What’s Wrong with the Economy, Part 3: Where Have All the Startups Gone?

July 22nd, 2011 at 10:25 am

Another challenge we’re facing on the jobs front is the lack of enough startups.  Good research, like this, reveals their importance to job creation, especially coming out of a downturn.

Startups are like experiments growing cell cultures in a test tube—many will fail, but among the minority that succeed, some will take off and give employment growth a critical boost at times like the present.  But if our lab (i.e., labor market) has too few test tubes, even if the same share were to succeed, they won’t contribute the raw numbers we need.

The figure shows job creation (it’s employment at these small businesses divided by total employment) for establishment openings at small businesses that employ 10-19 people.  It’s an arbitrary size, but I looked at all the small biz start-ups and they all show the same trend.  (Data nerds: this is from the very useful Business Employment Dynamics series from the BLS—openings aren’t exactly start-ups, but they’re very close (they include some seasonal businesses)).

Two points: first, openings are at historically low levels, and that’s hurting us in the sense explained above.  Second, it’s a long-term trend that began in the 2000s, and if anything, has flattened in recent years.

This last point is very important because we hear a lot of nonsense about how uncertainty, taxes, regulation, yada-yada, in current policy is keeping entrepreneurs from getting in the game.  So, um…how do you explain the Bush years?

What is holding back the startups?  Interestingly, my favorite explanation–demand–isn’t obvious given the long, negative trend.

Fact is, we don’t know.  Another way to ask the question is, “what’s holding back dynamism?”

I’ve got some hypotheses.  It may be financialization—the big money to be made in the 2000s was in financial markets and feeding the financing of the housing bubble.  It could be my bias, but shifting money around through the invention of exotic financial engineering doesn’t seem particularly dynamic in any lasting sense.  This would help explain why the 2000s looked worse than the 1990s.

Also, excessive wealth concentration may lower the potential returns to new entrepreneurial initiatives as the winner’s circle is diminishingly small.  If so, an economy like ours with such high levels of inequality could dampen dynamism.  Of course, this could go the other way—if the reward to making it to the top 0.1% of the wealth scale is huge, the incentive to try is that much greater.

Finally, while demand isn’t an obvious explanation, it may be the right one.  Though inequality increased in both the 1990s and the 2000s, the middle class and poor did MUCH better in the 1990s.  And so, demand was much more broad-based.  This meant a lot more sales not just at Nordstrom’s and Walmart (the top and bottom) but everywhere else as well, and that’s a much better climate for startups.

[Note: From the abstract of the paper linked to above: “our main finding is that once we control for firm age there is no systematic relationship between firm size and [job] growth.”  So maybe our employment and tax policies should stop kissing small-business butt so much.]

Source: BLS

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16 comments in reply to "What’s Wrong with the Economy, Part 3: Where Have All the Startups Gone?"

  1. jonathan says:

    First, you really should look at the type on your blog: serif font with a sans serif body is ugly. This is easy to change.

    My feeling is that we do have startups, lots of them, but they don’t create jobs as they did because any modern startup outsources nearly everything and certainly manufacturing. Look at kickstarter projects: come up an idea, like one I’ve backed for a couple of clips to unite my iPad and Apple wireless keyboard. Injection molded plastic that is easily prototyped with the old machine shop issues, likely done in China. To stay with Apple products, the iPod and now the iPad became huge businesses that spurred lots of startups. But they come up with a product and that is made in China or Malaysia or India, etc.

    And then lots of brainpower did move into finance and a lot also moved into virtual goods. Facebook has lots of employees but nothing on the scale of a decent sized industrial corporation. Software companies can be shockingly small given the advances in operating systems. The obvious one is app development, which can be a person or a handful, because now you tie your parts to extremely sophisticated API’s that do so much of what you had to worry about before.

