At least that's what Brookings Institution economists Ian Hathaway and Robert Litan conclude in the report released on May 5th, 2014, Declining Business Dynamism in the United States: A Look at States and Metros.
By now you've probably read the report, or at least read an article citing it. The report has been so widely circulated and commented on that the authors released a follow-up paper two weeks later in response to all the theories and debates it inspired. If you haven't read the report, Figure 1, reproduced above, sums it up nicely
Business dynamism has been declining for the past 30 years and is declining in all sectors, all states, and in all but a handful of Metropolitan Statistical Areas (MSA) including North Carolina and all of its MSAs.
But how can this be true given North Carolina's rise in entrepreneurial activity rates in 2013 reported by the Kauffman Foundation? It turns out that while similar, entrepreneurial activity and business dynamism are actually two different measures of different aspects of the economy. In this post I'll summarize the Brooking report, look at how NC's numbers compare to other states, and explain the best theories on why business dynamism is declining, and why it matters to entrepreneurs and the entrepreneurial ecosystem (Spoiler alert: entrepreneurs, we need more of you!).
Many economists believe our economy's health depends on business dynamism�the continuous birth and death of businesses�because it fosters the creation of new, better and cheaper innovative technologies, products and services. But why does business dynamism matter to the health of our economy? Good question.
To find out, I asked the smartest economist I know, Karl Smith, Contributor at the Financial Times Alphaville. Here's a summary of his response:
�Business dynamism contributes to our economy by enabling entrepreneurs who come up with a new idea to bring it to market, sharing with consumers newer, better, cheaper products. If the entrepreneur is able to build a large well-known, respected company based on their product, they will likely face competition down the road from another entrepreneur with a newer, better, cheaper product. The incumbent entrepreneur will either be pushed out of the market or to improve their product to better compete. Thus, either way, the consumers receive a newer, better or cheaper product and the economy benefits. That is growth.�
The differences between the two reports are:
1. They measure two different places in time�the recent Kauffman report's data is from 2013, while the latest business dynamism data currently available is from 2011.
2. They use different measures�business dynamism is comprised of three measures�percentage of firms less than a year old (called firm entry rate) percentage of firms that shut down (firm exit rate), and the difference between jobs created and terminated (job reallocation rate). The Entrepreneurial Index only factors new business filings.
3. They have different implications�unlike the Kauffman Index, business dynamism doesn't indicate how well entrepreneurs or the entrepreneurial ecosystem is doing per se but rather is an indication of how startups interact with and influence the broader economy.
Given the importance of business dynamisms, its decline is troubling. But even more troubling, is that it seems no sector, region, state or city is immune from the decline. And it seems the real issue is that firm entry rates have dramatically fallen, while firm exit rates have either risen, remained stagnant or decreased slightly each year.
This means at a national level, we are creating fewer businesses, doing a worse job at moving people from one job to another when they lose or leave their job, and still losing almost the same number of businesses per year.
How North Carolina stacks up
The change in North Carolina's numbers from 1980-2011 is slightly better than the national average and on par with peer states�entry rates dropped 5.7 percentage points, the job reallocation rate dropped 2.8 percentage points and our firm exit rates declined by .30 percentage points.
When we drill down to the MSA level, NC's MSAs remain similar to the national averages, with some MSAs faring better than others, but not one posting numbers significantly better than national averages. For example, Charlotte-Gastonia-Rock Hill's firm entry rate declined the least�4.2 percentage points�but its starting rate was lower than the national average, leaving the 2011 rate only 1.3 percentage points higher than the US average.
NC's highest performing MSAs fared well and sometimes better than peers. For example, the Raleigh-Cary 2011 firm entry rate, 8.8%, was higher than eight of the ten peer MSAs, with only NYC and Austin boasting higher rates.
Overall, the data indicate NC wasn't performing much (if any) worse in 2011 than other peer states and MSAs. On the flip side, we weren't performing much better either.
What is causing the decline?
When I asked Smith what was causing the 30-year decline in business dynamism, he replied, �The most honest answer is, no one knows.�
This uncertainty hasn't stopped pundits and experts from offering up their own theories. From �It's all Obama's fault,� to �It's all big-box retailers and restaurants like Starbucks and Wal-Mart's fault.� There's no shortage of theories.
In their follow-up paper, Hathaway and Litan address and caution against the theories that have popped up, suggesting the cause is likely more complex or the combination of several factors. They offer a few slightly controversial solutions worth checking out, but since they're mostly national-level strategies or policy goals, I won't go into them here.
Why it all matters to you
One could, and some will, argue that declining business dynamism doesn't matter. Certainly, the fact the data is dated could make one think this discussion is a waste of time. It's possible the downward trend continued in more recent years, or it could have reversed. But we won't know for sure until 2013's data is released in 2015.
We all can point to changes we've seen in NC's entrepreneurial scene the past few years, especially in the Triangle. In 2011, ExitEvent and HQ Raleigh didn't exist, American Underground was only a year old, and many support organizations, programs and events either didn't exist or were just starting.
According to Smith, the time delay is likely due to the lengthy process of cleaning and prepping the data for release. At a minimum, the delay makes it challenging to strategically plan how to best foster entrepreneurship or address declining business dynamism.
But data aside, how does this impact you, the entrepreneur? Because it prompts the question, if you're an entrepreneur, is it really better to try and fail than never to try at all?
For the betterment of the economy�probably. For you personally�it depends.
When firms like Argyle Social fail, the benefits the economy and our community would have lost if it had never been started in the first place are obvious. It offered a great product and pushed innovation in the field despite shutting down in May.
Did Argyle Social's founder and employees benefit from the failure? That's something to ask them. But I imagine they benefited from the firm's existence.
But what if a startup fails because it wasn't a good startup to begin with? Does the marginal benefit the firm's failure has on the economy outweigh the resources invested in its formation? My guess is economists would say yes, and indeed, the Brookings economists argue we need more entrepreneurs to increase the probability of a few becoming big, successful companies. But I can't personally get behind an economic strategy of throwing everything at a wall to see what sticks.
What might work?
In my opinion, encouraging anyone and everyone to start a business isn't a strategic or efficient way to address declining business dynamism. I would lean towards supporting strategies that encourage and foster an ecosystem conducive to assisting entrepreneurs with good ideas, products or services succeed. If that sounds familiar, it should. You live in an area with a lot of people dedicated to doing just that.
As for entrepreneurial support organizations, funders and investors, especially those in the Triangle, don't let the reported decline discourage you. Since our entrepreneurial activity rates rose in the Kauffman Index in 2013, I would predict we'll see NC's firm entry rates rise when we see the 2013 data.
Until then, I'd suggest continuing doing what you're doing and expand or teach others to do the same things.
If the downward trend continues, the need for more strong entrepreneurs is even greater than we imagined. But even if the trend has reversed or slowed� and I predict it has�it can't hurt to have more entrepreneurs with good ideas.
Even if we try but fail at this task, I'd bet it's better than not having tried at all.