In the new economy, small businesses, rather than Fortune 500 corporations, are the engine of American innovation and job growth. The Great Recession and subsequent jobless recovery have made this clear. Between 1992 and 2010, the economy gained 16.7 million jobs, 33 percent of which came from businesses with less than 50 employees and 32 percent from businesses with 50 to 499 employees. Between 2000 and 2010, the economy saw a net loss of 3.4 million jobs. Large businesses—those with 500 or more employees—accounted for 65 percent of that loss. In contrast, net employment in businesses with 50 to 499 employees was unchanged, while businesses with fewer than 50 employees experienced a 35 percent reduction.

Minority-owned small businesses play a crucial role in this economic picture. Such businesses employed 5.9 million workers in 2007, or 5 percent of the workforce. Furthermore, the number of minority-owned businesses, as well as their earnings and employment capacity, is growing at rates that far exceed the respective rates of growth for nonminority-owned businesses. Over the last decade, the rapid rise in revenue and employment among minority-owned firms suggests that those firms are extremely well positioned to help reduce the extraordinarily high rates of unemployment in minority communities.

But while minority-owned businesses have made tremendous advances over the last decade, they also face serious challenges. The ups and downs of the new economy are hurting all small businesses, but especially minority-owned firms. And while they can help make a dent in the unemployment problem, minority-owned businesses are still too much an afterthought in current thinking about the economy. Recent initiatives by the Obama Administration, such as the new Startup America campaign to accelerate entrepreneurship, show that policy-makers understand that entrepreneurship and small business lie at the heart of any recovery plan. Yet few policy-makers have homed in on the potential of minority-owned small businesses to help the United States out of the economic ditch.

Compounding minority business owners’ worries is the changing face of the global economy. Serious competitors to U.S. global economic leadership have emerged. In response, U.S. corporations have sought to become leaner, meaner, and more flexible, downsizing and transforming their operations by reducing the number of suppliers they depend on and requiring suppliers to have more capacity and demand flexibility. The government has also implemented changes in procurement policies that are somewhat analogous to the changes occurring in the corporate sector. To save more money, procurement departments are starting to bundle contracts and in-source more services. On top of these changes, new financial regulations have amplified the difficulties minority business owners face regarding access to capital. All of these developments have made it more challenging for minority business owners to increase their scale of operations. To ensure the continued development of these businesses, some changes in government policy need to be made.

The Lay of the Land

Over the last decade the growth of minority populations in the United States has been astounding. Newly released Census Bureau data indicate that between 2000 and 2010 the Hispanic/Latino and Asian populations increased by 43 percent each, the African-American population rose by 12.3 percent, while the white population grew by only 5.7 percent.

Less visible is the fact that business ownership among minorities is growing at an even faster rate. From 1982 to 2007, the number of African-American-owned businesses increased from just over 300,000 to 1.9 million, or by 523 percent; the number of Asian-American-owned businesses increased from 242,000 to 1.6 million, or by 545 percent; and the number of businesses owned by Hispanics and Latinos increased from 284,000 in 1982 to 2.3 million in 2007, or by 696 percent. Women-owned businesses also increased significantly, growing from 2.6 million to 7.8 million, or by 198 percent. Meanwhile, over the same period, white-owned businesses increased from 12.5 million to 22.6 million, or by 81 percent.

A milestone was achieved between 2002 and 2007. For the first time since the Census Bureau began compiling data on them in the 1970s, the number of minority-owned firms with paid employees, and the revenue from these firms, grew at a much faster clip than the respective increases for firms owned by whites. Specifically, the number of minority-owned firms with paid employees increased by 26.5 percent from 2002, while the number of white-owned businesses with paid employees increased by 2.3 percent between 2002 and 2007. Likewise, the revenue of minority-owned firms with paid employees increased by 54.9 percent over that time, while revenue of white-owned firms increased by only 24.1 percent. In all previous surveys, the growth of minority-owned businesses was concentrated almost exclusively among businesses that did not have paid employees.

