Small Business Crisis Point

We have a growing problem in the US that directly contributes to the rise in inequality. We have fewer and fewer new small businesses. Until we reverse this trend, inequity will rise.

A severe decline in national business dynamism contributes detrimentally to overall economic inequality in the US economy. The fall of small business churn has reached crisis levels.

Business ‘dynamics’ are the process of business birth, growth, decline and exit. The economy relies on the full cycle to continue to be productive, healthy, and innovative. New, high growth firms account for the greatest job and revenue growth.

Dynamism, principally small firm growth, has been declining for 30 years, and since 2000 labor mobility has coupled with it in a faster, downward spiral. This is a vicious cycle, as small firms create the most new jobs locally and nationally. Simultaneously, robust labor market options with churn in the job market are necessary to help entrepreneurs to take a risk, knowing they can return to the labor force easily if the venture fails.

Local jurisdictions must act to support local economies. Jurisdictions must do this by 1) supporting many more new start up firms through training and technical assistance, 2) reducing regulatory barriers to entry, 3) intelligently subsidizing the highest costs of all new ventures such as rent, and 4) buffering the risk of starting a new venture through better capital underwriting support.

DISTINCTIONS

There are important distinctions about what it means to start a new firm, and which firms are critical to creating an economy with high yield, equitable growth. The key is to have the right environment to incentivize a broad base of traditional start up firms that is actively churning, which in turn creates the opportunities needed for transformational, high-growth firms to start an flourish.

1. New establishments from existing firms are not the same as new firms.
2. Startups that are traditional business models, standard “Mom & Pop” endeavors, are needed to fuel the entrepreneurial and labor mobility ecosystem, but they are not the same as transformational startups with high growth potential.
3. High growth start ups may overlap with, but are not strictly synonymous with, “high valuation” start ups that are quickly bought up by bigger firms. Acquisition of high growth firms stunts the ecosystem by removing the benefits these transformational firms can offer for a local economy and for jobs.
4. High growth, transformational firms are hard to come by, and they are hard to support. They are quickly harmed by anti-competitive practices in the market place, which include activities like:

• existing firms of any size monopolizing a market through regulatory capture

• a lack of regulatory reworking to accept and support innovative business models

• being quickly acquired to limit their market potential to change markets and add jobs

IMPORTANCE OF LABOR & STANDARD START UPS

New firm creation is also deeply harmed by rigidity in the labor market and a lack of options for entrepreneurs to fall back on should a new venture fail. Rigidity means that workers lack mobility.

Entrepreneurs take big personal risks to start a new venture. Many would-be entrepreneurs need to feel confident that they can successfully reenter the labor market if their venture fails, and more than half of new ventures do fail. If the labor market is rigid, meaning that workers are not changing jobs and there are fewer job openings at any time, would-be entrepreneurs may be reluctant to step out.

The impact of a rigid labor market has compounding impacts. Fewer would be entrepreneurs start ventures, which in turn further tightens the labor market because fewer new firms form to offer new jobs. This tightens the labor market even more, and drives down wages as the negotiation that new hires engage in is a key driver of wage growth. Even with high employment, the economy stagnates.

SIMPLY PUT

To create a robust local labor market full of opportunities, good wages, and inclusiveness, jurisdictions must invest deeply and intelligently in small business.

It is not only that small business ‘supports’ jobs and the tax base.

New small businesses are the key to economic growth and sustainability across all sectors of the economy.

To jump start local economies and to overturn a troubling national trend, jurisdictions must realize that we need a groundswell of new small business.

Only a regulatory and investment redesign will overcome one of the key economic challenges of our time.

RESEARCH SUMMARY

The Secular Decline in Business Dynamism in the U.S.

Ryan A. Decker, John Haltiwanger, Ron S. Jarmin, and Javier Miranda, University of Maryland and NBER, U.S. Census Bureau, July 2014. (http://econweb.umd.edu/~haltiwan/DHJM_6_2_2014.pdf)

Seminal finding, business starts are down. “Recent work shows that a critical factor in the decreasing pace of business dynamics is a declining business startup rate and the associated decreasing role of dynamic young businesses in the economy. Young businesses exhibit a higher pace of both job creation and destruction, so the declining share of young businesses helps account for the declining pace of measures of business dynamism.”

ECONOMIC REPORT OF THE PRESIDENT Together With THE ANNUAL REPORT of the COUNCIL OF ECONOMIC ADVISERS

Transmitted to the Congress February 2016. (https://www.whitehouse.gov/sites/default/files/docs/ERP_2016_Book_Complete%20JA.pdf)

Regulations and licensing form barriers that have led to decreased business dynamism. “A partial explanation is that barriers to entry have increased in many industries. For some industries, these barriers could be in the form of occupational licenses (see Box 5–2 on Occupational Licensing). In other cases, these barriers could be in the form of Federal, State, or local licenses or permits.”

