, ages one to five; and thelargest and oldest companies. There is evidentlysomewhat of a barbell effect, with job creationoccurring at the youngest and oldest ends of thefirm age spectrum, and mostly flat in between. 8 Thisisnt the whole story, however, as there is aconsiderable amount of churnjob creation anddestructionoccurring in the youngest companies,as well as an interactive dynamic between theyoungest and oldest firms.

Lets begin with startups (defined in the data asage zero firms). Over the past thirty years, thesenewly created companies have served as a primary

source of immediate job creation for the U.S.economy.

Figure 2 has a remarkable implication: excludingthe jobs from new firms, the U.S. net employment

growth rate is negative on average.9

Indeed,without startups, net job creation for the Americaneconomy would be negative in all but a handful of years.

But not every startup sticks aroundroughly athird will close by their second year of existence,while half will make it to age five. 10 This means the

jobs that many firms create at birth willsubsequently disappear, so part of their positivecontribution to jobs in one year will turn to

8. We should again emphasize that we are discussing net job creation: the inflow and outflow of employment in firms of every age isnt reflected in the net figure. Sofirms in the middle part of the spectrum, those aged six to twenty-five, still hire people in gross. But every class of companies also lets go of a substantial number of people, and employees leave voluntarily. There is constant churn in terms of people flowing in and out of firms, but some classes of firms have a higher inflow thanoutflow and greater pool of firms, thus generating a positive net figure.9. Haltiwanger, et al, supra note 5.

Figure 2. Source: U.S. Census Bureau, Business Dynamics Statistics, at http://www.ces.census.gov/index.php/bds.

Figure 2. The Fir st Source of Job Crea tion: Startups6,000,000

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subtraction in the next few years. No economy couldlong survive if every years new jobs were simplyeliminated within such a short period. So whatabout the other half of startups, the fifty percentthat survive until age five? This represents oursecond major source of net job creation.

Using the special tabulation from the CensusBureau, we can see that, among existing companiesin 2007 (excluding startups), young firms accountedfor the lions share of job creationroughly two-thirds, in fact. 11

What this means is that in 2007, while the largestshare of employment remained in the oldest andlargest companies (the left censored category inFigure 3), young companies, those aged one to five,had been the most dynamic in adding new jobs tothe economy. Of the entire pool of new jobs addedin 2007 (roughly 12 million), about two-thirds wasgenerated by these young companies. This criticallyimportant fact about job creation becomes evenclearer when we translate Figure 3 into absolutenumbers and look at lifetime net job creation forfirms of different ages.

Again, firms between the ages of one and fivecreate the most net new jobs, dwarfing the otherage classes. These firms also create the highestaverage number of jobs: roughly four jobs per year.We also see in Figures 3 and 4 an apparently

positive contribution from the left censoredcategory: the oldest companies. As discussed below,this highlights the continuing dynamic betweenyoung and mature companies wherein the latter relyon the former not only for jobs but also innovationsand thus revenues.

These charts raise an obvious question: isnt agemerely serving as a proxy for size? That is, when wetalk about young firms arent we really talkingabout small business? To address this, we cantranslate Figures 3 and 4 into size classifications.

When we look across all firms of all ages, we do seesomewhat of a skewed distribution by size ofcompany: the firms responsible for net job creationare not only young but also small- and medium-sized (Figure 5).

What happens when we look only at young firms,those aged one to five? We see a similar breakdownby job growth and firm size (Figure 6).

It would appear, then, that firm age is somewhatcoterminous with firm size. This makes sensebecause most young firms will tend to be small: very

few grow to enormous size in their first three yearsof existence.

But there is a further way to approach job growthin the United States: the sectoral breakdown of jobgrowth, which should shed some light on the

10. See Dane Stangler, The Economic Future Just Happened, Kauffman Foundation, June 2009, at http://www.kauffman.org/uploadedFiles/the-economic-future-just-happened.pdf.11. Calculated by Census as two-thirds of annualized lifetime net job creation computed as total lifetime creation by firm age.

Figure 3: Young Firm s Accoun t for Large st Share of Job Crea tion

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Figure 3. Shares of annualized net job creation in 2007. See text. Source: Special Tabulationby U.S. Census Bureau for Kauffman Foundation from Business Dynamics Statistics.


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Figure 4: Young Firm s Accoun t for the Mo st Jobs and Highe st Average Number of Job s Crea ted

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Figure 5: Share of Ne t Job Crea tion by Firm Size: 2007

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Figure 4. For change in employment 2006-07. Source: Special Tabulation by U.S. Census Bureau for Kauffman Foundation.

Figure 5. Source: Special Tabulation.

Figure 6. Share of Lifetime Net Job Creation by Firm Size, Young Firms only, 2007. Source: Special Tabulation.


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S y m b i o s i s , C h u r n , a n d t h e W a v e E f f e c t


dynamic among young, mature, small, and oldcompanies.