Still, for all this progress, the revenue of African-American firms is significantly lower than the revenue of nonminority business owners and even other minority business owners. According to Small Business Administration (SBA) data, 95 percent of African-American firms earn less than $10 million, compared to $20 million for nonminority businesses. And while average revenues for nonminority-owned firms were $5.2 million, the average for African-American-owned and Hispanic/Latino-owned firms were $2.5 million and $3.8 million respectively. Clearly, there is much room for improvement for minority entrepreneurship.

The Important Role of Government Contracting

Until the civil rights movement of the 1960s and the legislation that followed, minorities had encountered centuries of racial inequality in the United States. Segregation and Jim Crow laws meant that African-American-owned businesses were confined in their operations to the resources, consumers, financial institutions, and distribution networks that existed within the African-American community. As a result, the types of businesses that emerged were those that were compatible with an enclave economy—small-scale personal service and retail establishments, or “mom-and-pop” enterprises.

The equal-opportunity laws that created greater access among minorities to educational institutions and business and employment opportunities brought about significant change. Preferential procurement programs (better known as affirmative-action programs) were established by local, state, and federal government agencies to remedy decades of racially exclusionary practices. These programs were critical because they created business opportunities and points of market entry that were unavailable to minority business owners before then.

The resulting growth in minority-owned businesses has been accompanied by a transformation in their scale of operations and industry concentration. No longer is the typical minority-owned firm a marginal establishment that is concentrated primarily in personal service, maintenance, repair services, or small-scale retail activity. Today, African-American businesses are much more diversified. In 1987, 25 percent of all African-American-owned businesses were classified as personal service, food establishments, maintenance, and repair shops. By 2007, that had declined to 18 percent. Meanwhile, 10 percent of African-American-owned businesses provided health care and social assistance in 1987; that increased to 19 percent by 2007.

The significant industry diversification that has occurred among minority-owned firms over the last two decades has been heavily influenced by preferential procurement programs in the public sector and corporate diversity programs in the private sector. Our research has found that African-American- and Asian-American-owned firms that pursue federal contracts are three times more likely to be concentrated in professional, technical, and scientific industries than in construction services. While significant disparities remain, it is indisputable that substantial progress is being made in narrowing the gap for minority-owned businesses.

The opportunity to participate in preferential procurement programs, offered in the context of lingering discriminatory barriers in the private sector, made African Americans, and to a lesser extent Hispanics and Latinos, heavily reliant upon government contracting opportunities. One program that became important to minority business owners was the SBA’s 8(a) Business Development Program, which allowed firms that were certified for the program to bid on contracts set aside exclusively for bid competition among 8(a) firms. Another program, the SDB (Small Disadvantaged Business) Program operated by SBA, has also been instrumental in minority business success. Certification in this program means that the firm has a greater chance of being selected as a subcontractor to a large corporation that holds a government contract. Procurement regulations require all large corporations that conduct more than $650,000 in federal government contracting to develop a subcontracting plan, the overall objective of which is to have large corporations subcontract to small firms at least 23 percent of the value of the award they receive from the federal government.

Similar mandates also exist at the state level. In particular, the Federal Highway Administration (FHWA) requires each state department of transportation and state and local transit agency that receives federal funds to develop a subcontracting plan that must indicate how so-called disadvantaged business enterprises—small firms that are 51 percent owned by socially and economically disadvantaged individuals—will be included in federally supported projects.

As an indicator of the relative importance of these programs to minority business viability, consider the following: Minority-owned businesses comprise just over 20 percent of the nation’s small businesses. However, our research found that in 2007, minority-owned businesses listed in the SBA’s Central Contractor Registry—the entity with which businesses interested in bidding on federally funded projects register—comprised just over 40 percent of all small businesses. This percentage suggests that minority-owned businesses pursue contracting opportunities with the government to a greater extent than other small businesses.

The Minority Startup Agenda

Small businesses are beginning to get recognition from policy-makers. However, many of the small-business proposals on the table are not appropriately targeted, and very few are specifically geared toward reinvigorating growth in the minority-business sector. Policy proposals advanced by the Obama Administration to assist small businesses include the Small Business Job and Wages Tax Cut, designed to provide a $5,000 tax credit to small businesses for each net new employee added to the payroll in 2010; reimbursement of Social Security payroll taxes for real increases in payroll resulting from new hiring; and establishment of a $30 billion fund to channel loans to small businesses through community banks.

