Politicians, even those who vilify corporate America, inevitably laud small businesses.
They are right to appreciate the enormous role that entrepreneurship plays in the U.S. economy, but it’s not clear how much public policy can do to conjure up entrepreneurs.
Recently, with broad support, Congress passed an amended version of the Jumpstart Our Business Startups Act (or the JOBS Act), with the expectation that President Barack Obama would sign it into law (something that may have happened already by the time this edition of Providence Business News has hit the street).
The act attempts to make startup financing easier to obtain by reducing financial regulations on smaller companies. Although this approach carries risks – light regulation makes fraud much easier – I still support the bill, at least with the Senate’s extra safeguards. Still, we shouldn’t kid ourselves that this will be a magic bullet. American entrepreneurship needs new ideas more than new financing mechanisms.
In every year since 1989, new companies have created more net jobs than the economy as a whole, which means that older companies are, on average, destroying more jobs than they create. In 2009, the latest year for which we have data, new businesses created 2.33 million jobs, while older businesses destroyed, on net, more than 7 million jobs. The share of Americans working in startups has fallen to 2 percent in 2009 from 3.8 percent in 1979.
The history of the United States’ local economies illustrates the dangers of relying solely on large, established companies. Fifty years ago, the economist Benjamin Chinitz noted that New York appeared more resilient than Pittsburgh, which he credited to the entrepreneurship inculcated by New York’s garment industry.
Chinitz noted that “the average establishment in the apparel industry, for example, has one-sixth as many employees as the average establishment in primary metals.” Since big companies produce middle managers more than entrepreneurs, he said, “You do not breed as many entrepreneurs per capita in families allied with steel as you do in families allied with apparel.”
Chinitz’s claim has been supported by many studies that have identified strong links between initial measures of entrepreneurship, such as average establishment size and the share of employment in startups, and regional economic success, typically measured by employment growth. Our measures of local entrepreneurship are pretty mediocre, which makes their robust correlation with economic growth all the more remarkable. The next figure sorts American metropolitan areas by average establishment size as of 1977 and shows subsequent employment growth across areas.
The correlation is quite robust even with controls for other local attributes, like education. If we look within metropolitan areas, we also find that sectors that have smaller establishments and more employment in startups grow more quickly. My recent work with economist William Kerr even supports Chinitz’s view that historic concentration in resource-intensive industries, such as steel, leads to larger companies across all industries and less economic growth today. We find that proximity to mines in 1900 reduces employment growth in the long run, even if we look only outside the Rust Belt and focus only on industries that have little to do with manufacturing.
Although I share the enthusiasm for entrepreneurship evinced by the authors of the JOBS Act, I am less optimistic about the ability of the government to make the U.S. more entrepreneurial by playing venture capitalist or by reducing financial regulations. My colleague Joshua Lerner, one of the giants of entrepreneurship research, has written an excellent book, titled “Boulevard of Broken Dreams,” which describes the vast number of failed public efforts to boost entrepreneurship.
My own mantra is that the best way to encourage local entrepreneurship is to attract and train smart people and then get out of their way. In that vein, I continue to believe that the U.S. can best lay the foundation for long-term entrepreneurship by improving education, so that more Americans acquire the knowledge needed for technological innovation.
An even easier way to engender entrepreneurship is to import it from abroad. The Kauffman Foundation, which is “devoted to entrepreneurship,” noted that, “Immigrants found companies here at greater rates than native-born Americans do, and are disproportionately successful in starting successful high-tech firms.” Kauffman advocates the expansion of visas for foreign entrepreneurs and more green cards to enable foreign students who study science to work in the U.S.
Still, the JOBS Act at least represents a clear acknowledgment that the U.S. has a dearth of entrepreneurship. The legislation eases access to financing for startups by eliminating financial regulations and reduces the need to disclose information.
This approach represents a vast improvement over government attempts to play venture capitalist. Neither elected officials nor bureaucrats are good at picking winners, and they are prone to choose the politically popular over the economically rational (remember Solyndra).
Moreover, some evidence links entrepreneurship with financial-market competition. A paper by economist Timothy Bartik more than 20 years ago found that entrepreneurship increased when states relaxed restrictions on branch banking. A more recent study focusing just on entrepreneurship and financial regulation found similar results.
The JOBS Act is not the solution that its supporters would wish it to be, and it carries costs as well as benefits. Even though investors have strong incentives to investigate before hazarding their money on some new startup, there will still be more fraud with fewer regulations. Yet America’s need for added entrepreneurs is sufficiently great that we should be willing to take that risk. We should not, however, think that the JOBS Act will solve our entrepreneurship gap, and we should continue working on education and immigration policies that will increase America’s stock of entrepreneurs. •