Wall Street Journal | November 7, 2014
A few weeks ago, I wrote about a surprising paradox I’d just learned about at a conference: Entrepreneurship has never been easier, but entrepreneurship is on the decline. Innovation and entrepreneurship are hot subjects the world over. With the advent of inexpensive digital technologies and cloud-based services, it should be easier than ever to become an entrepreneur and start your own company. But in fact, entrepreneurship has been declining for years.
After analyzing business data from the U.S. Census Bureau, economists Ian Hathaway and Robert Litan observed in a recent paper that new firm formation has been declining across the board since the late 1970s. In addition, failure rates have steadily increased for all companies under 16 years old, and they’ve been particularly high for early-stage firms. Consequently, there are fewer young- and medium-aged firms each year, thus leading to the overall decline in entrepreneurship.
In another paper, University of Maryland economist John Haltiwanger and collaborators used the same Census Bureau data to calculate the annual startup rates over the past several decades–i.e., the number of new firms in each year divided by the total number of firms. The startup rate was 12.0% in the late 1980s, went down to 10.6% just before the 2007 Great Recession, and then fell sharply below 8%. Such sharp declines add up over time. In the late 1980s, 47% of all firms were 5 years or younger. The percentage of young firms declined to 39% in the mid 2000s, and has since continued its downward trend.
Both papers noted that no one is quite sure what has caused this decline or what to do about it. Then a few days after posting my blog, I got an e-mail from John Dearie, Senior VP at the Financial Services Forum. For the past three years, he and a colleague have been trying to understand the causes behind this alarming decline in entrepreneurship.
“After considering a number of alternatives, we decided the best way to determine what is happening with entrepreneurs was to travel the country and ask them directly – What’s in your way?,” he wrote in the e-mail. “With that in mind, we organized roundtables with entrepreneurs in 12 cities across the United States, choosing our cities with the aim of covering the geographic expanse of the country and well as the industrial diversity of the US economy.”
“What we heard at those roundtables was nothing short of remarkable – and critically important from the standpoint of potential policy solutions. We recounted what we heard from the nation’s entrepreneurs, and offer a 30-point policy plan based on what we heard, in a book we published last year called: Where the Jobs Are: Entrepreneurship and the Soul of the American Economy.” The book was co-written with Courtney Geduldig and published in September of 2013. A few days later I received a copy the book.
The first chapter is a stark reminder of America’s job emergency. Between February of 2008 and February of 2010, almost nine million jobs were eliminated, wiping out all the employment growth of the previous decade. According to the US Bureau of Labor Statistics, in May of 2013 the unemployment rate was 7.5%, or around 11.7 million people. The unemployment rate was considerably higher for African-Americans and Hispanics–13.5% and 9.1% respectively–and for young people between 16 and 19 years–24.1%. The total number of unemployed and underemployed–what economists call the U6 unemployment rate,–was 13.8% or 21.5 million people.
The situation in September of 2014 is a bit better. The unemployment rate now stands at 5.9% or 9.3 million, and the U6 rate is 11.8% or 18.6 million. Those numbers are still quite high compared to pre-recession rates. Five years after the U.S. Great Recession is supposed to be over, unemployment and underemployment remain serious problems. And the main reason, according to Mssrs. Deary and Geduldig, is the lack of enough startups to create the new jobs we so badly need.
The book references a study based on U.S. Census Bureau data that shows that between 1980 and 2005, all net new job creation in the U.S. came from young businesses less than five years old. How can this be given that startups and young companies are a relatively small percentage of all U.S. companies?
The answer lies in the highly dynamic nature of the U.S. labor market. There’s a constant churn of jobs as companies hire and lose large number of employees every month. When the Labor Department reports that 200,000 new jobs were created in a given month, it’s because five million people were hired and 4.8 million left their jobs for one reason or another. “In 2011, for example, 47.5 million separations occurred while 49.6 million Americans took new jobs, for a net gain of about 2.1 million new jobs… Indeed, about a third of the U.S. labor force turns over in a typical year.”
Regardless of age or size, existing companies shed a net combined average of about one million jobs each year, either because the business failed or it’s trying to become more efficient by reducing its headcount. At the same time, new businesses are adding an average of three million net new jobs every year.
Thus, while around 20 million Americans remain unemployed, underemployed or have left the labor force discouraged, “the nation’s job creation engine – new business formation – has been breaking down in recent years.” This is the urgent problem that Mssrs. Dearie and Geduldig went on the road to investigate by conducting roundtables with entrepreneurs in 12 different cities.
What did they learn? First, that just about every startup faces four critical realities:
- “New businesses are extremely fragile” – one third fail by their second year and half by their fifth.
- “The policy needs and priorities of new businesses are unique,” and different from the requirements of existing companies.
- “Policy makers in Washington do not sufficiently understand or appreciate the unique nature, importance, vulnerability and needs of startups,” and as a result the priorities of startups are often overlooked and neglected.
- “Policy help for America’s job creators is urgently needed,” especially now given their central role in new job creation.
In their meetings across the country, they heard that a fairly similar set of obstacles are undermining the entrepreneurs’ ability to launch and grow new businesses. Six in particular came up, each the subject of a chapter in the book:
- “Not enough people with the skills we need”;
- “Our immigration policies are insane”;
- “Not all good ideas get funded anymore”;
- “Regulations are killing us”;
- “Tax payments can be the difference between survival and failure”; and
- “There’s too much uncertainty – and it’s Washington’s fault”.
“Where the Jobs Are… should be dropped onto the heads of America’s squabbling politicians,” wrote The Economist in an article in its October 12, 2013 issue. The article nicely summarized what Mssrs. Dearie and Geduldig learned.
“The first worry is over human capital. Entrepreneurs repeatedly complain that they cannot hire the right people because universities are failing to keep pace with a fast-changing job market… Exasperation turns to fury when it comes to immigration. Immigrants are responsible for launching about half the country’s most successful start-ups and producing a striking number of its patents. But the authorities do their best to drive them out of the country once they have been educated or to break their spirits on the visa treadmill…”
“The second problem is the complexity and cost of government. Entrepreneurs the world over complain about regulations and taxes. But America’s have lots to gripe about: in 2009-11 the Obama administration issued 106 new regulations each expected to have an economic impact of at least $100m a year. Besides this business founders suffer from the constant political uncertainty generated by a combination of ambitious new legislation, such as Obamacare, and ideological trench warfare…”
“The financial crisis has worsened the third problem: raising money. Over 70% of new businesses are launched using savings or assets-particularly houses. The crisis reduced the average net wealth of American households by about 40%. Business founders repeatedly mention other problems too. Venture capitalists are increasingly risk-averse. he Sarbanes-Oxley act imposes additional costs of $1m a year on public companies. Investors no longer bother with growth stocks because there is more money to be made in making lots of big trades in established firms.”
Despite all the problems the book concludes on a positive note. “Having witnessed such dynamism and commitment first hand, we are more optimistic about the future of the US economy – and it’s job creating capacity – than ever.”
“But for that tremendous potential to be fully unleashed, America’s entrepreneurs need help.” In particular, the 30 specific policy proposals in Where the Jobs Are represent a “vitally important game plan for unleashing the job-creating capacity of America’s entrepreneurial economy, and putting our beleaguered nation back to work.”
Irving Wladawsky-Berger worked at IBM for 37 years and was then strategic advisor to Citigroup for 6 years. He is affiliated with MIT, NYU and Imperial College, and is a regular contributor to CIO Journal.