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Startups Creating Fewer Jobs -- Not a Problem

The decline in new jobs created by small businesses could be a good thing. Here's why.
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Many policy makers and entrepreneurship advocates are worried. Startups are creating far fewer jobs than they used to, according to analysis of the Census Bureau's Business Dynamics database. New firms' share of employment fell by nearly two-thirds between 1977 and 2011.

In large part the decline in job creation stems from a decline in the new-firm share of businesses. Despite ticking up in 2011, the new company fraction has been trending mostly downward for the past 35 years and in 2011 was roughly half (8.2 percent) of its 1977 level (16.5 percent).

But the decline in new business job creation might be less of a problem than many entrepreneurship advocates and policy makers think.

Consider what else is correlated with startup rates and employment by startups and you will see why. Sure the startup rate is down substantially over the past 35 years, but so is the business failure rate, or the number of companies that go under every year. That is, as the rate at which people start new companies has gone down, so too has the rate at which existing businesses shut down.

A similar pattern is present with job creation. Just as the rate of job creation by new businesses is down significantly over the past three-and-a-half decades, so too is the rate of job destruction from business closures. As you can see from the figure below, as fewer jobs are being destroyed by the closure of existing businesses, fewer jobs are being created from the founding of new ones. 

This is where the decline in startup employment might not be a problem. Job loss from business shutdowns is a bad thing. No one wants people thrown out of work because their employer fails. Therefore, the declining startup rate is associated with a good thing: a declining business failure rate.

We don't know why both startup and failure rates have been going down over the past 35 years. But one plausible scenario is that existing entrepreneurs have gotten better at running their businesses. As a result, fewer existing businesses go under every year, destroying the jobs of those who work for them. With fewer existing businesses going under, fewer entrepreneurs need to start businesses to replace them, leading to lower levels of new company employment.

Consider the example of the local pizza place in your neighborhood, which is the prototypical startup. If the people running the restaurant are doing well, their business stays alive and maintains its current level of employment. No one else needs to open an eating establishment in your neighborhood because the surviving pizza place is meeting demand. 

But if the existing pizza shop isn't doing well and the entrepreneurs running it have to shut it down, there is unfulfilled demand for a restaurant in your neighborhood. So someone might take over the shuttered location and hire people to work in a new dining establishment. The first example means low rates of new company job creation and low rates of job destruction from firms going under, while the second example means high rates of both new company job creation and job destruction from companies going out of business.

Before policy makers and entrepreneurship advocates get too worked up about the decline in startup company employment, they need to ask the question: Are fewer people working at new businesses simply because fewer people are losing their jobs through the closure of existing ones?