Pethokoukis, Economics, U.S. Economy

Where are the entrepreneurs? More evidence the very heart of the US economy is failing

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America makes a grievous error if it dismisses the weak economic expansion — this month marks the fourth anniversary of the end of the Great Recession – as nothing more than the expected aftermath of a deep downturn and financial crisis. Sluggish GDP growth and yet another “jobless” recovery point to a secular problem rather than merely cyclical forces at work.

The US entrepreneurial spirit may be faltering. Check out these data points from The Wall Street Journal: a) In 1982, new companies made up roughly half of all US businesses, according to census data. By 2011, they accounted for just over a third; b) from 1982 through 2011, the share of the labor force working at new companies fell to 11% from more than 20%; c) Total venture capital invested in the US fell nearly 10% last year and is still below its prerecession peak, according to PricewaterhouseCoopers.

Credit: The Wall Street Journal

Credit: The Wall Street Journal

New companies are best at creating what business guru Clayton Christensen has termed “empowering innovation” (creating new consumer goods and services) as opposed to process innovation (creating cheaper, more efficient ways to make existing consumer goods and services). Empowering innovation produces new jobs, while efficiency innovation eliminates them, often through automation.

Don’t let Apple and Google and Facebook fool you. Right now, Christensen wrote in The New York Times last year, “efficiency innovations are liberating capital, and in the United States this capital is being reinvested into still more efficiency innovations. In contrast, America is generating many fewer empowering innovations than in the past.”

Not only do we need a vibrant entrepreneurial ecosystem so startups can flourish and generate disruptive innovation, these new entrants raise the competitive intensity for established players to become more innovative. In other words, explains banker and entrepreneur Ashwin Parameswaran, “unless incumbent firms face the threat of failure due to the entry of new firms, product innovation is unlikely to be robust. The role of failure in fostering product innovation has sometimes been called the ‘invisible foot’ of capitalism.” Big business must be subject to maximum competitive intensity.

In the WSJ piece, reporter Ben Casselman offers several possible causes for the decline in risk taking from the aging of the US population to rising health care costs to increased state and local licensing requirements: “One recent study found that roughly 29% of U.S. employees required a government license or certificate in 2008, up from less than 5% in the 1950s.” Parameswaran thinks Washington’s backstop of “too big to fail” banks play a role by encouraging the financial sector to take on macroeconomic risk of the sort the Federal Reserve worries about (housing, derivatives) rather than lending to small business or new firms. Another factor could be restrictive land-use regulations that prevent our most productive cities from being as populous as they could be. And Christensen sees schools at all levels failing to teach the “skills necessary to start companies that focus on empowering innovations.”

US workers need America to be as entrepreneurial and innovative as possible. So does the global economy. But right now we are taxing capital, educating kids, regulating banks, and managing cities in ways that are crippling America’s greatest economic asset.

41 thoughts on “Where are the entrepreneurs? More evidence the very heart of the US economy is failing

  1. As someone who works in early stage funding, I would disagree that “The US entrepreneurial spirit may be faltering.” I think the spirit is still there, but the hurdles of funding these businesses are much higher. Principle reasons:

    1. SOX and other regulatory burdens have closed the door on IPO exits for most companies. This simply reduces the ROI that investors (and employee option holders) can expect. LOiek any game, when the potential payoff is reduced you will have fewer players placing bets.
    2. Somewhat related to the above, but more in general, investors are increasingly cautious about the companies in which they invest. They want to see not only a great idea with great potential. They want to see some revenues that indicate that “the dogs are eating the dog food”. This means that the entrepreneur has to fund much more of the pre-market development from personal funds or “friends and family”. I still see lots of entrepreneurs with good ideas with good potential, but fewer that are able to take things to the stage where they can hire people who are working for salary rather than equity.

    If the “spirit” is waning it is perhaps among those willing to work for entrepreneurs in higher risk start-ups. But that also relates to the reduced payoffs to them when there is a non-IPO liquidity event. It’s harder to attract people to a business when the payoff (if there is one) is 5-10 years off, rather than 2-3 years off (the way it was in the 90s).

    • The spirit is not waning! With all the hurtles that you have to overcome it is a daunting process. If I was not as tough and stubborn as I am I would have faded along time ago with what I fear are many others. I have many well qualified, smart, trustworthy, eager workers that are waiting for us to start so they can go to work for a manufacturing start up. Sometimes the quality of the work place outweighs the instability of a start-up. Then again there is no stability in any job now. Workers are easy to come by if they have faith in the ones starting the business. The hardest part is the funding. If you do not have a spare 1 to 2 million in your pocket you better know where or how to get it. The bank is now ready and I am securing the spare pocket change now. I firmly believe that funding is so hard to get for a startup that this is where most of the problems are.

