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Sunday, June 29, 2014

Drag on startups is drag on the economy

We know that entrepreneurs are essential to economic growth in the U.S., but two economists (one of them Nobel) brought this point home last week:
Behind the Productivity Plunge: Fewer Startups
By Edward C. Prescott and Lee H. Ohanian

In the first quarter of 2014 … [productivity] declined at a 3.5% annual rate. This is the worst productivity statistic since 1990. And productivity since 2005 has declined by more than 8% relative to its long-run trend. This means that business output is nearly $1 trillion less today than what it would be had productivity continued to grow at its average rate of about 2.5% per year.

…In our view, an important factor contributing to declining productivity growth is the large decline in the creation of new businesses. The creation rate of new businesses, as well as new plants built by existing firms, was about 30% lower in 2011 … compared with the annual average rate for the 1980s.

If history is any indication, many of today's economic heavyweights will ultimately decline as new businesses take their place. Research by the Kaufman Foundation shows that only about half of the 1995 Fortune 500 firms remained on the list in 2010.

Startups also have declined in high technology. John Haltiwanger of the University of Maryland reports that there are fewer startups in high technology and information-processing since 2000, as well as fewer high-growth startups—annual employment growth of more than 25%—across all sectors. Even more troubling is that the smaller number of high-growth startups is not growing as quickly as in the past.
The authors (economists from Arizona State and UCLA respectively) attribute this to the regulatory drag on small business, both in terms of raising the cost of doing business and specifically the complexity of tax compliance.

However, another explanation (which I blogged last year) was the risk aversion of would-be entrepreneurs. Is that due to regulation? Due to a belief that the system is rigged? To the challenges of starting a company in an economy that never fully recovered from the Great Recession? Or — more simply — a loss of optimism by entrepreneurs that they can financially recover if their venture is unsuccessful.

I don’t have an answer, but this is just further evidence that making the US economy more startup-friendly is essential the country’s economic and political future.

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