    And of course the GOP approach has been to surrender or run hard away from any hint of investment in actual industrial products that we need. We are nowhere near the world leaders in producing green technology, nor bridges – the Big Dig in Boston used a variety of techniques developed in Europe and Asia – nor even hot water heaters. We actually pay our companies to move jobs overseas through the tax code. It’s not just jobs, but they move the manufacturing investment and know-how overseas. It then develops there instead of here so we import bridge parts. It isn’t as simple as saying they can make it cheaper but our industry has little chance to compete because they don’t get the investment put in that would allow them to add sufficient value to be competitive. The Germans, of course, do the opposite, which is why a country with 1/4 our GDP is the world’s export leader.

    The car industry should have been a wake up call some decades ago: autos created more wealth for more people than any other industry and we watched as other countries built their industries – to generate wealth for their people, taking it away from ours. We then blamed GM for falling behind when they were merely a symptom, really a harbinger of our fall. The GOP reaction is senseless: try to compete on cost with countries that have significantly lower standards of living. Germany, again, was smart enough to realize that was dumb.

    I’m reminded of a 1942 article on Ford’s transition to war production. They were given access to a German tank and realized it was craft built. They knew immediately we could outproduce them. (And we bombed heavily in part because our war planners believed we could disrupt craft production more easily than US style mass production.) We cling to this past. Modern manufacturing, even for cars, is about craft building on a larger scale. We have not adapted well and the GOP, for reasons genuinely hard to understand, stands opposed to the necessary change.


  2. Chris says:

    What about health care costs?

    As the cost of health care rises, people are less likely to give up a stable job with health insurance in order to strike out on their own.


  3. Rich C says:

    You should check out David Litan’s work at the Kauffman Institute; he makes a finacialization argument, but its not just about the attractive nuisance of high returns to speculation. He points out a number of changes in the structure of equity markets immediately after the end of the 1990s stock bubble that have made it much more difficult for entrepreneurs to take a company to an IPO (including the acquisition of IPO specialist investment banks by the big wall street banks, the emergence of small cap indexed ETFs, and the disappearance of analyst firms covering the small cap space), which has negative consequences down the line for start ups.


  4. comma1 says:

    Certainly financialization has something to do with it. One doesn’t need to be a genius to see two overlapping consecutive bubbles in a row are likely connected (tech, RE). IF for no other reason than it shows the market is becoming “trendy.” This new phenomenon of financial “trends” (like fashion), seems to create investments in only one “trendy” area at a time — tech, then RE, then tech (but only if a social network). This “trendy-ness” is made worse by your second point. The concentration of wealth in the hands of a few, would by my logic, necessitate less innovation but when combined with “trends” would create even less.

    After all, if there are ten investors in the world they may pick ten different places to put their money (energy, RE, tech, widgets, etc.) — maybe only 1 in 10 is successful. If there are five investors in the world, they are likely to put their money in only five places. Keeping the same 1 in 10 success ratio, suggests the number of start ups and successes would thus be lower. This means that even if the same number of innovators are around, they are vying for fewer investors, creating fewer start-ups, fewer successes, and fewer jobs. When the investors are “trendy” then they are looking at only start ups in particular fields, ignoring other fields and so success is diminished further.

    Information is also problematic. Certainly we are seeing an information problem here too. We are seeing the consequences of poor math and science education over the past decades. I would also guess we are seeing the results of over eduction too. With the indentured servitude of college grads via college loans (w/out any financial rewards for that education) weighing on many of the young today, they don’t have the ability to take a risk. Furthermore, they don’t have the ability to learn new material because they financially can’t afford more education, due to the student debt they already hold.

    Lastly, technology. Technological innovation (meaning the internet) has crushed a number of industries. That might also suggest that start-ups would begin to fall after 2000. After all, there are a number of industries that aren’t around today (or are declining) because technology has unseated or demonetized them. For instance, blogs overtaking magazines. What was once a job producing industry (magazines or journalism), and thus a place capable of creating start ups, has been replaced with an unpaid hobby or just more duties for otherwise employed people (ie, you). Furthermore, it can create higher startup costs, because now every startup is required to have some form of computer coding involved, which is, thanks to the poor education mentioned above, expensive. So even if there is a journalist who has an idea for a new startup, she can no longer just start one up with zero capital depending on her own hard work, but must instead first hire someone who knows C++.


