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Where Have All the Start-Ups Gone?

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Robert Samuelson, in his columns for the Washington Post, has done wonders in explaining stuff to econ idiots like yours truly. Lately, he has called attention to the economy’s lousy productivity growth (we’ve been puttering along at 0.9 annual growth) and the striking decline in U.S. entrepreneurship, as measured (principally) by business formation.Those trends are closely associated, and neither is explained by the great recession. What’s happening?

Among the usual suspects is run-away regulation. At some level and in some respects that has to be right. For the administrative state, things that move are The Enemy, and things that sprout up suddenly raise heightened suspicion. Hence, we’re licensing flower arrangers and yoga instructors; and even if we do it P.J. O’Rourke’s way (link no longer available), that can’t be good for business formation and productivity. But is it true in general—“Is Regulation to Blame for the Decline in American Entrepreneurship?”

Nathan Goldschlag’s and Alexander T. Tabarrok’s intriguing article by that title provides a surprising answer: no. More precisely, there doesn’t seem to be much evidence that increased federal regulation over the past decades has much if anything to do with declining rates of business formation or, more broadly, declining economic dynamism.

I suspect that the authors’ measure of regulatory stringency, for all its considerable sophistication (and it’s very impressive), may be missing something. For example, it could be the case that over a fairly wide range, the key variable isn’t regulatory stringency (the regulators are just re-pricing transactions on some margin) but uncertainty. The authors’ conclusion suggests additional lines of inquiry:

To the extent that Federal regulation is not the cause of declining dynamism, attention should flow to other sources of regulation such as state legislation and judicial regulation through the common law. Greater attention should also be given to deeper forces that may reduce dynamism such as a slowdown in the technological frontier that reduces the flow of new ideas ready to be profitably implemented. Technology, especially information technology, may also be changing the nature of dynamism in ways that are difficult to measure. The restructuring and rearranging of large firms, for example, can greatly improve the allocation of resources but is not currently well measured. The integration of business dynamic statistics globally would also give us a greater grasp on global dynamism, which may be increasing even as measured national dynamism decreases.

Complicated stuff, and hugely important.

Reader Discussion

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on April 16, 2015 at 09:16:30 am

It's an interesting idea (doubly so as I work in the tech field, and see the idea of technology being difficult to measure firsthand - we're not entirely sure how to even measure our impact internally), but I wonder, too, if the loss in entrepreneurship isn't also related to capitalization.

Banks aren't loaning for new business, venture capitalists generally also buy as well as build - so promising startups fold into 'mama' holding companies almost as fast as the venture capital arrives - and small business expansion capital is still fairly nonexistent as bank regulations still favor large business over small.

Working with an ESOP provider, we've found tightening capitalization across the small business sector - you can't get a bank terribly interested in a loan under five or six million dollars. What room is there in that for a sub-quarter-million small business loan?

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Shannon J. Lane
on April 16, 2015 at 11:05:52 am

Why a decline in new start-ups? Some hypotheses:

1. The market segments which have historically hosted most start-ups have undergone systemic changes:

A. Many traditional new firms were in retail. Economies of scale – Walmart, Amazon, etc. – have crushed small retail firms. The price of collectables, and thus the margins, has been decimated by internet sales.

B. Many traditional new firms were in repairs. Now, globalization has depressed the price of things without depressing the price of local skilled labor. Consequently, unless we’re talking about a home or car, we simply don’t repair things anymore; we replace.

C. Other traditional small-business operations included travel agents, real estate agents, video rentals, etc. The internet has crushed these businesses, too.

D. For what it’s worth, health care reimbursement rules used to reward medical care providers for organizing their own stand-alone ambulatory clinics. Behold, we observed the growth of stand-alone ambulatory clinics. These reimbursement rules have changed. Behold, we observe hospital buying out the stand-alone ambulatory clinics. Same number of health-care providers serving the same number of patients – but now, fewer “start-ups.”

2. Changes in capital markets -- or, what Shannon J. Lane said. As we entered into the longest bull market in history, lenders would finance anything on the theory that, "in a stiff wind, even turkeys can fly." After the collapse, lenders have more capital than ever, but tighter lending criteria. This means that big firms can borrow virtually for free, while start-ups can't borrow at any price. I have to suspect that this degree of risk-aversion is just a transitory phase, but who knows?

