Where are the start-ups?

November 3, 2014

The entrepreneurship rate, defined as the number of new firms in a given year as a share of all firms, has been in persistent decline for decades (15% in the late 1970’s, 8% in 2012).  It has been punctuated by tech surges – but those decline after a time lag (e.g., the dotcom boom/bust).  However one defines high-growth firms, their share of the economy is declining.  So argues this excellent AEI podcast about job creation, innovation, productivity, and national wealth.

High profile firms such as Google and Facebook (hardly start-ups, anymore) enjoy outsized awareness because they’re personal and omnipresent, and belie the fact that the data show declining business dynamism overall and for start-ups specifically.  No one knows at the outset which high growth firms will explode and disrupt – so we need “more shots on goal.”

As we once wrote:

There’s a heroic assumption propping up that line of thinking:  that there will always be a nicely growing economy, with plenty of opportunity, and no shortage of entrepreneurs.  We believe it is not safe to assume that entrepreneurs will continue to risk their wealth and careers, expend the energy, and make the enormous sacrifices required to build a business no matter how big a bite the taxman takes out of their eventual reward.  It’s fine to say investors will look for the best opportunity regardless, but if there are fewer entrepreneurs there will be fewer opportunities, and the economic pie will start to shrink…

“Terrific” ideas will still find willing investors, but what about all the not-obviously-terrific-but-still-really-good ideas?  For every Facebook there are hundreds of other early-stage companies who receive financial backing and grow nicely…  The economy is not built on a series of towering home runs that clear the fence no matter how strong the wind is blowing into the park.  Winning takes singles, doubles, walks, anything that advances runners and scores runs.  Over-regulating (or over-taxing) early-stage investment activity is like building a pitcher-friendly park and keeping the infield grass long:  you better plan on low-scoring games.

Hathaway believes over-regulation is a significant problem; particularly, how specific regulations impede firm entry and protect incumbents.  What we said in our response to a WSJ editorial about tax rates and early-stage investing is equally true of regulations:

[Large companies like] Costco may grow more slowly but will weather whatever tax regime is in place. However, small private companies (who create virtually all the new jobs in the country) lack a large company’s ability to shift income and lobby Washington, and they won’t fare so well.

(UPDATE:  As if on cue… today’s WSJ reports that Google has just become the country’s biggest political donor, knocking off heavily-regulated Goldman Sachs. – ed)

He also spends some time on the importance of the entrepreneurial ecosystem, the “networks and community, the dark matter, the softer things.”

The bottom line, whether it’s taxes, regulation, or institution-building:  some forms of activity promote economic growth and ought to be encouraged.

The entire wide-ranging podcast is worth a listen.  A few other well-said points:

  • The economy needs more than a narrow rebound in tech entrepreneurship, especially since the current rebound has been accompanied by an uptick in “hardening” or consolidation as early firms are gobbled up before they boom.
  • Using job creation as a measure is problematic because fewer people work for Twitter or Facebook than their previous equivalents – by the nature of what they produce.  Michael Spence divides the US economy between the one that competes globally vs. the local market (tradeable vs. non-tradeable).  The former generates national wealth but will employ fewer and fewer people;  however, that’s what sprinkles money around the non-tradeable localities.  “Not everyone can work at Google or Apple.”
  • Innovation can be costly for individuals and firms in the short run, but is the key to wealth in the long run.  E.g., productivity enhancements in low-tech/low-wage firms, consolidation that drives out less efficient mom&pops, and innovation that pushes stale incumbents out.

 

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