  5. John says:

    You’re trying, Dr. Bernstein – I’ll give you that. But you’re still in the box; you need to get outside it.

    Startup success rates over relatively short terms are not as good as a coin flip (i.e., less than 50%). I’ve seen estimates of 90% failure rates over the relative short term (a few years).

    So, maybe 1 in 2, maybe 1 in 10, startups will succeed. The startup glass is more empty than full. Kinda like looking for a job when one is out of work these days: 1 posting for every 5 or more applicants. And that’s 1 out of every 5 adults – the other 4 are in the full part of the glass, and they don’t seem to care much about the empty part, even though they might end up there themselves, through no fault of their own.

    Most of capitalism is about gambling on whether or not one can succeed – or more correctly, whether or not one can survive, or for how long.

    Put another way, it’s all an appeal to the gods of the markets.

    Maybe it’s just a metaphor for life. Sigh.

    I prefer not to believe that life needs to be a competitive game; that we could cooperate instead, and I try to live according to that belief.

    We should be learning a lesson from the behaviour of the Republicans these days.

    If there are those who insist on life being a game, who insist on competing and taking advantage for themselves at every imaginable opportunity, then all they have to do is get the game started, and by so doing they force the rest of us to play as well, just so we can survive. Then everyone plays, and everyone ends up thinking that all they can do is play – that there’s no alternative to playing.

    But winners in competitive games don’t play “winner share with losers,” they play “winner take all.” And in that environment, so much for cooperation – it won’t work for being undermined by the winners; and so much for improving the odds of survival for the losers, especially for those who don’t want to treat life as a competition at every moment, who make themselves losers by their beliefs.

    With winner take all, even with perfect competition, anyone can win, but not everyone will win – all but one will lose.

    So the games have to stop, so we can do something else besides play “winner take all” games. So we can cooperate instead.


  6. Susan Moore says:

    I’d like to pose another reason for the lack of start-ups over the last decade. I’m surprised that you did not mention it:

    I think the #1 reason is healthcare. In order to start my own business (and employ others) I would have to come up with about $28,000 per year for a private insurance plan — and that’s just for myself and spouse.

    I know dozens of people who dream of starting their own companies, but don’t dare leave a lousy corporate job with lousy benefits because there is no way they can qualify for — much less afford — any healthcare coverage at all.

    If single-payer were passed today, I would hire 50 people tomorrow. Business plan is in place, financing for the business is in place, but it would mean risking my health and my life to roll the dice without coverage.


  7. AndrewBW says:

    Here she is doing it live on Soul Train:

    http://www.youtube.com/watch?v=wmOX_L1Txb8&feature=fvwrel


  8. AJ_in_VA says:

    Interesting.

    As one who starting a boutique consulting business in 1999 and finally joined a longtime client as a full time employee in 2009, here are some hypotheses in my head.

    First, the thinning middle class with the escalating deterioration of the social safety net, combined with the increased costs of health care for small businesses competing for talent, all may combine to make the risk/reward calculation for startups less attractive.

    If the perceived downside risk of failure is buffered by the perception of a more robust middle class and safety net, then innovation is marginally easier to contemplate.

    Lack of real social visibility for the top of the wealth population may make it relatively harder for would be entrepreneurs to perceive social opportunity and mobility, assuming most of them are from more or less middle class backgrounds with some education and social capital.

    It would be interesting to do a more broad cross-country study of the effects of extreme wealth concentration on entrepreneurship, coupled with a study of the effects if any of types of social safety nets on entrepreneurship. Another way to think about this might be to try to tease out the effects demand side recessions on entrepreneurship, since it’s harder to imagine taking on the risk of building a better mouse trap when existing mouse trap suppliers are seeing weak demand, absent major technological breakthroughs that would confer market advantages sufficient overcome the costs of displacing established brands.

    Then of course, there is so much pro-big business regulation and patent/IP law specifically designed to discourage innovators and start ups, that the risk/reward profile of entrepreneurship is ultimately affected.


