The Crunching Of Small Business

Small business has been the core of the American experience since the beginning. The small businessman is where the innovations and inventions that created the American experience can prosperity. Yet in the last decade the small business has been crunched and there are all to frequent “For Lease” signs in retail strips and business parks. Those vital businesses that make the stuff we need and provide the services that make life possible. Somehow the parties that be in Washington have missed what’s going on outside the beltway.

The time has come to ask some hard questions.  And expect hard answers.

If you’re worried America is no longer great — excluding US Olympic prowess, of course — the above chart might neatly encapsulate those concerns. Looks like the Startup Nation is in the midst of an entrepreneurial crisis. Since the late 1970s, startups as a share of all firms have fallen by more than half, while the share of workers employed at new firms has fallen by three fourths.

This seems troubling on two levels. First, entrepreneurship of all kinds can provide employment and upward mobility. Second, high-growth or “transformational” startups are big drivers of high-wage job creation, innovation, and competition. As the Financial Times (source of the above chart) recently put it: “The suggestion that the US has a problem in the entrepreneurship department has come as a jolt for a country that prides itself in the red-blooded capitalist spirit that spawned the likes of Henry Ford, Ray Kroc and Steve Jobs.”

Theories to explain this chart include (a) the rise of big box retailers in the 1980s and 1990s, (b) a growing cronyist, regulatory state that favors big incumbent firms, and (c) access to capital, whether due to tougher post-financial crisis lending standards, the decline in housing wealth, or 80% of venture capital being concentrated in just a few states.

When looking at startups, however, it’s important to differentiate between high-impact startups — and those that dream of being the next Google or Facebook — and your local small business such as a dry cleaner, restaurant, or antique shop. Recent research finds the US economy seems to be creating lots of startups with high-growth potential, but they’re having trouble scaling up.

That finding is at least a bit curious to me though, since it is based on the idea that a “successful” startup goes public or is bought out. Yet one characteristic of the recent Silicon Valley boom is that valuable software firms are staying private, longer.  Likewise, many tech startups are able to generate big revenue and valuation without necessarily hiring lots of workers. As Andreessen Horowitz analyst Benedict Evans has explained, “The way I try to think about it is the prototypical startup 15 years ago, you’d raised $10 million and you had a hundred people and you had a million users. And now you’ve raised a million dollars and you’ve got 10 people and you’ve got 100 million users.”

Some good news on this front: Kauffman Foundation research shows a recent pickup in “growth entrepreneurship.” Of course, things could always be better. Helpful policy might include labor market reform (occupational licensing and noncompete agreements), housing deregulation in high innovation cities, increased basic science research, a more pro-investment tax code, looser intellectual property rules, and greater government investment in science research. In general, government needs to think harder about how new regulation affects innovation or favor incumbents over startups.

If the US is to grow anywhere near as fast in the future as it has in the past, an even more dynamic entrepreneurial sector will be needed.

Has America really lost its capitalist mojo?

The problem society has right now is that the old way of being able to start a business is tied up in red tape and taxed to the nines.  It’s hard to haven a dynamic entrepreneurial sector under that kind of burden.  Consider that a good part of American growth came when the burdens of regulations and taxes were much lower.


The fact is that every regulation passed or simply enacted has big consequences when the margins are already thin.  Every dollar spent in compliance is a dollar that is not invested in the business.  Which is a big deal when the business is small.

This may be a big part of the reason that startups have declined in the last thirty years as James Pethokoukis points out here.

Startups have been on the decline for 30 years, and I have written frequently on some of the possible reasons. One big open question: To what extent is government regulation playing a role in that decline? A blog post by Scott Shane, professor of Entrepreneurial Studies at Case Western Reserve University, offers a few data points that suggest rules and red tape could be hindering business formation. He notes, for instance, small business owners are complaining more about regulation than they have in the past — twice as much as in the 1980s, for instance. And this:

Over the past three-and-a-half decades, federal regulation has been rising, while new business creation has been falling, as the chart above indicates. Researchers at the Ewing Marion Kauffman Foundation, the Hudson Institute, the Hoover Institution and the Heritage Foundation believe the pattern is more than a coincidence. The per capita rate of new employer business creation and number of rules pages in the Federal Register — a common measure of the scope of federal regulation — correlate -0.67 over the 1977 to 2012 period. Similarly, the per capita rate of business creation and the number of pages in the Code of Federal Regulation — another frequently used estimate of government rulemaking — correlate -0.78 over the same period. (A correlation of 1.00 means that two numbers move in perfect concert.)

