Should the Small Business Administration Be Abolished?

How vital is the role of the federal government in promoting the role of small business in America? And specifically, how vital is the Small Business Administration in that promotion?

This article was originally published in The Wall Street Journal.

We hear a lot about the vital role of small business in the U.S. Especially in election years.

But that raises the question: How vital is the role of the federal government in promoting the role of small business in America? And specifically, how vital is the Small Business Administration in that promotion?

The SBA's supporters argue that it plays a crucial role, guaranteeing billions of dollars in loans for small businesses each year and providing an army of counselors and information resources for those who need help. It particularly focuses on those who, some say, have been failed by conventional lenders.

But the SBA's critics say that the agency's loans do more harm than good. The loans go to only a tiny fraction of the small businesses in the country, for example, and help the recipients compete with small businesses that aren't similarly subsidized. Thus, instead of playing a crucial role in the U.S. economy, the critics say, the agency really is directing resources where the market has determined they aren't needed.

Yes: It Is a Waste of Money

By Veronique de Rugy

Congress created the Small Business Administration in 1953 to fix a specific problem: Lenders allegedly were turning away large numbers of small businesses that, if given a loan, would generate untapped economic growth.

It is questionable whether this problem ever existed. However, there is plenty of evidence that today the SBA hurts more small businesses than it helps, wastes taxpayer money and distorts economic activity.

The SBA's main activity is to provide government-backed loans to qualifying small businesses. In fiscal 2011, the agency requested $1.5 billion in discretionary outlays. However, total outlays, which include projected payouts for defaults, were $6.2 billion. In the past, requested outlays were closer to $1 billion. Also, the gap between that request and actual outlays used to be much smaller, but the agency has suffered increased losses in recent years on its guarantees. How this trend will evolve depends on the economy and whether default rates on SBA loans continue to increase. Currently, outstanding loans guaranteed by the SBA—and federal taxpayers—total about $92.9 billion.

Negligible Benefits

For all that real and potential cost, the SBA's effect on economic growth is negligible at best. The problem is that SBA loan guarantees go primarily to businesses that have been rejected by conventional lenders, businesses judged by private investors as unlikely to create jobs, marketable innovations or new economic productivity. The SBA wrongly assumes that every high-risk borrower has the potential to succeed.

One might argue that such risks are justified, because the SBA is an important source of small-business lending. However, the loans it guarantees benefit a relatively tiny number of firms. According to the Government Accountability Office, the SBA flagship loan program accounts for only a little more than 1% of total small-business loans outstanding. So, for the most part, SBA loans help a fraction of small businesses compete with unsubsidized small firms.

The agency does indeed run other programs, typically with results as unimpressive as its loan activities. There have been instances of poor oversight, for example, of its preference programs intended to carve out a percentage of federal contracts for small and disadvantaged businesses. The SBA also offers some training, technical assistance and "know-how" courses, but this should not be the role of the federal government, and it isn't needed. The private sector is already providing such services through private associations like the National Federation of Independent Businesses.

The SBA loan program is best understood as a subsidy to banks. Borrowers apply to an SBA-certified bank. The SBA guarantees 75% to 85% of the value of loans made in the flagship program. The banks then boost their earnings by selling the risk-free portion of the loans on a secondary market. Ironically, it's also the biggest banks that do the most business through the SBA.

The SBA and its proponents constantly talk about how the types of firms they serve are vital to job creation. But the latest research argues it's younger businesses, not small ones, that drive employment growth. The data show that real job creation doesn't kick in until the new/small businesses survive and grow into larger operations.

SBA proponents dismiss the research, saying young and small businesses are one and the same. It is true that most new, or young, firms start out small. But the ones that end up creating huge numbers of jobs don't remain small for long.

Take your corner pizza restaurant. In 20 years, it may still employ only a dozen people. It won't be young anymore, but it will still be small and it will never be a source of job creation like the SBA touts as part of its mission.