Taking the most general breakdowns by businesssector, 12 it shouldnt be too surprising that there is arather wide spread among industries. It is wellestablished that at any given point in economictime, some sectors will be outperforming others. Weneed only look at the importance of informationtechnology over the past decade as well as studiesshowing that the American productivity resurgencesince 1995 has been heavily concentrated in just ahandful of sectors. 13

In particular, we have recently seen strong jobcreation in retail, health care, accommodation andfood services, and professional, scientific, andtechnical services, while sectors such as educationalservices and information appear to have lagged. Thisdistribution isnt altogether surprising: retail, healthcare, and accommodation and food services happento be among the largest sectors in terms ofemployment and number of companies (Figure 7).

What is more interesting about the sectoralbreakdown is what it reveals about the dynamicbetween firm size and age. In particular, there isvery little relationship between the amount of small

firm employment in a sector and its job growth(Figure 8).

By contrast, there is an incredibly tight relationshipbetween any particular sectors job growth and theperformance of young firms within that sector(Figure 9).

The bottom line: young companies are theengines of job creation.

Symbiosis, Churn, and theWave Effect

Clearly, the important fact that young companiesare primarily responsible for net new job creationhas many implications, particularly for policymakersas they confront a dire employment situation. Wewill highlight three: the symbiosis between youngand mature companies; the churn of employmentand companies; and the effect of new companiesthrough time.

Above, we mentioned a barbell effect with regardto job creation: startups and young companiesaccount for a large share of new jobs. But one thingthat stands out from the preceding chartsparticularly Figures 3, 4, and 5is that the largest

12. NAICS two-digit sectors.13. See, e.g. , Diana Farrell, Martin Baily, and Jaana Remes, US Productivity After the Dot Com Bust, McKinsey Global Institute, December 2005, athttp://www.mckinsey.com/mgi/reports/pdfs/usproductivity/US_Prod_After_Dot_Com.pdf.

Figure 7: Wha t Industries Have Been Crea ting the Mo st Jobs?

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Figure 7. Source: Special Tabulation.


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Figure 10. Authors calculations from Special Tabulation and U.S. Census Bureau, Statistics of U.S. Business.

sectoral cross-section of job creation, we find that byand large those sectors with the greatest share ofemployment in large companies (10,000+employees) were not those sectors with the highestshares of net job creation.

This pattern is not explained by the size of suchcompanies: the average number of jobs created atthese large firms is understandably big because theyhire in large batches. Instead, Figure 10 reflects thehuge number of young companies being formed inother sectors and adding more jobs. Remember, theaverage young company only adds about four jobsper year, meaning it takes a lot of young companiesto add up to a bigger amount of job creation thanthe largest firms. How, then, can we explain theapparent finding in Figures 3, 4, and 5 that thebiggest and oldest companies have positive rates of

net job creation?The nature of these data is such that we cannot

break out mergers and acquisitions, but we suspectthat the net addition of jobs in larger companiescomes from their symbiosis with younger firms. 14

Namely, one of the only ways for big companies to

add net jobs is to acquire the younger companiesthat are not only generating jobs, but also areresponsible for a good number of innovations thatwill keep the bigger companys revenue growth fromdiminishing. The U.S. economy supports an ongoingprocess of new firm creation, scale growth in somecases, another round of new firm creation, andselective acquisitions of new firms by thosecompanies that achieved scale. It remains the casethat young firms drive job creationmany of themare simply acquired at a young age by older andlarger companies, a process seemingly reflected inpositive net job creation for those established firms.Without more detailed data, a firm conclusion as tothis dynamic eludes us; yet we suspect that such aprocess (among many) is at work. Anecdotally, atleast, we see evidence of this in the acquisition

strategies of companies such as Cisco andMedtronic, who rely on younger companies topioneer innovations (and create jobs), at which pointthey purchase them. And, a good number ofventure capital-backed companies have their exitin the form of acquisition. Such dynamism in the

14. See, e.g., CARL J. SCHRAMM, THE ENTREPRENEURIAL IMPERATIVE (2006). We may also be seeing an effect due entirely to one sectorretailwhich has botha high share of job creation and a greater number of giant companies than other sectors with comparable job creation numbers. That is, the finding that big andmature companies can still produce positive rates of net job creation could be a function of the size and firm composition of the retail sector, absent which thiscategory of firms would show negative net job creation. This is an issue we will take up in subsequent papers.

Figure 10: Sec tors with Highe st Share of Em ploymen t in Biggest Com panie s areNo t the Sec tors with Biggest Neg Job Crea tion

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capital markets (among mid-size companies as well)is an area deserving of further research.

This symbiosis that we suggest highlights a secondfeature of job creation: there is a considerableamount of churn among young firms. Job creation,as noted above, is not a smooth process, and this isespecially true for those companies that areresponsible for it. Indeed, young firms have thehighest rates of job creation and job destruction.Some young firms, meanwhile, will survive to agenine or ten, and then shed many of the jobs theycreated. Others will create dozens of new jobs inyears one and two, only to see them disappear inyears three and four. Most findings on survival ratesindicate that roughly a third of new firms fail tosurvive to age two. When we talk about youngfirms, then, were talking about an ever-changingassortment of dynamic firmsentering and exiting;creating and destroying jobs. Such messiness is notcause for dismay or alarm; it is the provenance ofnet job creation. If we want to chart a rapidemployment recovery, we need to foster suchmessy dynamism.