Correlation may not prove correlation, but it can provide a helpful lead on where to look for the problem. And, really, the possible fixes seem like intrinsically good ideas anyway. Shane:

One idea is to limit regulation on new companies. John Dearie, Executive Vice President of the Financial Services Forum has suggested that Congress limit rules on businesses less than six years old to only “essential product safety, environmental, and worker protection regulations.” A young-company-regulatory-exemption would allow entrepreneurs to get their businesses up and running before facing the onslaught of federal rules, which would encourage more people to start companies. Another idea is to cull from the rulebooks regulations that are out of date and unnecessary. The creation of a federal commission to review regulations and to suggest to Congress those that could be eliminated and the inclusion of sunset dates on all federal regulations are two ways to trim the regulatory underbrush.


Is regulation choking small business formation?

If you plan to increase taxes, you will more than likely kill many small businesses. I started writing this post long before the election, but it looks like the country may have avoided a bullet here.  Taxing everything in sight does not end well.

We may have avoided a bullet, but the problems are real and deep, with serious consequences for the country. The country needs to get it’s entrepreneurial groove back or the other economic problems will only get worse.

New research shows that the country’s rate of new business creation, which peaked about decade ago, plunged more than 30 percent during the economic collapse and has been slow to bounce back following the recession. And that’s despite the fact that, over the last few years, the portion of the U.S. population between the ages of 25 and 55 – historically the prime years for starting a business – has been expanding, according to data compiled by the Kauffman Foundation, an entrepreneurship research organization that hosted the event  – the group’s annual State of Entrepreneurship symposium – on Wednesday.

Not surprisingly, fewer new businesses means fewer new jobs. Zandi cited Labor Department statistics showing that companies less than one year old contributed 5.2 million jobs in the year ending June 2014, down from the usual 6 million or so they generated in the years leading up to the recession and well off the normal pace of 7 million to 7.5 million jobs a year seen in the 1990’s.

“We’re getting less bang from our fast-growing companies,” said Wendy Guillies, Kauffman’s acting president. Echoing Zandi, she added: “I know the headlines look good, but when you dig a little deeper, something’s not quite right.”

It gets worse. While the rate of business formation has slowed, the pace of business closures, which had held steady over the previous decade, started to ascend in 2005 and spiked in 2008, according to data compiled by the Brookings Institute. Consequently, business deaths now outpace business births for the first time since researchers started collecting the data in the late 1970’s.

The result, as shown below, is that long-established companies represent an increasingly large share of U.S. firms, with those that have been in business for more than five years now accounting for more than two-thirds of companies. Meanwhile, the proportion of companies of every age from one to five years old has shrunk over the past 35 years.

That wouldn’t necessarily be a problem, except that previous research has shown that young businesses account for nearly all net new jobs (job gains minus job losses) created annually in the United States. Older businesses, by comparison, tend to collectively shed from their payrolls almost as many workers as they add.

In addition, new companies tend to continue adding jobs even during economic downturns, while hiring by established businesses has historically ebbed and flowed with the growth and decline of the economy.

What has been ignored by far too many is the impact that small companies have on urban poverty.  By providing solid employment at a better level than the typical service jobs available in the inner cities, the small manufacturers in the inner city make an important contribution to the economy of the cities that they are situated in.  Without those small companies, cites die quickly. Yet it seems like most city governments are all too willing to take the small companies for granted.


But his success is also because of the unlikely survival of Marlin Steel, a rare breed: the urban industrial manufacturer.

Marlin is a thriving factory in a place that, over the last half-century, factories have fled — first to the South, and later to Asia. That flight haunts the United States perhaps most in its urban areas — especially neighborhoods that once housed the nation’s working class — and helps explain why many African-Americans in particular today live in poverty in metropolises like Baltimore, Detroit, Newark and St. Louis.

The idea of manufacturing things maintains a powerful grip on the American psyche in politics and economics, and in the notion that selling burgers isn’t a path to the middle class. It is also at odds with cold, hard statistics.

Despite the candidates’ election-year promises, factories will never employ the masses of Americans they once did. Automation and foreign competition will not abate no matter who occupies the Oval Office. Over the last 20 years, industrial employment has dropped by nearly one-third. Only 12.3 million Americans work in the sector today, millions fewer than in leisure and hospitality, for instance, the category that includes frying chicken at Popeyes.

But small manufacturers like Marlin are vital if the United States is to narrow the nation’s class divide and build a society that offers greater opportunities for everyone — rich and poor, black and white, high school graduates and Ph.D.s.

