Wednesday, April 29, 2015

Stiffness in the Joints of the US Economy

The US economy has considerable strengths: its enormous internal market, well-educated population, its scientific and research establishment, its physical and legal infrastructure, and more. In addition to these, the US economy has been known for its flexibility in creating new companies and jobs. And by those measures, problems have been increasing for a couple of decades. I just recently discovered that the Business Dynamics Statistics program at the U.S. Census Bureau has a handy-dandy figure and chart generator, which I recommend playing with.

For those not familiar with it, the BDS is a longitudinal database of business establishments and firms going back to 1976. "Longitudinal" means that it covers the same firms over time, so a researcher can investigate patterns of firms that have just started, or firms that are five years old, and so on. It looks at the rates at which firms start up and shut down. And it looks at whether firms of different sizes and ages are adding jobs or subtracting jobs.

One pattern which comes out of the data is a long-run decline in the birth rate of firms in the US economy. The figure below shows the latest BDS data, released in September 2014 and covering the years up through 2012. (The numbers on the vertical axis can be read as percentages: that is, the number of firms with age zero in 2012 was 11% of the total number of firms in 2012.) As I've pointed out  in earlier posts on "The Decline of US Entrepreneurship" (August 4, 2014) and "New Business Establishments: The Shift to Existing Firms" (August 26, 2014), this downward trend in business births worsened during the Great Recession, but it had been on a downward trend for a couple of decades before that.

One sometimes hears a claim by politicians that we are now seeing for the first time that exit rate for firms is exceeding the entrance race. It's true that the exit rate of firms exceeded the birth rate for several years during the Great Recession, and that this had not happened during the previous two recessions. However, it did  happen for a year back during the 1981-82 recession. And the birth rate was again exceeding the exit rate by 2012. Of course, these claims do not contradict the overall pattern that the birth rate of firms has been declining over time.

Not surprisingly, as the birth rate of new firms has gradually declined, so has the job creation rate. The BDS data illustrates this point. The "job creation rate" sums up the number of jobs added at all establishments that added to their total number of jobs in a given year, and divides by total jobs. Conversely, the "job destruction rate" adds up the number of jobs subtracted at all establishments that reduced their number of jobs in a year, and divides by the total number of jobs. Notice that this method of counting "job creation" and "job destruction" is an underestimate of the amount of churn in the US labor market, because if a certain establishment shuts down a bunch of jobs in one area, but opens up an equivalent number jobs in a completely different area, then it is unlikely the workers will be able to transfer from one area to another--but from the standpoint of the BDS data, this establishment neither created new jobs nor destroyed existing ones.

Even by this understated measure  of job churn, it used to be that the number of new jobs created each year back in the late 1970s and into the mid-1980s was often about 20% of the total number of jobs. But this share has sagged over time, and during the Great Recession job creation fell almost to 10% of the existing jobs in a given year. Meanwhile, the rate of job destruction seems to hover around 15% of existing jobs in a given year--a little higher or lower depending on the state of the macroeconomy.  

Research using the BDS data shows that new firms play an outsized role in creating new jobs, both in the first year of the new firms, and also--even after attrition--in the few new firms that really take off as job creators. Looking ahead, part of the evaluation process for every new rule affecting business should take a look at how it affects incentives to start new firms and to hire. The US economy can't afford to take its entrepreneurism and labor market flexibility for granted.