Young firms, not small firms, make an outsized contribution to job growth here in the U.S., and the ongoing decline in start-up activity has taken a lot of the fizz out of the U.S. job market. We've gathered some research that considers why creative destruction in the business world has lost its creative half, a serious and ongoing issue for our workforce
In a presentation at a November 2012 IMF research conference, Teresa Fort, John Haltiwanger, Ron Jarmin and Javier Miranda note that between 2006 and 2009 employment growth in firms less than 5 years old with fewer than 20 employees fell from 26.6% to 8%, while employment in businesses more than 5 years old with more than 500 employees fell from 2.8% to -3.9%, narrowing the differential from 23.7% to 12.5%. They note that many of the hypotheses concerning why small firms are more sensitive to credit conditions apply more accurately to young firms and start-ups because they don’t have access to commercial paper and corporate bonds, and instead rely on their own finances to get started including, you guessed it, home mortgages. Specifically, they found that the housing price shock in California explains 2/3s of narrowing of the growth rate differential noted above, found like patterns in other states with severe housing price declines, and did not find them in states that did not experience such declines.
In a related paper, the same team, sans Ms. Fort, found that the largest declines in the share of employment accounted for by young firms (declines ranging from 11.8 to 14.3%) occurred to California, Nevada, Utah, Arizona and Idaho, while the second tier (declines of 7.1 to 11.8%) were wider spread, but included Florida, Oregon, Wyoming, and Michigan. So, all front-line housing bust states are all in the top tiers.
…and housing bust
The authors note the work of Atif Mian and Amir Sufi on aggregate demand at the state level, and note that the decline in housing prices cuts both into self-financing, and into local demand. A San Francisco Fed paper released yesterday authored by Mian and Sufi using state-level National Federation of Independent Businesses data finds a strong correlation between the decline in the employment-population ratio between 2007 and 2009 and the 20pp increase in businesses citing poor sales as their biggest problem. (The percentage citing credit conditions barely moved, which struck the authors, and us, as odd.)
They looked at household-leverage and found that the percentage of businesses citing weak sales rose more in states with higher household leverage, where largest declines in spending and employment catering to local customers took place as well. And although the percentage of small business owners reporting regulation and red tape as their biggest problem rose between 2008 and 2011, the increase was inconsistent across states—Rhode Island reported a rise of over 30pp while that measure fell by 10pp in New Jersey—and the states where the complaints about regulation and taxes rose the most also experienced the strongest employment growth, although the correlation was not statistically significant.
The weakness in start-up activity since the Great Recession is no mystery.
But what about the long if less dramatic decline since the 1980s? Of course there are many factors, including concentration of power in major corporations, barriers to entry, and outsourcing, especially of manufacturing activity, and we have identified a few other trends that have gotten less attention.
First there is a well-documented relationship between education and entrepreneurship: as of 2007, 28% of the overall US population had attained a bachelor’s degree or higher, but 48% of business owners with paid employees had bachelor’s degrees or higher. Between 1980 and 2010 both overall job growth and educational attainment have slowed from their 1950–1980 rates. Metro areas with smaller education gaps (the difference between the years of education required by the average posted job openings and the ears of education attained by the average worker in that area) have significantly lower unemployment rates for well and poorly educated workers alike. The decline in job growth/ed attainment coincides with the decline in start-up activity.
Second, in a paper in the January 2011 issue of The Journal of Health Economics, Robert W. Fairlie, Kanika Kapur, and Susan Gates used CPS panel data to expand on limited research on “entrepreneurship lock,” and found that self-employed business owners are “much less likely” than wage & salary workers, part-time workers and even unemployed workers to have health insurance, and that new business owners have lower rates than those in older businesses. Business creation rates are lower for workers with employer-based heath insurance, and higher for those who have no health insurance, or have insurance through their spouses. They estimate that, for men, this lowers the probability of starting one’s own business by 1% “relative to an annual base business creation rate of 3%.” They conclude that eligibility for Medicare has a lot to do with it: business ownership rates for men increase from 24.6% for those just under 65 to 28% just over 65, but there is no change between the ages of 55 and 75, meaning it’s not just because they reach retirement age. In closing they note that the relatively low rates of business ownership in the US may be related to differences in our health insurance coverage with coverage in other wealthy countries.
Third, a disproportionate number of start-ups are founded by skilled immigrants. A Kauffman Foundation study found that a quarter of the science and technology firms founded in the US between 1995 and 2005 were headed up by a foreign-born CEO or lead technician, and that in Silicon Valley the percentage rose to 52%, with Indian immigrants founding one fourth of the start-ups, and immigrants from Britain, China, Taiwan and Japan founding the other fourth. Weakness in our economy has caused a decline in immigration, and although there have been some legislative proposals to award VISAs to those who might want to start a new company here, it doesn’t really work that way. Generally firms are started by entrepreneurs who come here to go to school, work, or for family reasons, about not until they have been in the US for about 10 years. So this is likely to be a persistent problem as well.
There is much speculation about tax rates but, although increased tax rates on capital gains may discourage angel investors, David Friend, who has founded six companies in three decades, notes that the marginal tax rate “doesn’t make any difference” to entrepreneurs: they are unlikely to make much in their first few years, and are focused on “hitting it big” in the future, as were Bill Gates and Steve Jobs who braved top income tax rates of 70% when founding their companies.