There has been considerable hand wringing in recent months about research (pdf) showing a decline in American entrepreneurship, a fall in “economic dynamism” (the turnover of companies and jobs), and an overall aging of U.S. businesses. In the face of pessimistic long-term growth forecasts from the World Bank, International Monetary Fund, and Federal Reserve, these findings are worrying.
The founding and growth of new businesses has always been key to innovation, and young companies have been shown to be more prolific sources of job creation than their older counterparts. The velocity with which these firms move in or out and up or down is what economists call economic dynamism. It is critical to rising living standards.
But, according to research by the Brookings Institution and economic research published in leading journals, the United States has been on the wrong trajectory when it comes to these things. The rate of business creation has been falling for several years, even predating the 2008-09 recession, and the average age (pdf) of U.S. companies has been rising. The share of the overall population of firms accounted for by older businesses—those 16 years and older—rose by more than 50 percent from the early 1990s to 2011. Partly as a result, economic dynamism has diminished.
These trends are not necessarily new and have been covered before in the Washington Monthly, but recent discussions have brought new urgency to the issues. Why is this happening, and can we expect it to continue?
First, let’s dispense with two potential explanations. One possibility is that the sectoral composition of the US economy has changed, with more economic activity in sectors that inherently have lower rates of entrepreneurship. For example, if the health care sector has historically had less business creation than other sectors, its rising economic share could explain macro trends. University of Maryland economists Ryan Decker and John Haltiwanger, experts in this area, have disproved (pdf) this explanation.
A second potential culprit, as noted by Robert Samuelson recently, is public policy: either an increasing number of unfriendly policies, or the absence of policies that would boost entrepreneurship. Research is not abundant on this, but we think it is an unlikely explanation. The overall trends of falling entrepreneurship, slowing dynamism, and aging businesses have been relatively uniform across states, metropolitan areas, and different time periods. There aren’t many federal policies that could account for that uniformity.
It is possible that public policy has played an important indirect role in shaping the environment in which new and young companies operate. But changes in public policy wouldn’t appear to be a direct cause of falling entrepreneurship.
So what’s behind these trends?
One possibility that must be considered is that the data are incomplete. For one thing, the data used in these analyses only go through 2011. It is difficult to reconcile the findings on declining business creation with the explosion of efforts to promote and support entrepreneurship in the last few years. So, it is entirely possible that the downward trends are already in reversal (although likely not fully reversed).
This raises another possibility: perhaps we are undercounting entrepreneurship. The Census Bureau data used in recent research cover employer businesses. We know, anecdotally, that entrepreneurial activity takes many forms, and that in recent years the diversity of such forms may have been widening. What one colleague calls “fractional entrepreneurship” appears to be on the rise: ventures nestled inside other organizations, side projects that do not need incorporation, and so on.
Using a wider definition of entrepreneurial activity, other Census data indicate that new business creation actually rose during the Great Recession. Thus, our measurement methods could be lagging behind an increase in different kinds of entrepreneurship.
These issues also highlight the relationship between entrepreneurship and economic health. In a new book, The Innovative Entrepreneur, Northwestern economist Dan Spulber analyzes the lifecycle dimensions of entrepreneurship and finds that the decision to start a new venture depends on the range of opportunities and constraints facing a potential entrepreneur. One such factor, demonstrated by Rob Fairlie at UC-Santa Cruz, is the availability of wage and salary work. The opportunity cost of entrepreneurship depends on the labor market alternatives available to someone and their expected returns from those alternatives.
This explanation would not apply to recent years when the labor market has been sluggish. But since the fall in business creation identified by the Brookings research goes back 20 years, it could reflect better wage and salary opportunities available to many who, in different circumstances, might have started companies. Entrepreneurship trends need to be properly situated.
A third explanation could be demographics. The volume of business creation in the United States was actually rather steady (pdf) from the early 1980s up to the Great Recession, with an average of 500,000 new businesses created each year. Because the overall population of businesses was increasing—firms don’t exit at the same rate as they enter—the rate of business creation steadily fell.
We must be careful with casual empiricism, but one other factor that was steady during this same period was the American working age population. The labor market entry of baby boomers and women meant that the working-age share of the population held remarkably steady from the early 1980s to the late 2000s. Correlation is not causation, but the relationship between demographics and entrepreneurship cannot be ignored.
So what can we expect in the future? Will the purported decline in entrepreneurship continue? In a forthcoming paper, the Kauffman Foundation analyzes different trends and scenarios for why entrepreneurship may rise or fall. We can briefly canvass some reasons for optimism here.
Returning to demographics (pdf), over the next 20 years we will have more thirty-somethings than ever before. This matters because the “peak age” for entrepreneurship is the late thirties and early forties. While we might not expect an outright entrepreneurial boom, as Vox’s Matt Yglesias suggests, we are more optimistic than 538’s Ben Casselman, since the decline of the prime-age entrepreneurial population has coincided with the decline of high-tech entrepreneurship (as opposed to the big-box retailer driven decline in the decades prior).
Likewise, we might expect that the proliferation of entrepreneurship education and training programs across the country could translate into more new businesses over the next several years. And, the expansion of crowdfunding sites should encourage a higher level of entrepreneurial activity.
The present state of entrepreneurship, at least according to recent research, may not seem particularly healthy. But there are reasons to think that picture may be incomplete, and plenty of reasons for expecting an entrepreneurship boom in coming years.