  9. Kevin Rica says:

    Let’s let Occam’s razor take a slash at this.

    Start-ups thrive during periods of strong, steady, growing aggregate demand. You don’t need more firms to make more stuff if people aren’t trying to buy more stuff. New businesses need customers.

    China manipulates its exchange rate and takes ours. Then those Americans that would have worked to satisfy those markets cannot afford to be customers themselves and so on. So why start a business when the market is already satisfied?

    Seed that falls on barren soil will not thrive.


    • Jim Edwards says:

      Historically startups are created in recessions. Basically it’s the I’m out of a job so might as well keep busy phenomenon. I don’t think we know how many startups are out there until there is some economic recovery. With tech it’s easy to tinker and keep everything quiet until you are ready to go public. Other startups require business licenses and retail space, etc. My guess is there are tens of thousands of startups in the US right now and in a couple of years there will miraculously be hundreds of new companies. Whose going to tell the unemployment office, “No thanks. I’m working on a project that will make me money one day, maybe.”

      Also, I can speak for India but not for China but I am sure it is the same, Americans have nothing to fear from India regarding innovation. I’m speaking as a whole, not individually. India is not a nation of innovators. That is beaten out of them by a school system that makes everyone rise when the teacher enters the room. It is cut down by a university system where you cannot choose your classes. It is reinforced by a work ethic in which the boss is always right even if he’s wrong and the boss is always a he.

      This is changing and there are many factors in India’s favor such as being able to discuss politics and religion without fear of bloodshed. Acceptance of science as fact unless it can be proven in a peer reviewed process that it is not at which time it becomes fact again and this does not threaten my belief that Hanuman jumped across the sea to help Rama rescue Sita.

      This advantage will disappear, but it hasn’t yet. In China it won’t change until there is free and open exchange of all ideas.


  10. Neildsmith says:

    All the start ups are happening in emerging markets. Do economists still not realize that globalization and “free” trade has decimated the American work force? We can’t compete with government managed and subsidized businesses. Multinational corporations don’t need American workers or American consumers anymore. We really need to just get over it. This is the new normal no matter how many infrastructure projects you fund.


  11. Jim Edwards says:

    I know it’s a sample size of one, but I’ve spent most of my career working at startups or trying to start my own company. I also think it’s important to distinguish between starting a company and going into business for yourself. I found the latter to be very easy but unfulfilling.

    I was working for a small game studio in Seattle when it was bought by Sierra and quickly grew into a huge company called Cendant. I quit and went to a startup in the dot com bubble. At that time getting finance was as easy as handing out a business card. Finance didn’t come with so many strings failure was inevitable. Huge numbers of companies were formed and most of them went under. But, the investors rarely lost money. They pumped and dumped the IPO and walked away with a nice profit and I was off looking for work again.

    I went to a struggling startup in Canada who was bound by its investors so tightly it could not raise any more revenue. We were able to negotiate new terms and got the financing. The company turned around and is still in business today.

    From there I tried to start my own game studio based on new technology. This was now in the early naughties and financing was near impossible to get. Investors were wary of funding a tech startup especially given how much they could make in housing. The terms would have ensured failure.

    I found a startup in India and went there. I managed to get the projects under control and the outlook better. One partner was a major film company and understood the nature of entertainment, but the other was a pure businessman and didn’t understand a game is not a list of features.

    I worked for other startups here and have learned the Indian landscape pretty well. It’s the same here as back in the US. Investors want too much for the money. And why not with real estate doubling every year and call centers being a no brainer business.

    What I can do here that I can’t do in the US is have partners who live with their parents. Live on almost no money. Take no salary. Take what profits we make and hire other talent. Build a company by bootstrapping. Turn down investors. The company is over a year old and is growing steadily. I still take no salary. My partners still live with their parents. We can take the savings and continue to grow. In short it’s a lot like being in College and look how many dorm room companies there are compared to the financial funding model.