But policy-makers could be doing much more to advance the cause of startups and small businesses, particularly ones owned by minorities. It has to begin with a simple recognition by government that it must focus more attention on minority-owned businesses if it is to solve the national economic puzzle. Reducing the interest rate to near 0 percent and focusing on infrastructure and green projects alone will not suffice. (Indeed, infrastructure stimulus tends to benefit large corporations and corporate suppliers more than small minority-owned firms.) In addition, the government continues to put an unwarranted emphasis on the availability of loans as a way of jumpstarting small business recovery. Survey after survey has documented that it is the lack of demand that is the major problem dogging small businesses, not the absence of loans. This problem is acute among minority businesses because they have been hit particularly hard by changes in corporate supply-chain practices and government austerity policies that have affected procurement operations.

There are several steps the government can take to address these challenges to minority entrepreneurship. First, it needs to develop new and more innovative forms of credit scoring that provide subsidies so that financial institutions can consider not just the past credit history of small and minority business owners, but also their current and future revenue, and growth and job-creating potential. While the Federal Reserve maintains that banks have done a good job of satisfying the demand for loans emanating from the small-business sector, it has failed to recognize that the new, stricter regulatory environment has discouraged and deterred many small businesses (and especially minority-owned businesses) from even seeking loans for fear that they would not qualify given the stricter underwriting standards. The loss of demand experienced by minority-owned firms during the recession has likely placed the credit scores of many outside the range of potential approval.

Regulatory changes can also be made, and regulatory enforcement improved, to make government procurement programs with minorities more effective. For instance, according to our research, large businesses that have inaccurately self-certified as small businesses have reaped the benefits of programs aimed at eligible entrepreneurs. Closer regulation and harsher penalties for misreporting might help solve the problem.

In addition, the government should make adjustments in the criteria for SBA program eligibility. Currently, business owners who participate in the 8(a) program cannot have more than $6 million in total assets or earn more than $350,000 annually. But that threshold is the same across all industries; Entrepreneur A who wants to start a manufacturing firm faces the same limit as Entrepreneur B who wants to start a retail business. Clearly, Entrepreneur A will need more startup capital than will Entrepreneur B. But if their net assets increase over time at the same rate, Entrepreneur A will be forced to exit the program sooner than will Entrepreneur B because A had a larger endowment of net assets at the startup out of necessity. In other words, the single threshold penalizes a person who wishes to start a business in manufacturing, professional and scientific services, or heavy construction contracting, in comparison to a person who wishes to start a retail establishment, which would be more likely to stay under the 8(a) limits.

Encouraging Green Shoots

These recommendations are all realistic, achievable, and urgent. Minority-owned businesses are an increasingly important component of our small-business landscape. Furthermore, a larger share of their workforce is drawn from disadvantaged neighborhoods and groups that are disproportionately unemployed than is the case among nonminority-owned firms. By helping minority businesses to achieve greater scale, jobs and income are created in communities that have the greatest need. Our research has shown that 31 percent of minority businesses are located in high-poverty areas, as opposed to 24 percent of nonminority-owned businesses. In Baltimore and Philadelphia, 69 percent and 60 percent respectively of small, disadvantaged businesses were located in high-poverty areas. In addition, minority entrepreneurs operated more high-skilled ventures in these locations than was the case among nonminority entrepreneurs.

But boosting minority businesses is not just a matter of social equity. Minority-owned companies (whose formation rate has been many times faster than the formation rate of all small businesses) now employ 5 percent of the workforce. The most innovative and dynamically growing sector of the economy today is minority- and women-owned small businesses. The employment potential of minority businesses is evident by the results discussed above, and by the fact that businesses owned by African Americans in 2007 created almost one million jobs while businesses owned by Hispanics/Latinos generated almost two million jobs. In short, supporting the efforts of minority business owners to achieve greater scale and capacity is central to our efforts to revive the economy, and should be nothing less than a national priority.