The Rate of New Business Formation Has Fallen By Almost Half Since 1978

America's declining "business dynamism" has affected all 50 states and nearly every single metro area.

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Reuters

Historically in the U.S., about one new business has been formed every minute, while another shutters its doors every 80 seconds. This life cycle of birth and death – referred to as business dynamism – is a key driver of innovation and to overall economic growth, giving rise to the great “gales of creative destruction” that the economist Joseph Schumpeter identified as the motor of force of capitalism.

A growing chorus of economists suggests that this process of dynamism and innovation has slowed, becoming a key factor in our sluggish recovery and anemic job growth. George Mason’s Tyler Cowen has dubbed the decline in returns to innovation the “great stagnation," while former Treasury Secretary Larry Summers has proclaimed that the U.S. has entered a period of “secular stagnation,” comparable to that of the Great Depression, in which declining levels of investment, spending, consumption and growth are fated to become the “new normal.” 

A new Brookings report released today adds additional empirical evidence to these claims, finding that business dynamism appears to have slowed precipitously over the last several decades. The study, by economist Robert Litan of the Brookings Institution and Ennsyte Economics’ Ian Hathaway, tracked two key metrics of “business dynamism”—the rates at which firms are created, and the broader metric of job reallocation—from 1978 to 2011. They traced these patterns for the economy as a whole, as well as across states and metro regions.

Their evidence suggests that the U.S. economy is indeed less dynamic across all major industries as well as across geographic regions.

The two graphs below from the study show the broad picture of declining dynamism for the nation as a whole. The graph on the left looks at the firm entry rate, calculated as the share of all businesses that are less than a year old, while the one on the right shows job reallocation. Both slope downward since 1978. The first graph indicates that, though the firm exit rate has stayed relatively steady, the rate of firm entries has dropped substantially, especially since 2006. The entry rate has dropped by nearly half since 1978, and business deaths now exceed births. The graph on the right shows that job reallocation—a measure of labor market “churn”—has also declined since 1978, with the drop accelerating over the last decade.

Hathaway and Litan looked more closely at the geographic components of this decline, wondering whether this larger shift could mask any substantial variations across states and metro regions. I have often written about how the economy is being increasingly split into winning and losing regions and metro areas, as activity concentrates more and more in certain dynamic parts of the country.

But Hathaway and Litan’s data suggest a more pervasive pattern of declining dynamism. They write, “We would expect to see some regions in decline while others were immune. But, in fact, that is not what the data show.” 

The second set of graphs, below, also from the report, tracks business dynamism across states and metros. It charts rates of firm entry, firm exit, and job reallocation from 1978 to 1980 (on the vertical axis) and from 2009 to 2011 (on the horizontal axis). The darker blue dots represent states, while the lighter blue dots represent metros. Dots that appear above the line had higher rates of business dynamism in the earlier period, while those very few dots below the line are the places where their metrics of business dynamism saw improvement in the 2009 to 2011 period.

What these graphs show is that business dynamism declined in all 50 states and nearly every metro area. As they explain, “The performance of business dynamism across the states and metros has become increasingly similar over time. In other words, the national decline in business dynamism has been a widely shared experience.” Only one metro—McAllen, Texas—had a higher rate of firm entry in 2009-2011 than in 1978-1980. Just a dozen metros, mostly in the Midwest, had higher job reallocation rates in the more recent period. They include Ann Arbor, Niles-Benton Harbor, and Flint in Michigan; Rochester, Minnesota; Kokomo and Anderson, Indiana; Sheboygan, Wisconsin; Dubuque, Iowa; and Rockford, Illinois.

As Hathaway and Litan note, these trends reflect a different kind of winner-takes-all dynamic in the American economy. Big corporations continue to do well, and overall business leaders have become more and more risk averse. And there are ripple effects to this job churn slow down. As I wrote last week, the decline in job turnover has meant that Americans are moving between cities and states far less often than they used to.

The authors caution that their data cover the period through early 2011, so it’s possible that “these trends have reversed—or at least stabilized—since then.” The late economist Christopher Freeman, invoking Schumpeter’s “creative destruction,” long ago argued that economic crises set the stage for great bursts of innovation. Patent activity has ticked up since the crisis, and venture capital activity has surged in recent years.

But there are long lags between the onset of crises and these rebounds in innovation and entrepreneurial activity that power long-run economic growth. These Great Resets are generational events, with much longer time lines than typical business cycles.

Much of what will stoke the engine of innovation and dynamism lies outside government’s direct control, but the authors do suggest one policy proposal that could help jumpstart this process: Immigration reform. A key advantage of the United States has been its openness to foreign talent, foreign innovators and foreign entrepreneurs. They have provided a great deal of this country’s entrepreneurial energy, from the early industrial revolution to today’s Silicon Valley tech boom, where one quarter of all companies were founded by a person born outside the U.S. As the authors note, the United States should do everything it can to encourage talented foreign grads and entrepreneurs to stay in this country and help them thrive.

Making America the world’s most welcoming magnet for global talent is the most direct path to jumpstarting our economy and getting the U.S. job market back to where it needs to be.

Top Image: Serial entrepreneur and Tesla Motors CEO Elon Musk (REUTERS/Stephen Lam).

About the Author

  • Richard Florida is Co-founder and Editor at Large of CityLab.com and Senior Editor at The Atlantic. He is director of the Martin Prosperity Institute at the University of Toronto and Global Research Professor at NYU. More
    Florida is author of The Rise of the Creative ClassWho's Your City?, and The Great Reset. He's also the founder of the Creative Class Group, and a list of his current clients can be found here