Last week I discussed the recent MIT Second Machine Age Conference, an event inspired by the best-selling book of the same title published earlier this year by MIT’s Erik Brynjolffson and Andy McAfee. In his closing keynote, McAfee shared with us what to me was a rather surprising paradox: Entrepreneurship has never been easier, but entrepreneurship is on the decline. He showed us data from a July article by the Brookings Institution: in 1992, 23% of all firms were 16 year or older, and employed 60% of the private sector workforce; by 2011, such mature firms were 34% of the economy, and employed 72% of private sector workers. But, during the same period, firm share and employment declined for all other companies aged less than 16 years.
I was frankly not aware that entrepreneurship has been declining for years. To the contrary, I’ve viewed entrepreneurship as being closely associated with the transformative innovations all around us, and the core of Schumpeter’s 70 year old theory of creative destruction, according to which successful, mature companies that once revolutionized their industries are too slow to respond to the waves of startups now attacking them with innovative products and services.
Five years ago, The Economist published a special report on entrepreneurship. “Entrepreneurialism has become cool,” it said, and called it “An idea whose time has come.” The Economist concluded that “The rise of the entrepreneur, which has been gathering speed over the past 30 years, is not just about economics. It also reflects profound changes in attitudes to everything from individual careers to the social contract. It signals the birth of an entrepreneurial society.”
Moreover, as plenty of books and articles remind us, it’s never been easier to become an entrepreneur and start your own company. Digital technologies are inexpensive and ubiquitous, startups have access to all kind of cloud-based business services, and customers can now be easily reached and supported over mobile devices.
McAfee’s data comes from The Other Aging of America: The Increasing Dominance of Older Firms by economists Ian Hathaway and Robert Litan. “Like the population, the business sector of the U.S. economy is aging,” write the authors in their summary. “Our research shows a secular increase in the share of economic activity occurring in older firms - a trend that has occurred in every state and metropolitan area, in every firm size category, and in each broad industrial sector.” It’s not clear why this is happening, but “whatever the reason, it has become increasingly advantageous to be an incumbent, particularly an entrenched one, and less advantageous to be a new entrant.”
The authors explored the causes of the rising economic activity of older firms by analyzing business data from the US Census Bureau. They uncovered that new firm formation has been declining across the board since the late 1970s. Fewer new firms each year means fewer young- and medium-aged firms over the years, leading to an overall decline in entrepreneurship.
In addition, business failure rates have steadily increased for all except mature firms, - those 16 years or older, - whose failure rates have been flat for the past 20 years. Failure rates have been particularly high for early-stage firms, especially since the 2000 dot-com crash.
Thus, the aging of the firm seems to be the result of the declining formation of new firms combined with the increasing failure rates of younger firms.
Should we be concerned by this shift of economic activity toward older firms? Yes, say the authors: “an economy that is saturated with older firms is one that is likely to be less flexible, and potentially less productive and less innovative than an economy with a higher percentage of new and young firms.”
Another recent paper, The Role of Entrepreneurship in US Job Creation and Economic Dynamism, explored the contribution of startups to job creation. The paper was co-authored by economists from the University of Maryland and the US Census Bureau, and was also based on Census Bureau business data. Their analysis showed that startups and young firms are fundamental to job creation and productivity growth, and a major part of the creative destruction process that reallocates productive resources across firms in a dynamic economic environment.
Most startups fail, and even among those that survive, many remain small, providing employment for the entrepreneur and a few others, often family members. But, a small fraction of young firms will exhibit very high growth and contribute substantially to job creation. The authors note that when people discuss the importance of entrepreneurs in job creation and productivity growth, it’s this small fraction of transformational entrepreneurs that they have in mind. In addition, these high growth startups have a higher innovation intensity than mature firms as measured by the ratio of R&D spending to sales.
Their calculations confirm that startup rates, - i.e., the number of new firms divided by the total number of firms, - have been declining. The annual startup rate was 12.0% in the late 1980s, went down to 10.6% just before the 2007 Great Recession, and then fell sharply below 8%. This was true in all major sectors of the economy, with the exception of the high-tech sector whose decline started after the dot-com crash.
While the yearly numbers might seem small, their aggregate impact adds up over time. In the late 1980s, 47% of all firms were 5 years or less. The percentage of these young firms declined to 39% in the mid 2000s, and has since continued its downward trend. Their share of employment has similarly declined, from 18.9% in the late 1980s to around 13.4% before the Great Recession. Finally, these young firms contributed 39% of all new jobs in the late 1980s, but only 33% by the mid 2000s.
“The decline in the startup rate, coupled with the rising share of mature firms in the economy, is especially disturbing because new firms rather than existing ones have accounted for a disproportionate share of disruptive and thus highly productivity enhancing innovations in the past - the automobile, the airplane, the computer and personal computer, air conditioning, and Internet search, to name just a few,” write Hathaway and Litan in The Other Aging of America. “If we want a vibrant, rapidly growing economy in the future, we must find ways to encourage and make room for the startups of the future that will commercialize similarly influential innovations.”
No one is quite sure what has caused this entrepreneurship decline or what to do about it. In an earlier paper, Hathaway and Litan offered some policy suggestions to help foster entrepreneurship and reverse its decline:
- “Expand the numbers of immigrant entrepreneurs granted permanent work visas to enter and remain in the US;”
- “Allow foreign graduates of US schools who concentrate in the STEM fields to remain in the US to work for other enterprises, especially given the historical pattern indicating that immigrants are twice as likely to launch businesses as native-born Americans;”
- “At the state and local level, governments, educational institutions, entrepreneurs, investors and foundations should continue to experiment with ways to encourage new business formation. The increasing popularity of business accelerators throughout the country is a welcome development that should be nurtured.”
“Finally, policy makers, citizens, owners, employers and entrepreneurs must not be afraid of dynamism, or change, even though it can be unsettling for a time. To paraphrase President Clinton, we must make change our friend, because to resist it is to settle not only for the status quo, but in a world in which other countries and citizens are improving their skills, products and services, the failure to change will only ensure continued decline.”