“The closing of factories has taken the rungs out of the ladder for reaching the middle class in urban areas,” said Robert A. Johnson, a former hedge fund investor who is now president of the Institute for New Economic Thinking, a liberal research group. Many service jobs do not pay as well, nor do they offer the same opportunities for advancement…

For Mr. Branch, this is not abstract economics.

“This changed my life,” he said, standing next to one of the machines he operates, which can cost up to $300,000 each. “I went from minimum wage at Popeyes to making almost 70K a year. They’re proud of me in my old neighborhood. They say I made it out.”

With the rise of Donald J. Trump, much of the economic debate during the presidential campaign has centered on the anger and economics of the white working class in the Rust Belt and elsewhere. That is partly because blue-collar whites were especially hard hit by factory closures in the last decade, largely as a result of competition from China and the savage recession eight years ago.

But it was the black working class that was devastated first, by a decades-long decline of manufacturing employment.

As the sociologist William Julius Wilson has written in his classic studies, “The Truly Disadvantaged” and “When Work Disappears,” the exodus of factories from high-cost, union-dominated cities to cheaper, less union-friendly locales in the South and West in the 1960s and 1970s played a major role in the breakdown of urban cores.

“The trends among non-college-educated, white Americans today look like a lot like the trends among black Americans in the 1970s that so worried policy makers and social scientists,” said David Autor, a professor of economics at M.I.T., who researches the connections among trade, labor and employment. “You see it in the falling labor force participation, the decline of traditional family structure, crime and poverty. It’s all there.”

While some cities, including Boston, Chicago, New York and Pittsburgh, have managed to rebound in recent years, Baltimore remains mired in a cycle of economic and social dysfunction. Unemployment among young black men tops 35 percent, compared with 31 percent nationally, and among large cities, Baltimore experienced the largest percentage increase in murders in the nation over the last two years.

For Marlin and its 24 employees, all of this hit close to home when riots swept the city in April 2015 after Freddie Gray, a 25-year-old black resident of West Baltimore, died in police custody. Stores were looted not far from the industrial park that’s home to Marlin. The police enforced a nightly curfew.

One Marlin employee, Joshua Wallace, an Iraq War veteran who serves in the National Guard, was called to duty and had to patrol the streets instead of manning the computerized cutting machine. The factory’s night shift, which runs seven days a week, was shut down because Marlin’s workers couldn’t come or go after dark.

These businesses are not nice places to work, being typically loud and dirty to places to work. They do provide a livelihood for the people that work for them and make contributions in so many ways to the community that they are in.

When bankruptcies are a real problem, the problem spreads beyond the companies going under to the employees, vendors and customers of those businesses.  Most of the debt these companies take on was not by choice. Instead it was forced on them  as they struggle to survive by the heavier and heavier burdens of trying to meet requirements that come from outside the business.

My own state is a classic test case as to what happens to a state where the people in charge do not understand the economics of the small business.

The reason that the state of Connecticut is littered with “for lease” signs, empty factories and empty lots can be directly traced to the taxing and regulatory policies that stifled and killed the state’s small industrial businesses for decades now.  That has had a dramatic impact on the state’s economy and the ability of the state’s people to make a decent living.


  1. MadRocketSci · November 9, 2016

    One hypothesis that I had about technological advancement and invention (and why so much of it happened here and in England) instead of, say, continental Europe (where there were great scientists and mathematicians, but not anywhere near as often someone like Ford or Edison) is that the reason Americans are so innovative is that they own stuff.

    They by and large owned their tools. They owned their equipment. They owned the means by which they supported themselves. This is important, because you can’t experiment freely with something that isn’t yours. If it’s something that is on loan to you, something that you rent, then you aren’t free to expend it in some risky venture. You aren’t free to tinker with it. You can’t go on a long run of failed experiments if you have to justify your expenditures to a boss that is riding on a razor thin margin of profitability.

    The Wright brothers could not have built an airplane if they worked at someone else’s bicycle shop.

    This is one important reason why small businesses are vital to the future. We may make some limited theoretical breakthroughs in a world without ownership, but we’ll never make physical, technological progress (in any way that benefits individuals: Mankind as a whole, as opposed to their would be masters).

    Anyway, that’s my idea. I’ll have to see if it matches history as I learn more.


    • jccarlton · November 9, 2016

      I think you have a good point. Especially about bicycles and tools. The bicycle was about the perfect size for experimenting on. Also take a look at the machine tool history post.


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