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.