When the U.S. economy was booming in the 1990s, new firms flourished and willing workers found jobs quickly. In the current decade, these patterns faded. Startup and job finding rates have slowed so that employment has only just surpassed its 2007 peak. While part of current U.S. frailty remains cyclical, these trends suggest a worrying loss of economic dynamism.
Everyone knows that, following the deepest postwar recession, this recovery has been the weakest in postwar experience. Real GDP today is less than 7% above its peak 6½ years ago – a pace of growth that is only one-third that of the previous four business cycles.
By contrast, fewer observers are aware of the loss of U.S. business and job market dynamism. Market economies are characterized by high turnover of both workers and firms. This “churning” is part of the process of “creative destruction” that shifts economic activity to more productive uses. The U.S. economy has typically stood out for its level of dynamism. But recent research has highlighted the long-term slowdown in the U.S. pace of gross job creation and job destruction (see top panel below), at least part of which has been associated with the decline in firm startups (see bottom panel below).
Gross Job Creation and Destruction (top) and New Business Formation (bottom), 1980–2011
Source: Ryan Decker, John Haltiwanger, Ron S Jarmin, and Javier Miranda, “The Secular Decline in Business Dynamism in the U.S.” The job creation (destruction) rates show the share of private jobs added (removed) by new and growing (exiting and shrinking) firms.
How much does the secular loss of dynamism matter? To what extent does it contribute to the economic slowdown? The jury is still out, but the falling trend in business formation over the past quarter century is troubling. As the data show, the startup rate – defined as the number of new firms relative to the number of total firms – fell from roughly 12% in the late 1980s to only about 8% following the Great Recession. Now, it might recover, but there is surely reason for concern that without more startups, growth and employment will continue to suffer.
Modern search models of the labor market relate the job-finding rate (the share of the unemployed who find a job in any particular month) to the vacancy rate (the ratio of vacancies to unemployment): as the next chart shows, it is easier to find a job when there are plenty of offers. (The correlation between these two series is a remarkable 0.93!) In turn, a high average job-finding rate lowers both the average rate of unemployment and the duration of unemployment. If the secular decline in startups and gross job creation lowers the job-finding rate on a sustained basis, job-seekers (and probably output) suffer.
Job Finding Rate and the Ratio of Vacancies to Unemployment, 1990–May 2014
Source: Bureau of Labor Statistics, FRED, and authors’ calculations. The job finding rate is the ratio of the number of unemployed who find a job in month t (from the CPS labor flows) to the number of unemployed in month t-1. The data for vacancies (JOLTS) are available only since 2000.
To be sure, some of the measured loss of business dynamism may be benign – or even positive for economic growth. As one skeptical observer notes, when large firms (like Amazon or Walmart) replace mom-and-pop shops, business formation slows, but exits don’t. Even so, productivity advances due to scale economies and the larger firms’ better technologies.
Moreover, not all countries with low unemployment are particularly nurturing for start-ups or exhibit a high level of job churning (think Germany).
But the loss of dynamism would seem particularly threatening if it shows up in the sector that led the 1990s productivity boom: namely, high tech. Unfortunately, recent analysis shows that the disturbing trends evident for more than two decades in the broader U.S. economy also surfaced after 2000 in firms with high shares of STEM (science, technology, engineering, and math) workers.
What can be done? If the underlying problem is a shortfall of new ideas that generate firms and jobs, not much. Such productivity pessimism typically surfaces whenever the economy sputters. But we are less fatalistic. Giving up just won’t do. Instead, we see a broad set of policy alternatives from reducing protections that inhibit competition to promoting startup financing to subsidizing investment in human capital. All of these would be directed at encouraging the key to dynamism: entrepreneurship.