More on the Decline of Start-Ups

by Dave Schuler on June 26, 2014

Writing at the Wall Street Journal Edward C. Prescott And Lee E. Ohanian revisit a problem I’ve remarked on here from time to time—the decline in the rate of new company formation in the United States:

Virtually every state has suffered a drop in startups, which suggests that this is a national, and not a regional or state, problem. It may not be surprising that states hit hard by the recession, such as Arizona, California and Nevada, have a 25% to 35% lower rate of startups. But the startup rate in such business-friendly states as Tennessee, Texas and Utah is also down substantially, and in some cases exceeds the declines in the states that suffered most during the recession. Even North Dakota, which has benefited enormously from oil and gas fracking, has a startup rate lower than in the 1980s.

These numbers are likely to underestimate the decline in new business formation, because they do not count changes in the pace of new ideas and new business activity in existing establishments. The fact that the economy has been weak since 2007 suggests that new business activity has also declined in existing companies.

New businesses are critical for the U.S. economy to grow because a small fraction of today’s startups will become tomorrow’s economic heavyweights. Most of today’s workers are employed at older, established businesses, but the country cannot rely on existing companies to boost the economy. Businesses have a life cycle, in which even the largest and most successful reach a stage at which they stop expanding.

Here’s their analysis:

There are clear solutions to these problems. Immigration reform that increases the pool of skilled workers and potential new entrepreneurs. Tax reform that reduces and equalizes marginal tax rates on capital income, including reducing the corporate income tax, which currently exceeds 40% in some states. Reforming Dodd-Frank to make it easier and cheaper for small business to obtain loans. Reducing the regulatory burden on all businesses.

Something we should keep in mind is that there was, paradoxically, an enormous amount of new business formation during the Great Depression of the 1930s. I think we should entertain the possibility that measures we’re taking to prevent existing business from failing are also preventing new businesses from starting. That’s something too infrequently considered: established businesses that are able to mobilize government intervention will inevitably do so to beat down upstarts. There was an example in the news just this week. The Supreme Court has ruled against Aereo on intellectual property grounds. Whatever you think of the television network, Aereo, or intellectual property that’s a clear example of harnessing the power of government to prevent competition. Do enough of that and you’ll reduce the appetite for risk that is the definition of entrepeneurial activity and you’ll have a lot fewer business start-ups.

I also think that globalization is putting a damper on new business formation here. New businesses don’t grow out of nothing. The more manufacturing we send offshore, the more production engineering we send offshore. The more production engineering we send offshore, the more design engineering we send offshore. Historically, production engineering and design engineering are the soil from which a lot of start-up companies have grown.

{ 8 comments… read them below or add one }

... June 26, 2014 at 2:24 pm

“Here’s our Rx: let’s reform immigration policies to drive down middle class wages while reforming tax laws to help the financiers.”

Sounds like a winner!

Dave Schuler June 26, 2014 at 2:32 pm

I thought you might notice that.

The problem that goes unmentioned is that not all immigration is created equal and the overwhelming preponderance of our immigration is by low- and no-skill economic migrants who push wages down in any number of ways and probably aren’t starting a lot of businesses that employ people.

It might be that somewhere, somehow there’s a politician who’s arguing that we should increase visas for skilled workers and increase workplace enforcement to discourage illegals but that person is, shall we say, maintaining a low profile.

... June 26, 2014 at 2:44 pm

I bring it up as it is the most obvious way in which the elites are trying to screw the middle and working classes.

If we need more professionals in STEM fields, why aren’t the wages in those fields climbing rapidly? As it is I know of companies that are looking to offshore their engineering to the third world solely to reduce costs. This for companies looking to do projects in the USA with all the engineering done in Bangalore. These are mature companies, fully staffed, and not looking to grow, but just looking to cut wages. Guess who stands to benefit?

One of the more subtle ways is how larger businesses try to screw upstarts via government, which you brought up.

Ben Wolf June 26, 2014 at 4:35 pm

Every solution offered in the article is a supply-side approach, in an environment which presents little evidence of supply-side constraint. We’ve kept on this track for six years now for little result. Do we ever show a spine and try something different or shall we keep telling ourselves There Is No Alternative as the WSJ insists?

I can guarantee that when another round of such measures fails the same people will be calling for more immigration and top-bracket tax cuts as the solution.

steve June 26, 2014 at 7:48 pm

Why would top bracket tax cuts work when states with lower tax rates arent doing better than ones with higher rates in getting new businesses started/

Steve

Guarneri June 27, 2014 at 9:29 am

Private equity guy here. I’m playing too much golf these days. More substantial comment later. Folks only foolish capital is hyperactive right now. Think of that what you want.

... June 27, 2014 at 10:45 am

But do you do start-ups, Drew, or buy and “fix” existing companies?

michael reynolds June 27, 2014 at 7:56 pm

Steve:

Indeed. California’s tax rate is 8.84%. Nevada’s is zero. So Nevada is doing great? No. Unemployment in Nevada is slightly higher than in CA. Idaho has a corp. tax rate of 7.4% and unemployment at 5% while Wyoming next door has no corporate taxes and essentially identical unemployment at 4.6%.

This is just another exploded right-wing talking point.

In related news, Californians polled are increasingly optimistic about our state. The numbers are no longer upside down. This despite the income tax increases that were predicted to drive business out of the state.

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