Tuesday, May 20, 2014

The Decline of Entrepreneurship In America

A study by Ian Hathaway and Robert Litan at the Brookings Institute examines the issue of declining entrepreneurship or business dynamism in the United States over the period from 1978 to 2011.

Business dynamism is the process in which businesses are created, expand, contract and fail.  During the process, jobs are both created and destroyed.  Business dynamism is essential for economic growth; unless new businesses are formed and existing businesses expand, economic and job growth will not take place.  Looking back over history, a new business is created nearly every minute and another fails every eighty seconds.  For example, during every quarter in 2012, there were 13.2 million private sector jobs created or destroyed.  Unfortunately, despite all of that business creation and destruction, only 600,000 net new jobs were created in each of the four quarters.  

Two statistical measures can be used to examine the level of business dynamism; the first is firm entry defined as firms that are less than a year old as a share of all firms and the second is job relocation.   

Let's start this posting by looking at how many firms were created and destroyed during the period from 1978 to 2011:

The decline in the number of firm entries after 2006 is quite obvious as is the rise in the number of firm entries.

Over the period between 1978 and 2011, this graph shows that the rate of firm entry has dropped from just under 15 percent in 1978 to around 8 percent in 2011:

Note that the rate of firm exits rose slightly after 2008 and, for the first time in 30 years, the number of firms exiting exceeded the number of firms entering.  In other words, after 2008, the number of business births was exceeded by the number of business deaths.

Here is a graph showing the trend in job reallocation, a measure of churning in the labor market, from 1978 to 2011:

In 2011, job reallocation hit a record low, down from 36 percent in 1978 to 26 percent in 2011.

The authors then go on to look at whether there is a geographic component to the drop in business dynamism over the three plus decades.  Looking at the data for 50 states and 366 metropolitan areas, the authors found that current firm entry rates were lower in every state and all but one metropolitan area compared to three decades ago.  Here are the five states with the biggest declines in firm entry over the period:

Alaska - minus 60.9 percent
Vermont - minus 58.6 percent
New Mexico - minus 57.5 percent
Wyoming - minus 57 percent
Oregon - minus 55.7 percent

As well, job reallocation rates were lower in every state and all but a dozen metropolitan areas compared to three decades ago.  In all states and metropolitan areas, exit rates were more or less consistent across the three decade period.  The data shows that the decline in business dynamism or entrepreneurship is pervasive right across the nation.

What does all of this mean?

1.) Nationwide, there has been a decrease in entrepreneurship that has affected all 50 states and nearly all of America's largest metropolitan areas.

2.) The decline in business creation has not been isolated to a particular sector of the economy.

3.) Older and larger businesses are doing far better than younger and smaller businesses.

4.) Businesses and individuals are more risk adverse, preferring to hold on to cash rather than using it to start new businesses.

5.) Workers are less likely to switch jobs.

The decline in entrepreneurship in the United States may, in part, be responsible for the sluggish job market recovery since the end of the Great Recession.  Historically, new businesses have created millions of net new jobs for America's workers and without their contribution, the U.S. economy is far slower to recover from an economic downturn.


  1. Maybe it is unrelated, but the chart showing the decline in the entrepreneurship rate seems to mirror the decline in interest rates.

    I can't recall where I read it (maybe John Mauldin), but one investor theorized that in a lower interest rate environment larger players used leverage to acquire competition making markets less competitive.

    Of course correlation does not imply causation. I'd be interested to hear the thoughts of others on this theory or alternative theories.

  2. @MAS I think the answer stares us in the face for most goods or services a startup can't beat the competition on price and must rely on excellent service, but since the vast majority have little extra money to spare they will seek out the lowest price. This causes the new business to fail. Also since the masses are living hand to mouth who willing to take that risk to start up something new?

  3. It has been said that money is the mother’s milk of politics, this in many ways has been the Achilles heal of small business. The lobbyist that represent banks, big business and special interest have had their way to the detriment of America and small business. They have shaped and crafted regulation that has shifted commerce strongly in their favor. As the stocks of large companies rise we are often oblivious to the names of local businesses that cease to exist. More on this subject in the article below.

  4. Big business doesn't need to worry about getting sued by small startups with patents because patents are getting invalidated at a 85% rate: http://patent-counselors.com/?p=189

    If a small company doesn't have patents to stop big companies from stealing their ideas, what does a small company.