Small Businesses, Big Effects: Investing in Microenterprises

November 2013

Joe Ott: Welcome to the Federal Reserve's Economic Development podcast series. I'm Joe Ott with the Federal Reserve Bank of Cleveland.

Microenterprise lending can support entrepreneurs in starting new ventures, and may even result in hiring of additional employees if the business succeeds and grows. Elaine Edgcomb and Tamra Thetford at the Aspen Institute proposed an idea that encourages microenterprise investment as part of the "Big Ideas for Job Creation" project.

The project, sponsored by the Institute for Research on Labor and Employment at the University of California at Berkeley, and supported by the Annie E. Casey Foundation, was a call to academics and economic development practitioners to design jobs programs for cities and states that would lead to net new job creation in one to three years. Edgcomb and Thetford's idea, "Microenterprise Development as Job Creation," is one of several winning ideas from the project's second round that we are featuring in this podcast series.

Today I'm speaking with Elaine and Tamra. Thanks to you both for being here today.

Photo of Elaine EdgcombElaine Edgcomb: Thank you; good to be here.

Tamra Thetford: Glad to be here.

Ott: Tamra, could you tell us more about your big idea on increasing investment in microenterprises and what issues you address with it?

Thetford: Our big idea is a twist on an idea that we've heard a lot about since the Great Recession—this idea that small businesses have been a key source of job generation. But in discussions about small business there is often this really strong focus on the larger, high-growth small firms, and what we wanted to highlight in our research is the fact that some of the smallest businesses, or microbusinesses, are also job generators. And if you think about the fact that there are many more of these microbusinesses than there are the high-growth small firms, which are sometimes referred to as "gazelles," it makes sense from a policy perspective to also think about and support microbusinesses as well as the gazelles. And our research shows that microbusinesses create jobs, both full-time as well as part-time work for the owner and others, and they pay wages that exceed the federal minimum wage, and these wages help households move out of poverty.

Photo of Tamara ThetfordAnd job creation really grows among microentrepreneurs who receive help over time from what are called microenterprise development programs. And these mostly nonprofit programs, of which there are several hundred across the country, they help to start, grow, and stabilize microbusinesses. They're working to help microbusinesses get access to financing. Microenterprise development programs often lend directly to entrepreneurs or in some cases, they help them to get financing from others.

These microenterprise development organizations, aside from financing, also provide other business development services. For example, helping aspiring or existing entrepreneurs develop marketing or business plans; helping them to figure out how to better package or price their products and services; helping them to find new markets are some examples.

Ott: Elaine, we heard that your idea would take additional capital to really seed more microbusinesses. In a resource-constrained environment as we face currently, how do you propose creating additional new funding streams or expanding those that are already in existence?

Edgcomb: It's true that in order to enable microenterprise development organizations to help more businesses they need more resources. But I think we'd make the case that we really can't afford not to make these investments. One of the challenges of this recession and recovery is that they've come on the heels of several decades of eroding wages for the middle class, and many of the jobs that have been created during the recovery don't pay wages that are sufficient to support families, nor enable them to consume and generate additional demand.

So the work that microenterprise development organizations do to create jobs is really important, and it's also cost-effective. Our research estimated that the cost to support a microbusiness through the programs that we studied was between $6,300 and $6,600, and the cost to support a new job at one of these businesses was between $5,200 and $5,500. These costs compare very favorably to many other job creation strategies.

We also determined that the return on investment that a city or state would have achieved by supporting one of these programs was between 3.2 and 3.4 to one. That is, for every dollar invested, they generated another $3.20 to $3.40, and that return was measured in terms of earnings to workers and the owners. And if we added other benefits, like reductions in public assistance to people moving out of poverty or increased taxes paid by the businesses and workers, the return would have been even higher.

