Economics, Pethokoukis

Are we suffocating entrepreneurs and ‘Start-up America?’

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There are nearly 5 million small businesses in America, firms with less than 500 employees. On average, they employ 11 workers each and produce $1 million of output annually. They account for 60% of job creation, and nearly half of all employment and economic output.

But, says Citigroup, “the US small-firm sector is under substantial stress.” Small firm employment has declined about 20% relative to large firm employment versus its peak in the mid-1980s — including a 10% drop since the late 1990s. And the small-firm share of output produced by the private sector has declined to 45% in 2010 versus 50% in 1998. And, as the chart at the top shows, the birth rate of new small firms – the number created in a given year relative to the total number of such firms – has fallen to around 8% vs. 10% before the financial crisis and 12% in the 1980s

Some of the decline can be blamed on short-term reasons. Small firms make up a good chunk of the construction and real estate sectors, both hard hit by the Great Recession and Not-So-Great Recovery. But longer-term, structural issues also play a role. Citigroup:

First, large firms account for the lion’s share of U.S. exports and, as such, have been better positioned to benefit from the rapid growth of emerging market economies and globalization trends more generally. Consistent with this observation, we find that a depreciation of the dollar systematically raises large-firm employment relative to that of small firms.

Second, we find that large firms tend to be in more capital-intensive industries, which means that these firms have likely benefited more directly from the decline in interest rates that has occurred over the past thirty years.

A third structural headwind appears to have been the ongoing consolidation of the U.S. banking system. This has brought with it a declining role for small banks, which traditionally have been major suppliers of credit to small firms. Our sense is that such structural forces are likely to continue to favor large firms for some time to come.

The requirements of the new healthcare law may prove to be another structural headwind for the small-firm sector.

From a public policy perspective, the key would be to focus on entrepreneurship and the expansion of young firms — they’re the engine of job growth — rather than small firms in general. Indeed, research from the Kauffman Foundation finds that the fastest-growing 1% of firms typically account for about 40% of US job creation. And of that group, three-quarters are less than six years old.

Given the Citigroup findings, an entrepreneurship agenda might include a) a less concentrated banking system and b) getting business out of the health care business through consumer-driven reform. Beyond that, perhaps eliminating capital gains taxes on long-term investments and creating a more-skilled workforce. NGDP level targeting might also play a role, as Evan Soltas argues:

Economists believe that firms in the United States are risk-averse, and that’s not a bad thing in itself, but it does imply that nominal instability has real costs in the long run. In other words, if the economy is constantly swinging from boom to bust in NGDP, then if I run a business, I won’t invest as much as I would have if the economy grew with more stability, because I am afraid that if I invest (say, I open a new storefront) and a recession comes, then my investment will lose value. Now expand this consideration of one firm to the entire economy: when NGDP growth is unstable, firms make fewer investments — factories buy fewer machines, merchants open fewer stores, companies hire and train fewer employees, etc. — and what this means is that, in the long run, the economy grows more slowly because productivity increases more slowly. Alternatively, stable NGDP growth, which would be achieved by targeting NGDP, could increase the rate of long-run real growth because of the tendency of firms toward risk aversion when they invest.

More ideas welcome.

2 thoughts on “Are we suffocating entrepreneurs and ‘Start-up America?’

  1. There are several available fiscal tools that the FED and governments could apply in addition to interest rates and money supply if NGDP (or unemployment rates) were targeted. Investment incentives such as bonus depreciation, accelerated depreciation and investment tax credits are proven economic stimulants. The domestic producers credit is also good for small manufacturers which tend to be capital intensive and may not benefit proportionately to large companies from export incentives.

    R&D and hiring credits help also. Technology and capital make workers more productive – this is a robust path towards higher wages. Companies with profitable opportunities invest capital which increases demand for labor which drives up market wages – a driver of inflation. Higher productivity offsets higher wages relieving inflation and increasing global competitiveness.

    A major problem with all of these incentives is that they are uncertain from year to year. Capital intensive small businesses need to plan over a longer term than one and two year tax programs have offered. If, for example, bonus depreciation were to be structured at 20-30% permanently and raised to ten times the unemployment rate for the current year (8% unemployment = 80% BD) with a maximum drop of 20% per year, many companies would establish longer term capital investment plans.

    Bonus/accelerated depreciation is particularly virtuous as it scores neutral over ten years of public budgeting without dynamic effects counted. With economic impacts set against the cost of a few years of public debt it is very positive.

    If the FED and govt bodies were able to work together to authorize these incentives with less reliance on the conventional political brokering we might see them applied more smoothly and less porkedly (Solyndra).

    Perhaps a model where congress allows the fed to propose a package of business stimulants that can be voted up or down by congress with minimal amendment.

  2. A link to the Citi study might be nice. I suspect it would say, as the NFIB did in its current survey, that it’s the economy, stupid.

    ” Overall, this is a poisonous climate for investment and expansion. Twenty-three (23) percent of owners still cite weak sales as their top business problem; this is historically high but down from the record 34 percent reading last reached in March 2010. The net percent of owners expecting higher real sales fell 8 points to a negative five percent of all owners (seasonally adjusted), 17 points below the 2012 high of net 12 percent reached in February. Not seasonally adjusted, 19 percent expect improvement over the next three months (down 6 points) and 43 percent expect declines (up 9 points). The percent of owners planning capital outlays in the next three to six months fell 3 points to 19 percent. Six percent of owners characterized the current period as a good time to expand facilities (down 1). This compares to 14 percent of owners who felt positive about expansion in September 2007.”

    http://www.nfib.com/research-foundation/surveys/small-business-economic-trends

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