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The Number of New Startups Is Down -- and That's OK

The apparent decline in small businesses is not the national emergency some have made it out to be.

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Despite near record-low unemployment, U.S. economic growth remains stubbornly sluggish. A cottage industry of pundits has emerged in recent years to puzzle over the cause, and many have settled on what they believe is a plausible answer: declining new business formation. Gallup CEO Jim Clifton has prophesied that "this economy is never truly coming back unless we reverse the birth and death trends of American businesses." Economists Ian Hathaway and Robert Litan have written that the U.S. business sector is getting "old and fat" and that "nothing less than the future welfare of America and its citizens is at stake." Venture capitalists Seth London and Bradley Tusk have lamented, "Startups are the sinew of the American economy, but the uncomfortable reality is that American businesses are dying." And John Dearie, executive vice president of the Financial Services Forum, has warned that "this is nothing short of a national emergency."

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To address this supposed crisis, analysts and policy advocates of various ideological stripes have proposed a wide range of potential solutions, from lowering capital gains taxes and slashing regulation to increasing immigration. But, particularly noteworthy in this era of populist ascendency has been the idea of aggressive antitrust enforcement, which hinges on the theory that industry concentration has increased while startups have declined, so the former must have caused the latter. For New York Times economic columnist Eduardo Porter wrote, the decline in startups "is all about the decline of competition." This echoes antitrust crusaders Barry Lynn and Lina Khan, who argue: "The single biggest factor driving down entrepreneurship is precisely the radical concentration of power we have seen not only in the banking industry but throughout the U.S. economy over the last 30 years." Taking a page from former Obama administration chief of staff Rahm Emanuel, who famously advised "never want a serious crisis go to waste," they and others argue that only a radical antitrust enforcement agenda will open up space for startups, and the U.S. economy, to flourish again.

But, the premise of this argument falls apart on two main grounds. First, according data from the Census Bureau's Economic Census, in about 40 percent of industries concentration has not been increasing and most of the remaining 60 percent remain substantially unconcentrated, with their top eight firms commanding less than 30 percent of their respective markets. Second, there is little relationship between the growth of industry concentration and the rate of change in new firm startups, anyway. For example, in the catch-all industry sector that the Census calls "other services" (which covers everything from equipment and machine repairing to personal care), startups fell by 24 percent from 2003 to 2011, but the biggest eight firms in the industry actually lost market share over the same period. Meanwhile, in "wholesale trade" and "arts, entertainment and recreation," startups declined 16 percent and 14 percent, respectively, but there were no changes in the market shares held by the sectors' biggest eight firms.

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So, if monopoly hasn't caused the decline in startups, then what has? One big reason has been stiff international competition, particularly from China, which has employed a host of unfair trade practices. There is little incentive to start a new manufacturing firm when many big U.S. customers are now overseas, or when you know you will face a big, subsidized foreign competitor. A second factor was the Great Recession. The housing bust meant that construction startups fell 26 percent while real estate, rentals and leasing fell 13 percent. Similarly, with the financial crises and the bankruptcy of multiple banks, financial services startups fell 29 percent.

And in some industries technology has meant that larger firms can more efficiently serve the market. We see this particularly in retail, where startups fell 16 percent, but not because large firms abused their market power. Rather, technologies such as software-enabled logistics systems and web-based ecommerce enabled the average retail firm to get larger, meaning there was less market space for startups unless they had something truly unique to offer. Why open a local hardware store when stores like Home Depot and Lowes are so ubiquitous and offer much lower prices and vastly more choice?

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But, the truth is there's no need for reflexive hand-wringing about the decline of startups, particularly if by startups we mean new "mom and pop" subsistence startups. In fact, there is no relationship between that sort of small business and economic growth. MIT's Catherine Fazio and coworkers find that "Yearly fluctuations in counts of firm births appear to hold little relationship to medium-term measures of economic performance." This is because if Justin and Ashley don't start that pizza parlor, then someone else will. And in the long-run, as we show in our new book Big is Beautiful: Debunking the Myth of Small Business, small firms on average pay less than large firms, are less productive and provide less stable jobs with fewer benefits, so having fewer of them might actually be a good thing.

What really matters is how high-growth, innovation-based startups are doing (think: biotech or robotics startups, not owner-operated pizza parlors). And here, things are healthy. When MIT professors Jorge Guzman and Scott Stern looked at trends in high-growth entrepreneurship for 15 large states from 1988 to 2014, they found that even after controlling for the size of the U.S. economy, the second-highest rate of high-growth entrepreneurship occurred in 2014. And when the Information Technology and Innovation Foundation examined data on more than 5 million technology-based startups in the United States, it found that the number had grown 47 percent over the last decade.

In short, we should not worry about the total number of new small businesses of all kinds, since the vast majority are founded so their owners can fulfill personal lifestyle goals and many more won't survive the cradle. Alarmism over the entire class of dwindling startups is misguided -- and if the mistaken diagnosis leads to harmful policy prescriptions, such as radical anti-trust enforcement, then it could even be dangerous.

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