  2. The first is the most interesting in my opinion. I wonder how it would look as a share of total new jobs, adjusted for new establishments percentage, etc.

  3. This is a very interesting chart. As it happens, I have recently been reading Joseph Stiglitz and so herewith a heterodox thought.

    One of Stiglitz’s interesting observations (and he’s got a lot notwithstanding Bhagwati’s trenchant criticisms) is the importance of wealth. His critique of IMF policies was in part that if you make people poor, they change their behavior.

    So that’s a thought from the Left. Now two thoughts from the Right. With the dissolution of the family, and with the rise in immigration, many of whom are poor, and as a general rule don’ t have wealth that often is generational, well you don’t have the same friends and family that often finance entrepreneurial activity.

    Seattle Sam is talking about top-end entrepreneurs. I bet this data source includes a much broader group of people. I mean how many companies ever go public?

    This analysis would also help explain the weak economic performance of Europe. Japan, I am going to say, is mostly old age.

    Does this make sense?

    P.S. I am down (in the colloquial) on land use and regulation. We are the new License Raj.

  4. As a serial entrepreneur having helped create a series of public companies, I would agree with Seattle Sam (above) and comment specifically that:
    1. The level of time I have to spend dealing with regulatory issues, mandated paperwork and services is up dramatically since the 1990s – up from a nuisance hour a week to easily 15-20% of my time.
    2. My costs for providing healthcare (a necessity to attract people in my industry) have risen >25% each of the last two years. This is my second largest costs after salaries. Insurers attribute it to having to cover increased expenses generated by Obamacare.
    3. Sarbanes-Oxley and other associated regulations and the necessity to meet them drains millions a year from my business. What a complete waste of effort for small companies. A solution to a problem that was already illegal under prior regulations that burdens a thousand companies with huge expenses for each one appropriate company it hassles.
    4. The effective demise of the IPO system engendered by Sarbox compliance and other regulatory issues as well as some larger financial issues basically punishes the VCs who invest in startups.
    5. I might note that my experience working with governments in other countries (in Asia) is remarkably more positive than working with the US government in the last several years. They seem to get the point that people starting and growing tech businesses is a good idea and that they should facilitate not strangle the businesses. Our government, filled with people who feel no responsibility for the growth of business or our economy and indeed recently with people who ideologically hate businesses is remarkably hostile.
    6. The massive decline in the number of analysts that followed from the intimidation of the industry by Elliott Spitzer benefitted nobody. At the time the effort was made to basically smear analysts involved with startups due to potential conflicts and occasional bad recommendations. The effect was to intimidate banks into putting walls between analysts and investment bankers and clients. All very well intentioned if highly ideological. The effect was to make the provision of analyst services a money-losing cost to banks since they could no longer interact with potential IB clients. The intention may have been to make the analysts conflict free but the effect was basically to massively decrease the number of analysts. The decline in the number of analysts does not hurt giant well-covered companies like GE but it kills companies in the sub-$1B bracket because there is nobody to tell our story. A classic example of unintended consequences perhaps. I might note that there is no evidence that analysts are any more accurate now than they were before the Spitzer regulations. Given their reduced interactions with clients it is hard to see how they could be.

    The bottom line is that entrepreneurs live in a larger economic environment. When government policies raise costs through hyper-regulation, induce increased litigation, raises expenses for every business through inefficient political boondoggles like Obamacare, reduce investment incentives by raising the capital gains tax, reduce incentives by decreasing the ROI for executives by raising tax rates on the income we get from our options, and focus the country on a negative environment based on jealousy and condemning industry, it is a bit unsurprising that entrepreneurial activity declines.

    My sense of it is that the bar has been dramatically raised as the result of intended and unintended consequences of government action. It is still possible for those of us who generate exceptional performance or bring forward exceptional opportunities to succeed but the higher bar makes the successes fewer and further lowers investor involvement.

    I think of it like a chemical reaction. When reactants react they produce new compounds plus (exothermic) or minus (endothermic) heat. Reactions that generate free energy (heat, exothermic) go forward on their own and as they generate more heat they speed up their own growth. It is possible to tap some of the energy to drive the creation of other compounds (like ATP) – lowering the free energy released and slowing the reaction but it proceeds as long as it is liberating energy. In a sense this is what government is doing with taxes – sucking off value created by others and trying to use it to create other things. But in chemistry when you take away too much energy, cool the reaction, it slows and if you take away too much it starts to go in reverse.

