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Stagnation is Stunting Economic Growth

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Stagnation is Stunting Economic Growth

March 28, 2017

The American economy is stagnating. The creative destruction of old businesses exiting and new ones starting up has slowed. Fewer people are working at new companies. These trends have only accelerated post-recession. Many of the fresh new entrants hailed as disruptive startups, such as Uber and Facebook, have been on the scene for a decade or more.

This stagnation reduces the amount of competition and the rate that new ideas are introduced. Economic growth and individual workers both suffer as a result. How much have things slowed down, and can anything reverse it?

Every year since 2008 has seen a lower rate of new firms starting, also referred to as the firm birth rate, than any year before that, according to data from the Census Bureau. This begins at the start of the data series in 1977, and encompasses multiple recessions and periods of economic turmoil. In 2010 the rate of firms exiting, or firm death rate, outpaced the birth rate for the first time on record. While the death rate has recovered to some extent, both remain below historical averages.

Source: United States Census Bureau, Business Dynamic Statistics.

A lower flow of businesses entering and exiting is troubling in any individual year, but the accumulated harm of this trend persisting over time is even worse. The Kauffman Foundation calculates that the density of new companies per 1,000 firms has fallen significantly from 107 a decade ago to 80. If recent trends continue, this density will only deteriorate further in the coming years.

As the Economic Innovation Group (EIG) has shown, this slowdown is not isolated to one industry or sector. The study estimates that 924,000 additional jobs would have been created if the rate of new firm entrances had been the same in 2014 as 2006. The decline in dynamism has corresponded with an increase in market concentration.

In almost half of U.S. industries the four largest firms capture at least 25 percent of the market. In more concentrated industries dominated by incumbents, companies might plausibly turn their attention more towards influencing regulations to exclude new entrants—rather than creating new products. This would make it even harder for newcomers to get a foothold, reducing competition and slowing the spread of new ideas.

Creative destruction has been one of the major ways which new technologies or business models are introduced to the market. This infusion helps the economy grow faster. One recent working paper published by the National Bureau of Economic Research found that 27 percent of growth from 1976 to 1986 could be attributed to creative destruction. This declined to just 19 percent for the period 2003 to 2013. Dynamism is not the only factor influencing growth, but its reduced role is holding the economy back.

The churn of firms exiting and new ones being introduced is also an important driver of job creation. Since 1980 the average share of employment in new firms has been roughly three percent, but this plunged during the recession and remains around two percent.

Source: United States Census Bureau, Business Dynamic Statistics.

These trends can be particularly damaging to people trying to find their way into the labor market. Fewer job openings mean fewer opportunities for people already at risk of not working—young people, workers with lower levels of skill or education, or people coming out of a spell of unemployment. New firms or establishments create jobs at a higher rate than incumbents, providing fresh opportunities for people.

Some of these effects, such as the decline in the rate of firms entering and exiting the market, seem to be happening over a longer time-frame. Are these inevitable changes that policy cannot influence? The variation between states suggests that policy has some influence. In 1980 Connecticut had a higher rate of new firms starting than Texas. While the rate fell steadily in Connecticut, in Texas it remained relatively stable and by 2014 the rate in Texas was 56 percent higher.

A policy framework that encourages investment and reins in regulations that make it harder for businesses to get started could at least attenuate these trends.  Policies that move in the other direction would only exacerbate them. New businesses, and the fresh ideas they bring, have long been a major driving force of the American economy. Our laws and regulations should encourage their formation.

Charles Hughes is a policy analyst at the Manhattan Institute. Follow him on twitter @CharlesHHughes.

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