Seen and Unseen

More than 150 years ago, French economist Frederic Bastiat noted that many economic fallacies persist because the beneficiaries of government actions are easily visible, while the victims are harder to identify. The SBA is a classic example. Small-business owners who get subsidized loans feel good (so do the banks that profit from the loans), but we can't identify how that capital would have been used absent government intervention. We can count the jobs created at the subsidized businesses, but we don't know how many more jobs might have been created if market forces determined the allocation of capital.

That's the economic analysis. The political analysis is that politicians have successfully sold the SBA as a program to help small business—a widely held belief that's almost as sacrosanct as baseball, motherhood and apple pie. In reality, the SBA is a form of corporate welfare, and America's biggest banks are the only clear winners, leaving taxpayers on the hook for billions of dollars.

No: Its Role Is a Crucial One

By Barbara Kasoff

Small businesses created two of out three net new jobs in the U.S. from 1993 to 2009. About half of the people who work in this country are employed by a small business.

With unemployment still over 8%, now is not the time to eliminate one of the most important resources available to America's job creators.

The power of the SBA isn't just measured by the number of loans it makes. The Small Business Administration helps keep capital, contracts and know-how flowing to small businesses. In fiscal 2011, the agency guaranteed $30.5 billion in loans to about 61,000 companies, helped small businesses win nearly $100 billion in government contracts and mentored one million entrepreneurs through its network of business counselors, such as the 13,000 volunteers of Score, a nonprofit association of business counselors.

Through its Small Business Development Centers, Women Business Development Centers, and similar facilities that help minorities, women, veterans and other business owners, companies of fewer than 500 employees can learn about marketing and forecasting, and how to navigate the federal contract system. Some 14,000 counselors and trainers, including Score volunteers, help entrepreneurs get started and help established owners take their companies to the next level. The training resources are mostly free and are delivered in person or through a variety of media.

Aiming for Success

Such training gives these businesses the greatest possible opportunity to succeed. The SBA further collaborates with many private nongovernmental organizations to offer additional training, resources and technical assistance.

Even if the number of loans made by the SBA is relatively small, the aid goes to some of the most important, and most in need, sectors of our economy. In a 2009 study, the Urban Institute found women and minorities were three to five times as likely to get a loan through the SBA as they were through conventional lending.

I spoke recently with a woman in Tennessee who, after failing to get bank loans to launch a small manufacturing company, obtained an SBA loan within 45 days. Now, a year and a half later, she is preparing to meet with SBA counselors to expand her business and begin exporting her goods. She has two employees and several contractors, and is looking to hire.

Women and minority business owners play a substantial role in our economy already, but could contribute so much more. Get rid of the SBA, and they will contribute so much less.

The argument that SBA loans are given to applicants with poor plans and prospects, as judged by the market, misses a key point: The market too often is misjudging the viability of many of these businesses. Research shows women start their businesses with less capital than men, and there's a widespread perception that it is harder for women- and minority-owned businesses to get loans from financial institutions than it is for similarly qualified white men to get loans.

This isn't because women-owned businesses are less likely to succeed; it's because the market mistakenly perceives they are less likely to succeed.

Critical Advocate

The SBA is an advocate for small businesses with lenders at all times, but its role is especially important during economic downturns, when the squeeze on commercial credit can disproportionately affect small businesses. The SBA played a key role in arguing for policies to force the nation's biggest banks to resume lending to small businesses after the financial crisis hit in 2008.

The agency also worked closely with community banks to encourage more lending during the recession, and recently worked with 13 of the largest banks in the U.S. to increase their commitments by $20 billion over the next three years.

President Barack Obama recently elevated the SBA to a cabinet-level agency. Making SBA Administrator Karen Mills a cabinet member gives small business a seat at the government decision-making table like never before.

Those who wish to abolish the SBA cite research that makes the puzzling assertion that it is young businesses, not small, that drive job creation today. I doubt that any small business will understand this argument. Small and young businesses are one and the same. Small businesses employ about one-half of U.S. workers. Of 120.6 million nonfarm private-sector workers in 2007, small firms employed 59.9 million and large companies 60.7 million. About half of small-business employment is in second-stage companies (10 to 99 employees), and half is in firms 15 years old or older.

For our economy to grow and to become competitive again, we must increase our investment in our people and our resources.