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The Relationship Between High-Quality Startups and Geography

We know that startups are highly concentrated in certain places in the U.S. But a new report finds that high-quality startups are even more so.

Marcio Jose Sanchez / AP Images

Although the Silicon Valley remains the epicenter of global innovation and entrepreneurship, there’s no shortage of concerned voices arguing that America’s innovative engine has run out of steam. In his new book The Rise and Fall of American Growth, the economist Robert J. Gordon argues that America’s great glory days of innovation are behind it. Others such as former Treasury Secretary Larry Summers agree that the U.S. has entered a prolonged phase of low innovation, low productivity, low growth, and “secular stagnation.”

A new report by MIT economists Jorge Guzman and Scott Stern generates relevant and important data on the increasingly concentrated geography of American innovation and entrepreneurship. The report develops several key measures of quality and quantity of entrepreneurship in the U.S., covering the period from 1988-2014.

Ebbs and flows of startup activity

First and foremost, the report finds that, while America’s entrepreneurial potential is rebounding, it is not reaching its full potential. The chart below, from the report, graphs the entrepreneurial potential of startups (based on the Regional Entrepreneurship Cohort Potential Index, which measures both the quality of entrepreneurship and the number of firms in a region) in 15 U.S. states from 1988-2014. By examining the characteristics of startups near the time they were founded, the study is able to identify not just the number, but the quality of entrepreneurial startup companies in key entrepreneurial regions of the U.S.

As the chart shows, U.S. entrepreneurship peaked during the late 1990s and early 2000s (the period of the tech or dot-com bubble), then declined shortly thereafter. It experienced a brief upswing in the mid-2000s before spiking downward during the Great Recession. But entrepreneurship has begun to rebound since that time. The year 2014 saw the second highest amount of “entrepreneurial growth potential,” according to the report—even when accounting for changes in the economy over time. This is in line with theories of innovation—notably that of the late economist Christopher Freeman—which suggest that innovation declines during economic crises, only to reignite in bunches as recovery sets in. (This notion is at the heart of my own theory of “Great Resets.”)

The economic historian Alexander J. Field has found that, in the wake of the Great Depression, the 1930s ultimately ended up being the most technologically progressive decade of the 20th century. Guzman and Stern’s data suggests that U.S. entrepreneurship may be turning the same kind of corner right now.

Troublingly, however, the report finds that “the U.S. entrepreneurial ecosystem is still dramatically less conducive for growth” than it was in the boom days of the late ‘90s and early 2000s (emphasis theirs). The crux of the problem lies not in the number of entrepreneurial firms, which has rebounded considerably, but in the inability of those firms to ultimately turn into the next big thing. “To the extent that the current state of American entrepreneurship is facing a crisis,” the report notes, “it is not in the rate of creation of high-growth-potential startups or even in the initial funding of those firms, but, instead, in the potential of those firms to scale in a meaningful way over time.”

That said, the report finds a higher probability of growth among startups with certain characteristics. Compared to average startups, which have a one in 3,500 chance of experiencing growth, the top one percent of firms with these characteristics have a much better chance (one in 100) of taking off. New startups are four times more likely than the average startup to grow if they are a corporation, two and a half times more likely if they have a short name, and five times more likely if they have trademarks. Furthermore, firms that apply for patents are 35 times more likely to grow. And, curiously, eponymously named firms are a whopping 70 percent less likely to grow.

Mapping entrepreneurship in key regions

The map below shows the uneven and spiky geography of U.S. startups, as measured by the Entrepreneurial Quality Index (EQI), a measure of the average growth potential of startups in a region. Each point on the map corresponds to the EQI of a given ZIP code, with the size of the point representing the quantity of startups (the larger the point, the greater the number of startups). The color of the point represents the quality of startups. Darker red indicates firms with greater entrepreneurial potential, while white indicates firms with lower entrepreneurial potential.

No surprise, entrepreneurial activity is highly clustered in the San Francisco Bay Area, Southern California, the Pacific Northwest, between New York and Boston, and in parts of Texas. In contrast, places like Florida, Missouri, Michigan, and parts of the Midwest have larger concentrations of low-potential firms.

Next, the report zooms in on a few key startup hubs. The graph below charts the entrepreneurial potential (RECPI) of the San Francisco Bay Area (including the Silicon Valley, the city of San Francisco, and surrounding areas) between 1988 and 2014. The Bay Area is the nation’s premier entrepreneurial hub, accounting for more than 40 percent of all venture capital investment in startups across the U.S., according to my own research. Even more so than in the U.S., entrepreneurial potential in the Bay Area increased slowly from 1988 to the late 1990s, before spiking during the dot-com crash. It then rose again, before plummeting during the Great Recession, and surging to record highs in recent years. Entrepreneurial potential is now 50 percent higher than the peak of the dot-com era, according to the report.

The maps below show the changing geography of entrepreneurial quality (EQI) in the Bay Area between 1988 and 2012, mapping it at the neighborhood or ZIP code level for 1988, 1996, 2000, 2004, 2007, and 2012. Darker red on the maps indicates more quality entrepreneurship. In 1988, virtually all entrepreneurial quality was in the Silicon Valley, particularly around Sunnyvale and San Jose. But by the 1990s, entrepreneurial quality began to cluster more around the university communities of Stanford and Berkeley. By 2000, we can see evidence of what I have called the “urban shift” in startup entrepreneurship, with the darkest red now popping up in neighborhoods in and around downtown San Francisco. By 2012, this shift was so pronounced that half of San Francisco ZIP codes ranked in the top five percent of all U.S. ZIP codes on entrepreneurial quality.

The next set of maps does the same for Boston. Back in the late 1980s, the preponderance of high-quality entrepreneurship was concentrated in the suburbs along the Route 128 corridor outside the city. Again by 2000, you can see entrepreneurship extending back into the city. By 2012, there is plenty of dark red in the city and around MIT and other areas of Cambridge. As the report notes, “over the past decade, the center of high-quality entrepreneurship has shifted. There is still high quality entrepreneurship around Route 128, but Cambridge (particularly Kendall Square) and areas of Boston (such as the Innovation District) have emerged as the leading areas in terms of intensive entrepreneurial quality in the Boston region.”

The report also maps Miami’s entrepreneurial ecosystem, which—despite having a high-level of self-employment—is far less developed than that of Boston or the Bay Area. As the maps below show, Miami has in fact experienced a decline in entrepreneurial quality since 2000.

While the geography of startup ecosystems in the U.S. has long been spiky, quality startup activity is even spikier. The highest quality entrepreneurship is heavily concentrated in a select few metros on the East and West Coasts. It has also undergone a great inversion of its own, shifting out of the suburbs and back toward the urban center.

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