The third implication follows from this churn of jobs and firms: a snapshot of any given yearsemployment distribution fails to convey the wave-like movement of firms, particularly new firms,through time. When talking about job creation, weare unavoidably talking about the in-and-outdynamic of new and young companies (as well asmore established companies, which occasionally failas well). Firms creating jobs in a two-year periodwont necessarily be the same companies creating

jobs in the subsequent two-year periodand may

have even closed (or been acquired). This becomesespecially apparent when we look only at thefastest-growing young firms in 2007, the top5 percent of young job creators.

Figure 11 excludes one- and two-year-old firms, sowe are looking only at firms aged three to five years,those creating the most jobs, on average twenty-sixper yearor seventy-eight to 130 over a five-yearspan. And indeed we see that when displayed byfirm size, these young companies have grown intomuch larger companies, in some cases employingthousands of people. Importantly, these companies

could still fail at some subsequent point or beacquired by older and larger companies; or theycould stop growing and remain the same sizeindefinitely. Some of these firms, meanwhile,continue to generate positive rates of net jobcreation at older agesrecall Figures 3 and 4, inwhich firms aged six to ten years show up as aconsiderable source of jobs (at least relative to olderage categories). As will be explored in later reports,this can likely be explained by the presence of thesefast-growing companies that continue to create jobspast the age five threshold.

What does all this add up to? Out of each pool ofnew companies, some emerge to create lots of jobsand are succeeded over the next year or next twoyears by an entirely new pool of firms. The net effectof all this is to consistently add roughly two millionnew jobs to the economy every year, assuming thedemand to support their output exists. The economygenerates a wave effect of new companies and new

jobs each year.

Figure 11: Ne t Job Crea tion for the Fa stest-Growing Young Firm s by Size

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Figure 11. Percent of Annualized Net Job Creation for Top Performing Young Firms. Source: Special Tabulation.


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Entrepreneurs = RecoveryIf the pessimistic forecasts for how long it will take

the United States to recover from the currentemployment shock are even in the ballpark, we

could well be facing a long and slow economicrecovery in which employment lags behind mostother indicators. There are various reasons, too, tothink that the severity and nature of this recessioncould seriously dampen new firm formation. Ifexisting companies see little reason to expand theirworkforceafter all, productivity is risingwhyshould anyone see fit to start a new company? In adarker vein, will companies formed in this recessionbe somehow weaker and more prone to failure? Wehave also seen a sharp contraction in credit,particularly commercial loans which, at the time ofwriting, showed few signs of recovering. Credit isoxygen for new and young firms and, if loans arescarce and if household wealth (a big source offinancing) has fallen, will new companies be able toraise money?

These are important questions, not to be takenlightly, and they highlight the need to betterunderstand the dynamics of firm formation,particularly in a macroeconomic and historicalcontext. It could be the case, for example, that thisrecession opens up opportunities for massiveamounts of reallocationsome see this underwayalready in the auto industry and among those laid

off in that industry. Too big to fail, once a roughguideline for policymakers, has become a lightningrod for public opprobrium. It could be the case thatthe cachet of large organizations has taken anirreparable blow as people seek more security inyounger and smaller companies. The slow recoveryof employment may also work to spur even higherrates of firm formation: instead of waiting aroundfor new jobs, people may take their future into theirown hands.

To encourage new business creation, there areaffirmative steps that can be taken, and negative

steps that should be avoided. For example, withcredit scarce, government at all levels may be able tohelp loosen the financing spigots. President Obamaannounced just this sort of step in October byraising the ceiling on SBA loan guarantees, andextending cheap credit to community banks willingto use it to make more business loans. 15 A much

bolder policy action would be to grant a payroll taxholiday for new and young companies, thusfostering job creation. Such a step would not bewithout difficulties (it would temporarily add to thedeficit and might create a payroll tax ceiling beyondwhich companies hesitate to cross), but would serveas a signal that the U.S. economy, searching for apath to recovery, is open for (new) businesses.

Still, virtually all of the attention amongpolicymakers and the media has focused on thewaiting game by larger firms, currently reluctant totake back employees they dismissed, and unwillingso far to begin hiring new employees again. Theanalysis here, however, suggests this attention ismisplaced. The overwhelming source of new jobs isnew firms. The key implication for policymakersconcerned about restarting Americas job engine,

therefore, is to begin paying more attention toremoving roadblocks to entrepreneurs who will leadus out of our current (well-founded) pessimismabout jobs and sustain economic expansion over thelonger run. This much-needed shift in focus cannotcome soon enough.

15 See Henry J. Pulizzi, Obama Announces Steps to Channel Loans to Small Businesses, WALL STREET JOURNAL, Oct. 21, 2009, athttp://online.wsj.com/article/SB125615610024099681.html.

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Where Will the Jobs Come From: Source - The Kauffman Foundation