The number of small business firms grew and bankruptcies declined in 2003, a trend that continued into 2004. Corporate profits were up, and sole proprietorship income also increased.

Trends in employment by small firms varied from industry to industry, which the SBA says is in keeping with historical patterns identified by research. For example, both small and large firms engaged in service-producing businesses experience similar changes in a downturn, while those in goods-producing industries experience different effects based on firm size.

The financial markets were on track to support more growth in 2003, the report states. Low interest rates spawned corporate bond issues and generated a wave of mortgage refinancings that helped boost consumers' discretionary spending power.

Equity markets also began to rally in 2003, although that did not immediately translate into a stronger equity market for small firms. Lending to small businesses by banks showed little growth over the study period, but that was due in part to the economic recovery not picking up steam until late in the year.

The number of small business firms grew and bankruptcies declined in 2003.

"Questions about how banking concentration will affect small business credit availability over the long term continue to be a topic of study for policymakers," notes Chad Moutray, chief economist for the SBA Office of Advocacy.

Home-based businesses now account for more than half-53 percent, according to the report-of the small business population in the U.S. They represent a broad range of industrial sectors.

About 60 percent are involved in service industries, 16 percent in construction and 14 percent in retail trade. The remaining 10 percent are scattered across manufacturing, finance, transportation and communications.

SOLO ACTS

However, that doesn't mean home-based businesses are spared all the bureaucratic headaches that bedevil businesses in other sectors of the economy. According to the report:

"Although home-based businesses are exempted from many industrial regulations, new Advocacy-sponsored research finds they face particular regulatory hurdles in two areas: Internal Revenue Service tax regulations at the federal level, and zoning regulations at the local level."

The report points out that some of America's best-known companies started as spin-offs of university technology development efforts. "University spin-offs enhance economic development in several ways, for example, by commercializing academic inventions that might otherwise go undeveloped," it states.

One section of the report is devoted to a study of five types of government policies and their role in encouraging economic development through university spin-off companies. They include funding of academic research, provision of intellectual property rights to universities, laws to encourage university technology licensing, direct mechanisms to support development of spin-offs and programs to reduce financing gaps in early-stage technological development.

The report emphasizes that small businesses are important players in the U.S. economy, representing about half its total output and employing about half of the private-sector work force.

Ninety-one percent of sole proprietorships have no other paid employees.

"Individual small businesses in various industries face a wide array of business conditions, and they tackle them with unique solutions using their diverse resources, with a range of outcomes," the report says.

"Many business owners are content to maintain a thriving business but have no desire to expand; a few foster exceptional growth, with a large impact on the economy," it adds, citing material presented at its "Entrepreneurship in the 21st Century" conference.

Testifying before Congress in early 2004, Federal Reserve Chairman Alan Greenspan observed that, "Last year seems to have marked a transition from an extended period of sub-par economic performance to one of more vigorous expansion."

The pace of economic expansion strengthened considerably in the second half of 2003, after almost two years of weak and uncertain recovery. Although a favorable monetary policy and stimulative fiscal policies were in place by the spring of that year, economic activity remained hobbled by a number of other factors.

Both consumer and business confidence returned in the second half of 2003, and the economy shifted into higher gear. Real gross domestic product shot upward in the final quarter, the number of new businesses started to grow, and business bankruptcies declined more than 9 percent for the year.

"Businesses across all size categories had solid returns in 2003," the Office of Advocacy reported to the President. "Corporate profits of large and small businesses were up 18.3 percent, while sole proprietorship income rose 6.2 percent." Labor and capital costs remained in check during the year, and productivity rose by 4.5 percent.

GROWTH-MINDED

A survey of firms by the National Federation of Independent Business (NFIB) at the end of 2003 showed the highest percentage since 2000 of businesses believing the next three months would be a good time to expand.

The report notes that while private sector employment declined between 2000 and 2003, industries with fewer economies of scale and a higher percentage of small-firm employment "avoided disaster" during the downturn.

The two industries with the highest small-firm shares of employment-construction and real estate-saw employment fall in only one of the three years. The two industries with the greatest shares of large-firm employment-utilities and management of companies-struggled during the downturn, losing jobs in all three years.

Business confidence returned in 2003, as the economy shifted into higher gear.

Business turnover-i.e., business startup and closure-is largely the domain of small businesses, as relatively few businesses grow to be large. It is business turnover that makes markets more competitive and productive, the report concludes.

"Business turnover is a natural occurrence during a period of favorable business conditions; poorer conditions exacerbate the challenge to grow and survive, increasing turnover," the report explains.

"As wage employment opportunities shrink in a downturn, the opportunity costs of self-employment decrease, and the ranks of the self-employed tend to swell. With rising self-employment-and as firms cut supply in reaction to diminished demand-average business size declines, and the small business share of the economy increases," it states.

Increases in self-employment are clearly seen in periods of labor market stress, but there are other, less obvious business cycle phenomena related to small businesses. For example, small manufacturing firms are less cyclically sensitive than large ones, and credit conditions are the main driver of small business output growth or decline.

Demographically, the small business sector is becoming more diverse. Hispanic-owned businesses, for example, increased to more than 7.4 percent of the total at the start of 2003 from just 5 percent in 1995. Businesses owned by older people (aged 55-64) have also shown a sharp increase, up to almost 20 percent from 15.9 percent across the same period of time.

It is business turnover that makes markets more competitive and productive.

SBA's Office of Advocacy observes that "structural changes in the economy of the 21st century are still playing themselves out, but small businesses have played an important role in leading the U.S. economy out of the recession of 2001." By the end of 2003, the agency notes, "the stage was set for companies, both large and small, to expand, and for new companies to fill new market niches."

Financial trends have certainly played a role in helping small businesses bounce back into a growth mode over the past couple of years. A loose monetary policy continued into the second half of 2003, in spite of signs that an economic recovery was already underway. Low interest rates also spurred many consumers to refinance their homes, putting more discretionary dollars into circulation.

On the borrowing front, smaller increases in capital expenditures and rising profits restrained demand for external financing by small businesses. Net borrowing by non-farm, non-corporate businesses declined to an annual rate of $131 billion in 2003 from $142 billion the previous year.

"In the continued weakness and uncertain recovery of the first half of 2003, bank lending to small businesses was anemic," the Office of Advocacy reports. The rates of growth in the amounts of loans outstanding for all three sizes of small business loans declined from levels that were already low.

Moreover, the number and value of the smallest loans (under $100,000) declined for the first time since the data on small business lending became available in 1994-1995. "The previous fast growth in the smallest loans (for example, in the business credit card market over the past several years) seems to have come to a halt, based on the decline in both the number and dollar amount of loans under $100,000," the report suggests.

However, some of the decline may be attributable to an accounting phenomenon caused by a revision in reporting methodology related to data collected on the total number of accounts and active accounts.

"This explanation seems plausible," the report allows, "since many major small- business credit card lenders reported declines in the number of loans outstanding in their June call reports, even though they continued to promote small business credit cards; they also reported continuing increases in both the number and dollar amounts of the smallest loans in their Community Reinvestment Act (CRA) reports for the year 2002."

Bank consolidations continued to affect the relative importance of banks of different sizes in the small-business loan market in recent years. While the number of commercial banks filing call reports declined by 133 between June 2002 and June 2003, the number of the smallest banks with assets of less than $100 million again declined significantly, by 347.

Small businesses generally have little trouble gaining access to financing sources.

The full report is available as a PDF file through the SBA Web site. It can be accessed at http:// www.sba.gov/advo/stats/sb_econ2004.pdf.