3 The data reflects a measurement error. New firms are simply harder to recognize. When I start re-selling used clothes on eBay, driving for Uber, caring for my elderly parents, or get lured into prostitution because the internet makes it easier and safer, economists neglect to count it as a new business.

4. The analysis of the data is skewed. Maybe there are as many or more start-ups as before, but there’s more churn in the start-up world. Entrepreneurs start a firm, then close it to start another, and again, and again. The total number of firms doesn’t change, but the age of firms existing at any one time continues to bifurcate. That is, established firms get older; start-up firms don’t.

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nobody.really
on April 16, 2015 at 11:37:17 am

We are living in an age where Private Enterprise is encouraged and Free Enterprise is discouraged. The powers that be frown on "independent" "mom and pop" or even small businesses,especially if they deal in a lot of cash. Larger corporations and corporations in general are easier to tax,regulate and control. Corporations,which are an artificial entity,and a creature of the state,are today common place in even the smallest of "mom and pop" and one man businesses. While 50 years ago corporate status in most small businesses was very rare. This corporate entity is encouraged by governments,insurance companies,lawyers and accountants to "protect" the individual businessman. But in reality it gives more control to the state,it's regulators and it's tax collectors. When you trace the growth of the state you can also trace the decline in the growth of truly independent small businesses. Most,but not all,of such entities as drug stores,hardware stores,convenience stores,fast food operations,super markets and a plethora of other enterprises that were either individually or family owned and operated have been replaced by mega-corporate chains and franchises. The only area of enterprise that has really grown over the last 15 or 20 years is the "underground" or "off the books" economy. This segment of the economy has been forced upon these owner/operators by the state because of draconian taxes and regulations. It is the only way they can survive. The end result of today's business climate is a general increase in size and wealth of the nonproductive Political Class and a lowering of the standard of living for the productive Economic Class, In essence,it is every elitist and socialist's dream come true.

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libertarian jerry
on April 16, 2015 at 11:53:26 am

Nobody:

Excellent analysis.

Let me ask you something regarding start-ups, at least a subset of them.
Consider a pharmaceutical start-up. It has a product that may be effective in ameliorating some severe condition.
It has some promising theoretical work / testing behind it. It comes to pass that they fell they are ready to enter into the byzantine world of FDA testing. This will involve a good number of years of closely regulated observations, trials, etc.
It does not have the capital to fund these activities. The banks are reluctant to fund this venture as the cost of, say, $15 million, is small and does not present a large enough return for the bank. Ultimately, the start-up is bought out by Big Pharma.

Would you say that regulation played a part in the demise of this start-up?
None of this is to argue against your points above - I believe that they are quite valid. Yet, I think they may be dismissive of some of the real barriers to entry that current regulations present to certain start-up ventures. (Incidentally, I base the question upon the personal experiences of some friends involved in the development of what are today some fairly common drugs).

What say you?

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gabe
on April 16, 2015 at 13:45:34 pm

Would you say that regulation played a part in the demise of this start-up?

I would. I share the view that regulation can depress a variety of transactions, all else being equal, and probably this burdens smaller firms more than larger ones. So in evaluating regulation, we need to compare the anticipated benefits to the anticipated burdens.

Yet this has always been true. When Obama was putting together his stimulus package in 2009, I recall a survey showing that businessmen, when asked, “What is the biggest obstacle you face?”, identified “Taxes and regulation” more than any other answer. This fact was cited as evidence that the stimulus package was misguided (even though a third of the package consisted of tax reductions).

But then I read an article showing “Taxes and regulation” had been the top answer of businessmen since time immemorial, regardless of the economic or regulatory climate. In contrast, what was new in the 2009 survey was that the answer “Lack of customer demand” was now nearly as common as “Taxes and regulation” – and a stimulus package would be precisely the policy to boost demand.

In short, it appeared that the survey was not well designed to measure businessmen’s concern with taxes and regulation, because they gave the same response regardless of stimulus. This answer was like a guy driving down the highway with his left turn signal on: The driver may in fact intend to turn left, but the signal really provided no evidence on this question. In contrast, the answer “Lack of customer demand” did vary depending on circumstances – and thus, this answer provided meaningful information.