    As I see it that is where we are now. Government is directly (taxes and fees) and indirectly (mandated costs, mandated compliance) sucking off more from the economy than the creators can sustain and we are locked in stagnation. Europe paved this ground for years and in the last several years the US has moved decisively in the direction of stagnation. This is bad for the US but fortunately there are other environments around the world that entrepreneurs can work in that are not quite so predatory. Either the system in the US will decide to go back to letting capitalist do capitalism or it will continue down the road of predatory government stifling economic activity. Given the fact that even communist countries like China were able eventually to figure out that predatory Marxist economics only created famine and poverty, I have to believe that leftists in the US will eventually figure out the same thing. Obviously there are counter-examples like Cuba and North Korea and Zimbabwae and examples of countries sinking into socialism like Venezuela but it is hard to believe that the US government will be so stupid as to persist with their absurd ideological obstruction of enterprise. I certainly hope the US will wise up and return to our pro-enterprise roots but if it does not it is a big world filled with national environments that are not so predatory.

      • How utterly typical that you find comfort in blaming Bush. In this specific instance, conservatives will join you in condemning Bush’s expansion of the regulatory environment. The left’s canard that Bush deregulated and thus caused the financial recession has no basis in fact. Bush continued the growth of regulations and contributed to that extent in the meltdown. Obama has doubled down on that dynamic and has the economy in the grip of stagnation.

        • G117 is right. The most notable regulatory change under Bush was Sarbanes Oxley. The one where Bush would have (and in retrospect, should have) increased regulation was in the mortages. He tried and failed. Didn’t try hard enough. Much like Reagan tried and failed to cut the size of government, and then got blamed for its growth.

      • Sarbox was a BUSH imposed law. It kind of fits the graph too, if you consider the initial decline in the 00s was from the end of the bubble, and once Sarbox was enacted, it was all downhill from there.

  5. They missed a pretty big reason why investment is down. It’s why investment is down across the board, the economy is still weak, and nobody expects it to gain any real momentum anytime soon.

    Consumers do not have money to spend, and the federal government is not spending. Those two generate demand, and businesses invest to meet that demand.

    This is pretty basic macroeconomics, and it feels like the analysis of entrepreneurs here bends over backwards to avoid the obvious explanation. Sure, some of these factors are probably true, as is the fact that capital is way more mobile and global now. But the economy is a huge part of the story.

    • The federal government is not spending? Then why is it borrowing so heavily? Federal spending is an all-time high. Go to federalbudget.com and see the numbers for yourself.

        • Its not spending enough. Consumers cut WAY back, so the Government needed to step in.

          Why? The government is a parasite that lives off the productive class in society. If people want to cut back spending let them. If the economy needs to contract so that the market can liquidate malinvestments let it. Central planning does not work and when government let the markets work the recoveries were a lot faster and more durable.

  6. US workers need America to be as entrepreneurial and innovative as possible. So does the global economy. But right now we are taxing capital, educating kids, regulating banks, and managing cities in ways that are crippling America’s greatest economic asset.

    America can never be as entrepreneurial and innovative as possible when the Fed and regulators work to prevent the markets from clearing and insist on protecting established firms that cannot really compete in a free market.

  7. As the chart reflects, the economy has been failing since Bush took office. No surprise there. This will continue until Reaganism is reversed.

    • If you look at the chart, entrepreneurship increased under Reagan, maybe you should get your eyes fixed. 30 years of a drip drip drip economic regulatory environment has eroded entrepreneurship.
      But don’t let your hate of Reagan get in the way. And Alpha was correct, your not.

  8. Why aren’t people trying to create businesses? Every single person I talk to says it’s because they can’t afford health care. Change health care, make it affordable and you’ll see a big surge in small business creation.

    It’s fairly simple.

    • Sorry; health care is only a focal point. Those of us in the start up/small business sector are sitting on our hands because: 1)Regulations are knee bending to the one man band 2) Employees cost too much and are too much hassle. Everyone I know is trying to find something to do that doesn’t require them to hire anyone. 3) If you do succeed, the government will take too much. 4) government exudes dislike of business–see #3.

      Health care is just an example.