Fewer new entrants reduce the innovation and growth of existing firms. “Moreover, absent entry or threat of entry by startups, incumbents in these concentrated industries have less incentive to innovate, leading to lower productivity growth in the long run.”

Declining Business Dynamism in the United States: A Look at States and Metros.

Ian Hathaway and Robert E. Litan, The Brookings Institution, 2014. (https://www.brookings.edu/wp-content/uploads/2016/06/ declining_business_dynamism_hathaway_litan.pdf)

Concluding that the 30 year decline is geographically universal. “[D]dynamism has declined in all fifty states and in all but a handful of the more than three hundred and sixty U.S. metropolitan areas during the last three decades.”

Declining Entrepreneurship, Labor Mobility, and Business Dynamism: A Demand-Side Approach

Konczal, Mike and Steinbaum, Marshall, Roosevelt Institute, July 2016. (http://rooseveltinstitute.org/wp-content/uploads/2016/07/Declining-Entrepreneurship-Labor-Mobility-and-Business-Dynamism-A-Demand-Side-Approach.pdf)

Highlighting:

Finding, both labor mobility and entrepreneurship have declined since 2000. “The erosion in labor mobility and entrepreneurship since 2000 can be [] explained by weak demand, especially during the slow recovery from the two previous recessions.”

Arguing, rigidity in the labor market reduces entrepreneurship through heightened risk. “[T]he decline in mobility, dynamism, and entrepreneurship is a result of declining labor demand since 2000. When it is hard to find another job, employed workers stay at the jobs they have, impairing their ascent up the job ladder and the accompanying wage growth over careers that historically led to the middle class. Declining entrepreneurship can also be explained by workers’ reluctance to leave large, stable incumbents to start their own firm or to work at a start-up when they cannot be assured that they will be able to return to a more stable job. Thus, we find that the concentration of employment in old firms and in large firms mirrors the timing of declining labor mobility due to declining demand.”

Declining US business dynamism: It’s for real, and it’s spectacular. I mean, spectacularly worrisome

Pethokoukis, James, American Enterprise Institute, May 2014. (https://www.aei.org/publication/declining-us-business-dynamism-its-for-real-and-its- spectacular-i-mean-spectacularly-worrisome/)

Highlighting:

Problem, small firms lack resources and face regulatory barriers. “Younger, smaller firms do not have the resources that larger, more established firms do to hire full-time attorneys or compliance officers, which should put them at a progressively larger competitive disadvantage as regulations continue to grow in number and complexity.”

Solution, remove barriers to entry and stop favoring incumbents with subsidies.

“Governments can encourage this by minimizing the barriers to entry and exit in an industry, opening their markets to trade, repealing subsidies and regulations that favor incumbents, and breaking up monopolies.”

“America Without Entrepreneurs: The Consequences of Dwindling StartupActivity”

John W. Lettieri, Economic Innovation Group, Testimony before The Committee on Small Business and Entrepreneurship United States Senate, June 29, 2016. (http://www.sbc.senate.gov/public/?a=Files.Serve&File_id=0D8D1A51-EE1D-4F83-B740–515E46E861DC)

Arguing, the impact of reduced dynamism is wide-ranging. “Americans today are also less likely to move to new areas of the country. They are less likely to switch jobs. The average company is rapidly getting older. Industry sectors are seeing widespread consolidation. Historically, the churn caused by a steady influx of new businesses has acted as a kind of shock absorber for our economy. This is no longer the case. Even as the global economy has undergone massive transformations driven by technology and globalization, the U.S. economy is rapidly becoming less flexible, less able to adapt, and less efficient at allocating resources — including its most precious resource: human capital.”

Noting, we still have the infrastructure for entrepreneurship. “ We are home to the world’s leading university and research system that has long served as a cradle for gamechanging innovations. We own the majority share of global angel and venture capital. We are a magnet for the world’s top talent. We have a historic tolerance for entrepreneurial risktaking. And the United States remains home to the world’s most dynamic clusters of innovation. The right policy decisions and the right leadership can help us rediscover the broader economic dynamism that defined our nation throughout the 20th century.”

Finding, the geography of startup activity has become highly concentrated, and DC is left out.

“[T]he geography of new business formation was highly concentrated in a few elite hubs following the Great Recession. Half of the entire net rise in business establishments in the United States from 2010 to 2014 was contained in only 20 counties — despite the fact they were home to only 17 percent of the nation’s population.4 Furthermore, 17 of these 20 super- performing counties were found in just four states: California, Florida, New York, and Texas.

There is significantly more research on this topic that has been conducted over the past 5–10 years, which can be compiled and analyzed as needed. Above are a few key highlights.