You Can't Scale What You Don't Start

In his new book, Zero to One, the entrepreneur and investor Peter Thiel talks about the importance of new companies to economic and social progress. Such progress depends on more people starting companies; more people looking for a better way to do things. Unfortunately, the latest data on this score are not encouraging.

The Census Bureau’s Business Dynamics Statistics only go through 2012, which frustrates any real-time comparisons, but they offer a look at what has traditionally been the most dynamic part of the economy: new businesses and the jobs they create.

Contrary to expectations, new business creation did not rebound sharply from the historic nadir reached in 2010. In 2012, 410,001 new employer firms were created, which represented only a slight increase from the prior year.[1] Those new firms accounted for 8.1 percent of all businesses in the United States, again only a slight increase from the depths of 2010 and 2011.

Figure 1. Source: Business Dynamics Statistics, U.S. Census Bureau.

As the chart indicates, both the volume and the share of new business creation remain far below the rather steady level the United States enjoyed from the late 1970s through the 2000s. The 2012 figure is still 27 percent lower than the peak reached in 2006, when 561,721 new employer firms were formed.

The table below compares four different periods: the 1980s, 1990s, the 2000-07 expansion, and the 2008-12 recession and recovery. The latter period clearly stands out as well below the historical averages.

Table 1. Averages Across Different Periods

Time Period

New Firms

New Firm Employment

New Firm Share Total

















As indicated, falling business creation has been accompanied by lower job creation among new businesses, which have traditionally been a leading source of new job creation for the entire economy.

In 2012, the American economy gained 650,000 fewer jobs from new businesses than it did, on average, from 1978 to 2007. In total, from 2008 to 2012, 2.68 million new jobs were not created because of the decline in new business creation. In past business cycles, job creation from new businesses also fell, though only briefly; at least according to these data, the last several years are a historical anomaly.

Clearly, new business entry matters for job creation. The lackluster job recovery since 2009, which only finally gained steam in 2014, might have been very different if new business creation—and job creation from those new businesses—had remained at historically average levels.

These two charts and the table also tell us that some of the recent anxiety over the “aging” of American businesses is a bit overblown. In 2012, only 8 percent of companies in the United States were founded before 1977 (the first year for which data are available); most of the “older” companies that have been discussed as slowing down the economy were actually founded in the 1980s and early 1990s. “Aging” and “older” are relative terms, and 20-year-old companies shouldn’t necessarily be grouped together with 100-year-old companies.

Furthermore, as Daniel Isenberg of Babson College pointed out, business survival is a desirable economic outcome, not a bad one. From this perspective, the 2012 data brought good news in the form of an increasing population of businesses after four straight years of decline. From 1978 to 2007, the population of American companies had shrunk only once, in 1981; from 2007 to 2011, however, the total number of American businesses fell continuously. This decline reversed course in 2012, and the population of employer firms climbed back over 5 million for the first time since 2009.

The happy economic indicator of a rising business population, in fact, is one reason that the overall rate of new business creation appears to have fallen so steeply over the past few decades. Because the “rate” is calculated as the number of new firms divided by the total number of firms, it would take a rapidly rising pace of new business entry to generate a higher share. For example, as mentioned, 2006 had the highest number of firms founded during the entire period, 561,721. But the share of new businesses that year was only 10.7 percent, below the decennial averages of the 1980s and 1990s. The overall phenomenon is well illustrated by the averages in the table: the 2000s enjoyed the highest annual average of new firms created, but a lower share of new firms overall. This occurred because existing businesses were surviving at a higher rate than new businesses were being formed. That is not, prima face, bad for the economy.

Still, there is considerable disagreement over what a “correct” volume and rate of new business creation should be, and if an increase would actually be good for the economy. Isenberg, for example, observes that “new company starts are easier to count, but they alone don’t have the positive impact on economies that growing a company does.” For Isenberg, it is “scale-up” not startup that matters for economic outcomes. He challenges the “unquestioning acceptance” of the assumption that “the decline of newly registered businesses, in and of itself, is a bad thing.”

Isenberg is absolutely correct that growth-oriented companies—what he calls scale-up firms—are economically essential. Fast-growing companies that grow to hundreds of employees are, along with new businesses, the other principal source of net job creation in the U.S. economy. Every new Silicon Valley startup is in search of scale for a reason, and there is no apparent correlation between the number of new firms started in any given year and the number of scale companies that eventually emerge.

It is also not clear how much of an effect different levels of business creation have across countries. In part, this is because of data comparability issues. But it’s also because the specific mechanisms through which entrepreneurship drives economic growth remain largely unexplored by economists. Since 2007, according to the OECD, business creation has risen steeply in Portugal and the United Kingdom. The economies of those countries, however, faltered during that period, with Portugal at the center of the sovereign debt crisis two years ago. Yet business creation has fallen steeply over the same time period in Germany and Spain, which have had very different economic experiences. No clear guidance emerges from such high-level comparisons.

Nonetheless, the presumed choice between scale-up and startup is a nonexistent one. For one thing, the slowing pace of new firm entry over the past decade has coincided with a diminishing economic impact from scale-up firms. The United States has been getting less job creation from the fastest-growing companies (and also less job destruction from the fastest-shrinking companies). This doesn’t mean scale-up firms are any less important, but it’s another indicator of fading dynamism, and is likely related to overall business creation.

It is also difficult to argue with the evidence on the link between firm entry and job creation. The foregoing charts and table demonstrate the strong link in the United States, and recent research has confirmed this relationship across 17 other countries. If you want new jobs, you want new firms. (It’s important to note here that, in these analyses, one should take care about equating self-employment with entrepreneurship. They are not the same thing.)

Finally, although startup and scale-up rates are linked, they are not mutually exclusive. New business entry is essential for economic renewal. Scale-up firms certainly matter for “jobs, growth, value, and sustainability,” but they can also become entrenched incumbents that seek to protect their position rather than innovate. Rent seeking through regulation and restriction begins after the scaling phase. While empirical research is limited, there is growing evidence that greater incumbent protection is increasing concentration across many sectors and thus suppressing innovation by keeping out new entrants. An economy without entry is an economy without growth.

The volume of new business entry matters. No society can afford to not have as many entrepreneurs as possible addressing as many problems as possible. Many of those entrepreneurs will hopefully scale their firms when they hit on solutions to those problems, but we won’t get those scale-ups without more startups. To put it in Thiel’s language, without more attempts at 0 to 1, we won’t invent the economic future.

[1] The Census Bureau also revised the 2011 number downward, meaning the numbers are even lower than they first appear.


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