Subject: Small Business / The Falling Business Formation Rate
From: "Altman, Roger" <[email-masked]>
To: "[email-masked]" <[email-masked]>
Cc: "[email-masked]" <[email-masked]>
Date: Tue, 26 May 2015 21:31:24 +0000

I saw that HRC commented on small business issues last week in Iowa.

A related issue for the campaign is the weakness in start-ups.  Despite media preoccupation with Silicon Valley, the business formation rate has plunged since 2008.  And, this decline appears to be spread across all key business sectors, including technology.  It means that American economic dynamism is weakening which, in turn, signals lower productivity and economic mobility.

According to Brookings data, the percentage of total U.S. businesses which were less than 12 months old, had been slowly declining for 30 years.  But, until 2008, it still exceeded the percentage which failed during the prior year.  In other words, we were still creating more businesses than we were losing.  But now, for the first time since the data has been collected, these curves have crossed.  Because, there has been a sharp, nationwide drop in start-ups since the financial crisis.  As shown below.

Table 1:   Declining Economic Dynamism
Source: U.S. Census Bureau, the Brookings Institution

This trend helps explain why the job relocation rate - the moving of workers from declining businesses to growing ones - also has fallen.  This is a proxy for social mobility.  And, all of this is particularly important because the small business sector represents nearly half of private sector employment and half of its GDP.
The reasons for this drop in business formation are not yet fully understood.  A long paper on this subject was presented last fall at the Fed Retreat in Wyoming, but it mostly ruled out certain hypotheses.  Including that high tech services weren't similarly impacted and that the fall was concentrated in manufacturing.

However, the proportion of young people owning stakes in private companies has hit a 24 year low.  Some believe that this reflects the greater post-2008 difficulty in raising capital for start-ups.  Others cite the role of slowing population growth and greater rates of business consolidation as causes.

Table 2:   Job Creation and Job Destruction in the High Tech Sector
Source: U.S. Census Bureau, the Kauffman Foundation

Table 3:   The Declining Job Re-Allocation Rate
[IMG_0523]
Source: U.S. Census Bureau, American Enterprise Institute

What Can Be Done?

HRC appears to be focusing now on policy goals rather than detailed prescriptions, which is natural at this early stage.  For the moment, then, it may be useful for her just to note this decline in start-ups and dynamism and the importance of reversing it.

But, when you see the overall weakness in the small business sector, as revealed by the Federal Reserve and NFIB surveys, it argues for an eventual, broad initiative on small business, minority business and entrepreneurship.  By some measures, this sector is still in recession.

There are four policy areas, among others, which might form the basis of such an initiative:
(1) tax reform;  (2) federal support for R&D;  (3) immigration reform; and  (4) occupational licensing requirements.

Tax reform could facilitate business formation through steps like liberalized allowances for expensing fixed investments, expanding the 15% corporate tax bracket and others.  If President Obama's business tax reform does not pass in this Congress, which seems likely, then HRC would have a clean slate for tax reform.  Including such steps.

Federal support for research and development, both defense and non-defense, has fallen considerably since 2008.  This isn't healthy at any level, but it also hurts entrepreneurship.  Because, there is a long-standing relationship between federal research and private start-ups, with the former often serving as fuel for the latter.  With DARPA and DOE bring prime examples.  An effort to restore economic dynamism, then, would likely require increased federal R&D.

Table 3:   Declining Federal R&D
[IMG_0522]

Source: AAAS Research and Development reports and analyses of appropriations.

Immigration policy also is an obvious factor.  Today, nearly a quarter of U.S. scientists and nearly half of U.S. engineers - those with post-graduate degrees - are immigrants.  And, most economic research supports the positive correlation between immigration levels and business formation.  Especially highly educated immigrants, many on H1-B Visas.  Although, this question shouldn't be separated from that of comprehensive immigration reform.

Finally, occupational licensing requirements have soared over the past 30 years, largely imposed by state laws.  Manicurists, dental assistants and innumerable others now must pass examinations to become licensed and practice.  In the early 1950's, less than 5% of American workers needed a license to conduct their jobs.  But, the comparable percentage appears to be over 30% today.  And, this growth in mandated licensing has become a major factor in the U.S. job market.

Yes, such requirements are generally for health, safety and quality reasons.  But, different occupations, e.g., interior design, pose smaller risks than others.  Plus, state-by-state licensing practices vary widely.  The key state of Iowa, for example, has twice the percentage of licensed workers as New Hampshire or Rhode Island.  These differences limit job relocations and mobility.

A 2014 Hamilton Project paper recommended 4 state and federal reforms for alleviating the job limiting impacts of such licensing.  I won't review them here except to note that some reforms are called for.

Conclusion

If you have an interest, I can look into any of these issues further.  But, the point of this note was to flag the fall in business formation rates, as it hasn't received the attention it deserves.

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