  9. there will not be a robust recovery. this is it kids. remember at the beginning of every State of the Union speech, when every President says, “the fundamentals of our economy are sound”? they arent. in fact they are corroded and unable to support thir own weight.

    imagine the economy as a mighty river rushing along carrying individuals, companies and even governments along with it. thats the way it was for almost 200 years.
    until recently. the creation of $1T deficits, a $20T national debt, huge portions of the public recieving assistance (on the federal credit card) and nonproductive
    in any meaningful way are gian boulders dropped in the middle of our mighty river. the creation and nuture of “crony Capitalist” segments – key segments of our economy – specifically in Health care, banking and media companies are several more large boulders dropped in the flow. health care companies not only do not compete for customers, they are legally protected from doing so. read the recent time magazine issue devoted to the larceny and avarice of the “system”. Banks to big to fail and media companies have also sheltered themselves from havign to either compete or be regualted, through their wealth and influence buying, soaking up capital and opportunity while stifling growth and jobs. when the lasty time Disney/Cap Cities/ABC/Pixar/Marvel/ESPN lowered your cable bill because their ratings weer down? never. okay just drop the channels you dont want to pay for. can’t. and they steadily ratchet up what the cable systems charge you or comcast gets blacked out. That monopoly stream funds the other businesss, which then become large enough to buy their own shelter.

    The once mighty river is clogged with boulders. all the stimulus and tax games and rhetoric in the world will not make the water flow again. we are done until the government gets its spending in order and we break up the new monopolies and foster growth once again.

    • Please don’t use the term “crony capitalist”; there isn’t any such thing. Call if by its correct term: “Corruption.”

    • The economy is only being supported by the Great Bernanke Bubble. Once that blows, the collapse will shock the world. You will see a terrified public turn to total socialism as the only means of survival. We will become the USSR.

  10. Face it, all the factors dragging down the economy are permanent. New regulations have been written at an astounding rate the last five years, and regulations never die. We have dozens of new regulatory bodies, thanks to Obamacare and Dodd-Frank, and they are just beginning to add their burden to the economy. Obamacare will not be repealed, so its unintended consequences will permanently harm small businesses. The intentional increases in energy costs ripple through the entire economy, especially food, adding their drag on families. Federal borrowing is a permanent black hole in credit markets that otherwise would be available to small businesses. And on and on and on. America’s best days are behind us.

  11. The lack of trust and the broken risk and return relationship. You cannot even invest in zero return investment and expect to preserve your spending ability due to FED policies. There is no trust the GIvernment will not regulate or force costs on you or force you to give up more and more of your wealth. When job creators trust the GIvernment then they will jump back in. Until then we can just look at charts and laugh/cry at the current leaders stumble and bumble.

    • EXACTLY. Right now, the only thing we can “Trust” the government to do is make our life harder. It has always been so, but the old parable of the straw that broke the camels back holds true, eventually.

  12. Stating that the “economy is failing” suggests – and connotes – that the economy itself is at fault. That is not the case. What we have is a government actively destroying opportunity – and thereby the economy – with the same policies that ALWAYS cause economic downturns. These “Progressive” policies have never worked and never will. Only those immune to the vagaries of the real world – academics, politicians – even THINK they can work. What we HAVE are policies that have given us the worst “recovery” in history from a recession. This is ALL DUE TO THE GOVERNMENT ITSELF. It is not the economy that is failing – it is the government that is failing the economy, the nation, our citizens and our future.

    • A pretty good rule of thumb is that whatever the government claims a particular law or policy will accomplish, the most likely result is the exact opposite.

      If the government wants to “fix” the economy, DO NOTHING.

  13. If we concentrate the blame on the feds, we’re missing the boat. Bloated municipal, county, and state governments and their excessive and punitive regulatory environments stop entrepreneurs dead in their tracks. The feds then come around and kill off a portion of any that survive the local and state gauntlet. Business success is attacked, subdued, and destroyed as a matter of policy at every level. Until we change that federal regulation is just an irritant

  14. What we have developed is a system that, when a new business venture begins to succeed, the success is siphoned off right away. So, in essence, the seedling is uprooted well before it becomes a healthy and productive plant.

  15. RPM is correct: entrepreneurs are trying to not hire anyone. Our entrepreneurial spirit is doing just fine, but when the government makes hiring someone more expensive, rational entrepreneurs will cut back on hiring, or cut out hiring entirely. Look at the number of self employed, and to find the “employees,” look at the number of jobs working for “temporary” agencies.

  16. I own a small business and have taken to subbing out work to independent contractors who are adept and able to get the job done. Hiring people has always been a difficult art and with onerous and burdensome regulations it becomes completely unnatractive. As to that the costs of unemployment insurance, health insurance, worker’s comp, social security, etc. the whole thing becomes implausible.
    Furthermore, as business owners we work long hours, risk our dollars, and take full responsibility all while being judged because our goal is to make a profit.

