3 Factors That Affect Business Dynamism
Firms of all sizes suffered during the Great Recession. Even as established firms closed, the number of startups did not increase. In fact, 2009 represented the lowest number of new firms since 1977.
Despite this recent trough and the subsequent (modest) rebound, the number of new firms each year has been relatively stable for the last 30 years. While the number of new firms has stayed relatively stable, the number of total firms each year has grown slowly, resulting in decreased business dynamism.
Several factors affect the declining rate of entrepreneurship — some of which I’ve outlined previously. Drawing on recent papers from Karahan, Pugsley, Sahin (2015) and Pugsley, Sahin (2014), let’s focus on the decline in the growth rate of the labor force, the decline in the startup rate, and the subsequent reduction in firm dynamics.
Declining Growth Rate of the Labor Force Changes Business Dynamics
The current U.S. labor force stands at a little under 158 million people, which represents a labor force participation rate of 62.6 percent (a tick up from October 2015, which was the lowest level in 30 years). Importantly, the growth of the labor force remained relatively flat for approximately 20 years until declining markedly since the Great Recession.
In both papers, the authors contend that the slowing growth rate of the labor force had negative consequences for startups because the startup rate is particularly sensitive to the labor supply. However, this slowing rate does not affect incumbent firm dynamics. With a reduction in startups, there are fewer new jobs because new and young firms are responsible for the vast majority of all net new jobs. This tightening of the labor market in turn shifts employment into incumbent firms. Incumbent firms grow stronger as a result, and the economic environment for startups worsens.
Because startups are largely responsible for net job creation, the startup deficit has an immediate effect, as it weakens the employment growth trend. The startup deficit also has a delayed effect on employment dynamics by shifting the age distribution of firms, and older firms behave differently as noted above.
Essentially, fewer workers means fewer startups which means fewer workers; the cycle is self-reinforcing because young firms are more responsive to business cycle shocks than mature firms.
Shift of Employment Into Older Firms
The authors in both papers contend that the reduction in the growth rate of the labor force does not affect incumbent firms. Essentially, the slowing rate is only hurting the number of new startups (the slope of the line in the first chart).
Between 1987 and 2012, the share of mature firms (age 11+) increased from approximately one third of all firms to nearly half. Moreover, the employment share of mature firms increased from approximately 65 percent to 80 percent between the late 1970s and 2012. The authors find that the percent of employment in startups falls in half, from 4 percent to 2 percent.
In sum, part of the reduced business dynamism story is that the slowing of the growth rate of the labor force leads to fewer startups, which in turn leads to an allocation of workers into older firms. Pugsley and Sahin find that the growth rate of younger firms is twice as sensitive to shocks (business cycles) as mature firms.
One potential interpretation of these findings is that with older firms less responsive to business cycle shocks, we see jobless recoveries like the one we’re experiencing now. We need startups to create jobs, but there are large business cycle factors limiting their creation.
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Derek Ozkal is a program officer in Research and Policy for the Ewing Marion Kauffman Foundation, where he assists with writing and analysis of various Research & Policy initiatives and administers grants, which includes managing and overseeing assigned grant portfolios, monitoring grantee performance, and reviewing grant proposals.