So in our paper we suggest four ways that cities and states could find resources to make these investments. First, they can tap the community development block grant program, which provides a flexible source of financing for economic development activities. Secondly, cities could partner with private-sector funders to build and grow programs in underserved communities. Third, they could tap capital access programs, which are existing state programs that help lenders reduce risk, and they could make those available to microlenders and help reduce the costs of making loans. And fourth, we also encourage states to look at the Self-Employment Assistance Program, which is a federal program that helps the unemployed start their own businesses, and that program was accepting applications through June of this year. There are other federal opportunities that could be explored as well, such as through the Workforce Investment Act or TANF (Temporary Assistance to Needy Families).

Ott: Tamra, in your brief, you describe the Chicago model that encouraged microlending through public-private partnerships. Can you describe that program and the related results? What suggestions do you have for locales looking to implement similar initiatives?

Thetford: The city of Chicago recognized the limited availability of microlenders, and consequently microloans, within its own boundaries. And so it created a program that was intended to increase both the number of qualified microlenders as well as the volume of microloans available to entrepreneurs across the city. The program is called the Chicago Microlending Institute. The way it works is that the city provided $1 million in loan capital to Accion Chicago, which is the city's leading microlender, and then a national bank and community foundation together provided a quarter million dollars to fund Accion to build the capacity of additional local nonprofits so that they could add microlending to their own portfolio of activities.

In the first phase of the program, Accion has increased its own lending and it's helped two nonprofits develop the staff and services to make loans. Three hundred and fifty-three jobs have been created or maintained as a result of that lending.

Over four years, the goal is to make an additional 280 business loans and support 850 jobs that would provide $1.4 million in payroll to these employees. So the program is certainly well on its way.

What we thought was important about the Chicago program is that it really recognizes the need to invest in developing institutions for the long term. So often, cities want to provide money to lend, but what's key is to support the staff time and resources that it takes to get that money out efficiently.

It certainly might not look the same in all cities. In other cities the issue may be that there are already lenders or other microenterprise organizations, but they're really missing the investment capital they need to grow. So it can really be a very site-specific approach.

Ott: Elaine, in your experiences, what type of economic development benefits have cities derived from microenterprise initiatives, and how have these efforts sparked other economic development initiatives?

Edgcomb: Microenterprise development initiatives help create and grow businesses and jobs, and they provide income for people, many of whom are likely disadvantaged in the current labor market. Our data, drawn from surveys of close to 1,200 entrepreneurs, found that as a group these business owners, when they were assisted with financing and skills development, were able to increase the number of new jobs they supported by over 100 percent within two years. There were 2.9 jobs per business, including that of the owner, and two-thirds of those owners worked full-time at their businesses, and a third of all employees were also full-time workers.

The businesses paid wages that exceeded the federal minimum wage, and for owners the median wages were 53 percent higher than that minimum wage, and for workers the median was 38 percent higher. Importantly, whether the work was part-time or full-time, 81 percent of owners who were below the federal poverty line when they first joined the program were able to move above that line with help from the increased earnings from their businesses.

In addition, some studies have shown that workers in these businesses are also disadvantaged just as the owners are disadvantaged entrepreneurs. And small businesses employ a larger share of employees on public assistance and a higher share of those with lower educational levels than larger firms. So to the extent that cities and states are concerned with job creation for challenged individuals and communities, microenterprise development offers a reasonably cost-effective option for moving those people into the labor market.

Finally, some econometric studies have shown that the benefits go beyond that initial return of over three to one, which I mentioned earlier was the return on investment that we saw in our study. For example, a study of Opportunity Fund—a microlender based in San Francisco's Bay Area—found that every dollar it lent to local businesses between 1995 and 2010 generated nearly $2 in additional spending in the region. So $13.5 million in loans generated more than $22 million in annual economic activity. And, of course, loan dollars can be recycled repeatedly to foster even more economic return over longer periods of time.

Ott: This concludes our podcast. We've been speaking with Elaine Edgcomb and Tamra Thetford at the Aspen Institute.

Plan to join us for the 2014 National Interagency Community Reinvestment Conference that will be held March 30 through April 2 of next year in Chicago. The conference will feature discussions on innovations in community development policy and practice and CRA examination training, and it will also include the National Community Development lending school. For more information, please visit the Federal Reserve Bank of San Francisco's website.

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