Volume 12, Number 2 – April 2015

America’s Start-Up Slump: What the $X&?! Is Going On?

America’s start-up engine is ailing.   As the chart below (from a recent Brookings Institution analysis shows, start-up rates in America are declining and have been for some time.  Even worse, new firms are closing more quickly and generating fewer jobs and economic benefits than in the past.  And, around 2008, the US economy hit a fateful crossroads where the number of firm exits (i.e. closings) exceeded the number of firm births (i.e. start-ups.)

These trends make for sobering reading—especially for folks, like us at EntreWorks Consulting, who have long advocated for greater local investment in supporting entrepreneurs.  Thus, it is especially important to understand what is happening and why.  That’s what we’re seeking to do in this edition of EntreWorks Insight.

There’s not much doubt about the veracity of the data on the entrepreneurial slowdown—it’s pretty clear that a big shift occurred in the mid-2000s. But, there is much debate about the causes of this shift.  Here are a few potential explanations.

The Great Recession

Clearly, the Great Recession played a role in driving down business start-up rates.  When the economy is in the tank and opportunities are lacking, it’s no surprise that fewer people start businesses.  This pattern occurs in all downturns, but, as numerous studies suggest, the Great Recession was different.   The downturn in new business starts was faster and deeper, and the recovery has been much slower.   So, the Great Recession is clearly an important factor, but not the sole cause of these trends.

Demographics

A number of demographic factors appear to be at work   First, overall US population growth rates are declining, and the declines are biggest in many once fast growing regions of the South and the West.  Research from Brookings’ Robert Litan and Ian Hathaway finds that fast population growth was a primary driver of faster start-up activity in the 1970s in these regions.   As population growth has slowed, these areas have seen start-up rates decline and regress to look more like the rest of the US. 

Age demographics matter too.   Today, American society is dominated by two age cohorts:  Boomers and Millennials.    Boomers are actually booming when it comes to start ups, starting firms at twice the rate of Millennials.   People aged 55-64 started 1/3 of all new US businesses in 2013, up from only 14% in 1996.    However, boomers tend to start firms for lifestyle reasons, and, while these can be exciting business opportunities, they are less likely to blossom into fast-growing job creators.   At the same time, we should not expect or plan on boomers continuing the same levels of start-up activity as they move into their 70s and 80s.

Meanwhile, Millennials have not been particularly entrepreneurial when compared to other age cohorts.   This is understandable given that they grew up in the midst of the Great Recession, while also facing many other impediments such as large student loan debt burdens.   Nonetheless, many observers hold out hope for Millennial entrepreneurship.  This age cohort is the best educated in US history, and has also been widely exposed to entrepreneurship, via specialized education programs and popular culture (in TV shows like Shark Tank).  Given the size of the Millennial cohort, an uptick in their business startup rates would have large ripple effects.

Housing Prices

Recent research using Census Bureau data suggests that the collapse of housing prices might play a role in slowing start-up rates.    Studies have found that states with the most severe housing price drops, such as California and Florida, also faced the biggest slowdowns in new business activity.  States with stable housing prices, like North Dakota, saw more limited impacts.   The specific causal pattern of this impact remains unclear, but a couple of factors may be at work  Lower housing prices will put pressure on consumer spending and on the availability of finance for new business starts.  They likely also put a big hit on the construction sector, traditionally an important source of new business starts.

The Rise of Big Firms

Some analysts point to the emergence of Walmart, Home Depot, Best Buy, and other large corporations as another factor at work in the start-up slump.   These large players have decimated the ranks of traditional “Mom and Pops,” such as hardware stores, local restaurants and other retailers.  Here again, we probably have a partial answer.   The startup slump is strongest in the retail and service sectors, but it has also occurred in manufacturing and technology industries.  Walmart may hurt Mom and Pops, but other things are affecting startups too.

Regulation

Some casual observers have claimed that burdensome regulations might be at work in the startup slump.  In particular, many are pointing to the rise of occupational licensing as an undue burden on start-ups.  (We previously discussed that topic here.)  While regulations can be a hassle, the evidence for a more significant economy-wide impact is pretty weak.  As a new study from George Mason University researchers finds, “Federal regulation has had little to no effect on declining (business) dynamism.”

New Ways of Working

The factors listed above are the most likely issues driving the decline in US business dynamism, but I also believe that one other factor might be at work:  new ways of working.  As more people move into independent work (the 1099 economy) and the distinction between an employee and an entrepreneur becomes fuzzier, our old categories of tracking business dynamism may need updating.   Many things that we once labeled a business startup may now be labeled as a freelancer or an independent worker.  Similarly, the business activities that once occurred almost exclusively inside the firm may now be occurring in less well defined and poorly measured networks or partnerships.  So, some share of the “missing startups” might be found in the 1099 economy.

It’s likely that this final factor is a minor cause at best.   And, if these new work entities aren’t growing or generating new opportunities, we still have a business dynamism problem on our hands. 

So Now What?

As in some many complex public policy issues, the startup slump lacks a single cause.  In fact, it seems like there are almost too many causes at work here.   However, this analysis does suggest that doing just one thing, such as enacting startup visas or changing regulations, is really going make a huge difference.   Instead, solutions will require sustained focus and continued support for the building of regional and local entrepreneurial ecosystems. And, it may require a re-examination of some issues, such as growing student debt burdens, through the lens of how they affect entrepreneurship rates.   The good news is that the most recent data suggest that startup rates are now heading up.   While these “green shoots” are encouraging, a continued focus on stoking America’s economic engines will be needed.

What’s New at EntreWorks Consulting?

Spring has sprung with lots of time on the road in the coming months.  If you’re based In Appalachia, you’ll have the best chance of sighting Erik Pages this Spring.  Thanks to two large projects focused on Appalachia, we’ll be spending lots of time there.  This work includes the development of a new strategic plan for the Appalachian Regional Commission and the provision of technical assistance to communities facing job loss in coal mining and related industries.  This latter project is supported by the National Association of Counties and the National Association of Development Organizations.   In June, you can also find Erik teaching a course on measuring innovation and entrepreneurship at the Council for Community Economic Researchers’ (C2ER) annual conference in Portland, OR.  We continue to provide more regular news and updates at the EntreWorks blog at http://entreworks.net/blog.   You can also access blog updates at our Facebook and LinkedIn pages and on Google Plus.