To rephrase, if we want to explain changes in start-up activity over time, we need to see correlations with changes in other variables over time. A static observation that “regulation tends to depress transactions, all else being equal,” isn’t very helpful for explaining dynamic variables.

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nobody.really
on April 17, 2015 at 09:00:50 am

Places where there may be lots of regulation but are relatively stable will still have manageable risk. Places where regulation may be on the whole lower but variable, with higher degrees of discretionary political decision making going on, will foster uncertainty--especially political uncertainty. I think Higgs' analysis of Crisis and Leviathan may well be applicable to our situation here in the US, and the unfortunate aspect of this for policy analysts is that this is incredibly hard to measure.

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Hans Eicholz
on April 17, 2015 at 12:44:26 pm

I'm told Australia's parliamentary-ish system does not suffer the kind of gridlock we observe in the US. The coalition in power will generally be able to get its agenda passed.

However, control in parliament changes constantly. So instead of gridlock, Australia experiences decisive movement to the left followed immediately by decisive movement to the right, again and again and again, After experiencing the ping-pong match, people long for a stretch of good, ol' fashioned gridlock!

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nobody.really
on April 17, 2015 at 15:02:40 pm

And that is a rather nice critique of Buckley's book advocating Parliamentary government.

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gabe
on April 19, 2015 at 17:50:09 pm

"Startup" is a term with implications, often taken for innovations and novelties, improvements, etc.. But, that is a limiting view. Perhaps the bulk of "startups" are replications of existing activities.

So, lets look at what is involved in all - motivation.

Are we considering (or disregarding) the changes that have occurred and continue to occur in the factors that shape the formation of individual motivations in the members of the various segments (classes, if you prefer) of our society.

In some segments (crucial as to skills and intellect) have the factors trended toward participation in organizational systems in the formation of individual motivations?

From what "roots" of formations of motivations did preceding instigators of "startups"
did previous individuals come? Do those "roots" no longer produce those fruits; or have the roots been displaced?

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R Richard Schweitzer
on April 20, 2015 at 12:06:58 pm
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nobody.really
on April 20, 2015 at 14:12:13 pm

Yep, that was "muddy" to put it mildly. Let me revise the last paragraph:

From what "roots" of *formations* of motivations of preceding instigators of "startups" (via those previous individuals) come? Do those "roots" no longer produce those fruits; or, have the roots been displaced?

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R Richard Schweitzer
on April 21, 2015 at 20:44:09 pm

Goldschlag and Tabarrok's analysis is fundamentally flawed because their measure of federal regulation is flawed.

Goldschlag and Tabarrok rely exclusively on RegData, which is an analysis of the Code of Federal Regulations by McLaughlin and Al-Ubaydli at George Mason University. RegData attempts to quantify the severity of regulation of particular industries “based on the actual content of regulatory text.” But to accomplish this goal, it does little more than “count the number of binding constraints or ‘restrictions’—words that indicate an obligation to comply, such as ‘shall’ or ‘must.’” In other words, it ignores meaning and context.

While RegData is an improvement over previous methods that simply counted the total number of words in various regulations, it is still incapable of assessing the market impact of various regulations. As an example, Goldschlag and Tabarrok themselves cite the case of the interstate trucking industry:

We usually think of trucking as having been deregulated circa 1977-1982 but that was primarily price deregulation. The index suggests that in most respects trucking remains a highly regulated industry.

Yet the interstate trucking industry (along with the air transport industry) experienced significantly greater dynamism after “having been deregulated circa 1977-1982.” Aircraft manufacturing, which is a similarly heavily-regulated industry, has instead continued to consolidate and atrophy.

The type of regulation matters. Regulations which prescribe best industry and operational practices — in other words, practices which a well-managed company might likely employ on its own initiative — have little effect on dynamism. Regulations which restrict innovation and competition or which attempt to direct economic outcomes (“picking winners and losers” or “leveling the playing field”) can have catastrophic effects, particularly on new entrants.

Economist's Phil Gramm's recent Wall Street Journal op-ed, What’s Wrong With the Golden Goose? offers a far more accurate (if less pedagogical) perspective on the connection between government regulation and economic dynamism.

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Glen

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