  17. Did anyone else notice this data is 3 years old? There is a lot of horrible things to be said about an Obama run economy but 3 year old data doesn’t say much of it.

    • We need to stop thinking this is about personalities. This is a system failure. Any time you have micromanagement through regulation, you’ll create an inefficient system. When it gets inefficient enough, it will fail.

  18. The U.S. economy isn’t failing. Obama is killing it. Obama is the most anti-business, anti-growth, anti-domestic energy, incompetent, extreme left wing ideologue to ever sit in the White House. In Obama’s American the American dream is no longer to succeed through hard work, or building your own business. Nope…that is what greedy, nasty, hateful, near criminal do. Besides if you work hard or own your own business, and manage to make any money after fighting through Obama’s massive new regulations and Obamacare, Obama just intends to take most of what you earn in taxes. Under Obama the new American dream is dropping out of the workforce completely onto the Government dole and Foodstamps at the highest freebie level possible. If you get more foodstamps than your neighbor you are a success in Obama’s America. DEBT, Massive, growth in Government, regulations, corruption at the IRS and Justice Departments. Trillions in funny money being dumped into the economy creating a bubble in real estate and the stock market? The day is coming where the damage Obama is inflicting on our economy will reach the breaking point. That day isn’t that far away.

    • The U.S. economy isn’t failing. Obama is killing it.

      It might be more credible to note that Bush was not any better than Obama. He presided over a huge increase in regulations and an explosion in government spending. There isn’t any difference between the DP and the GOP and both need to go.

      • Actually, killing the US economy is a bipartisan affair. The Democrats actually believe in it; the GOP just does it because. W didn’t hate the private sector like Obama does, but he was almost as big a disaster in laws passed.

        • That is my problem with Republicans. Most of them rightfully see how Democrats destroy the economy but when the destruction comes from their side they tend to be blind to it.

  19. The reality is that America has six million corporations, but just 2,600 of them own more than 80 percent of all business assets. And the concentration of ownership is increasingly narrowing, which effectively denies the 99 percent, from a practical standpoint, from acquiring over time a viable individual ownership share in America’s FUTURE wealth-creating, income-generating productive capital assets. The 1 percent are effectively accumulating the bulk of the money through monopolized productive capital ownership.

    Increasingly entrepreneurs end up working for the 1 percent ownership class. Our scientists, engineers, and executive managers who are not owners themselves, except for those in the highest employed positions, are encouraged to work to destroy employment by making the capital owners’ assets work more productively. How much employment can be destroyed by substituting machines for people is a measure of their success––always focused on producing at the lowest cost. Only the people who already own productive capital are the beneficiaries of their work, as they systematically concentrate more and more capital ownership in their stationary 1 percent ranks. Yet the 1 percent are not the people who do the overwhelming consuming. The result is the consumer populous is not able to get the money to buy the products and services produced as a result of substituting machines for people. And yet you can’t have mass production without mass human consumption. It is the exponential disassociation of production and consumption that is the problem in the United States economy, and the reason that ordinary citizens must gain access to productive capital ownership to improve their economic well-being.

    Without this necessary balance hopeless poverty, social alienation, and economic breakdown will persist, even though the American economy is ripe with the physical, technical, managerial, and engineering prerequisites for improving the lives of the 99 percent majority. Why? Because there is a crippling organizational malfunction that prevents making full use of the technological prowess that we have developed. The system does not fully facilitate connecting the majority of citizens, who have unsatisfied needs and wants, to the productive capital assets enabling productive efficiency and economic growth.

    Once we reform the system to enable consumer earning power to be systematically acquired in the course of the normal operations of the economy by people who need and want more consumer goods and services, the production of products and services should rise to unprecedented levels, and entrepreneurship should flourish. Furthermore, the quality and craftsmanship of products and services, freed of the cornercutting imposed by the chronic shortage of consumer purchasing power, should return to their former high levels. Along with flourishing entrepreneurship, competition should be brisk. Cost should be deflationary and the purchasing power of money should remain stable year after year.

    The solutions can be found in the Agenda of The Just Third Way Movement at http://foreconomicjustice.org/?p=5797, Monetary Justice reform at http://capitalhomestead.org/page/monetary-justice and the Capital Homestead Act at http://www.cesj.org/homestead/index.htm and http://www.cesj.org/homestead/summary-cha.htm

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