    As I see it the barriers to entrepreneurship in the US is funding is very difficult to get, comes with too many strings for too much of the pie, and is a full time job securing and maintaining the relationship. So that’s an MBA I have to share the company with who contributes zero to the product. The US is too expensive and too risky to not have a job.

    A decent safety net would allow people to take greater risks for a longer time making bootstrapping a possibility. Financial regulation lowering the price of money would create incentives for investors to invest in national wealth rather than a fictional bubble. Finally, let all government research be available easily to everybody rather than sold quietly to big companies, many of whom sit on it as it threatens their market share. As one commenter pointed out computer OSs do this to drive development for their platform. The US should do it to drive innovation.


  12. Daniel says:

    SARBANES-OXLEY!!!


  13. Patrick Morris says:

    Why would you start a business when your prospective customers don’t have any money? Even Wal-Mart is in its 9th quarter of declining US revenues, with 10 or 20 million unemployed/under-employed customers. US corporations are sitting on $2 trillion of cash because there’s nowhere to invest it with any reasonable return because consumers don’t have money.

    Companies won’t hire because consumers aren’t spending. Consumers can’t spend because there are not enough jobs.

    The only entity that can break this Catch 22 situation is the US government, through massive hiring for public infrastructure. But the party of Grover Norquist would rather suffer an extended recession than agree to “socialism.”

    If you showed up at the emergency room with chest pains, you’s be pretty irritated if the doctor started lecturing you about diet and exercise. “Yoga’s real good for stress relief,” you hear as you’re grabbing your chest. You’d be asking for CPR, defibrillation, maybe a stent or bypass. Later, when there’s enough blood flow to keep your heart muscle and brain tissue alive, you promise to improve your diet and exercise.

    Our nation is in economic arrest. The loss of our economic lifeblood, jobs, can lead to the death of vital economic organs and tissue such as companies, mortgages, college educations, retirement accounts, infrastructure, and healthcare. All of these things cost far more to rebuild than it would cost to simply maintain them with the CPR of government stimulus.

    (In Iowa, they’re grinding rural roads into gravel, because they can’t afford to maintain them.)

    Jobs fix everything. The economy, the budget deficit, Social Security and Medicare revenues, all would be fixed with enough jobs. It’s vitally important that we simply create jobs. It doesn’t matter how, and no method of job creation is worse than the cost of inaction.


  14. Virgil Bierschwale says:

    I agree with a lot of the comments here.
    Now let me show you why regulations are preventing the real small start ups.

    I’m a software person and have been all of my life holding positions from developer all the way up to project manager.

    Now all of a sudden because I went into the navy instead of college, I am no longer qualified.

    Typically a person like myself would be faced with three options

    1. Software for 100,000
    2. mechanic or small biz owner for 50,000
    3. convenience store or wally world for 15,000

    Option 1 is no longer available.

    So my thoughts are, people will always eat, and maybe it is time to start a bbq/burger joint like you see on diners, drive ins and dives and even though I have 1 acre of land with a couple of outbuildings and two 1,000 gallon septic tanks, I cannot start this up without replacing the septic tanks with some kind of fancy system for an estimated cost of 25,000 to 50,000 or more.

    If it took off, I might employ 5 or more people, but it won’t take off if a small guy has to come up with 100,000 to open the doors knowing full well that the odds are stacked against him to start with.

    And if you think for one instant that I’m going to give up and be forced or driven into option number 3 just because you think thats all I’m qualified for, well you don’t know me.

    So for now, and even though it doesn’t pay the bills, I’m going to keep working on my keep america at work site to see if I can get you educated folks to understand what we are doing to our country and to the world.


    • Kevin Rica says:

      Virgil,

      If there is a regulatory angle, you forgot to mention it. In a tight job market, some employers may have to make do with what is available. While some customers could prefer formal training (sounds like a government contract), others will accept anyone or whoever is cheaper.

      When there are lots of people out one the market and some get left behind, employers can be picky. Only people with college degrees, Mets fans, and Finnish speakers can write cell phone apps.

      It sounds again like a very bad job market.


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