Declining business dynamism: Implications for productivity?

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Declining business dynamism: Implications for productivity? By Ryan A. DeckerJohn HaltiwangerRon S. Jarmin, and Javier Miranda.

The last few decades have seen a decline in business dynamism, as measured by indicators such as new firm formations, worker flows, and job creation and destruction. This is a potentially worrisome trend because an important driver of productivity growth is the reallocation of resources from less productive to more productive firms. Ryan Decker of the Fed, John Haltiwanger of the University of Maryland, and Ron Jarmin and Javier Miranda of the U.S. Census Bureau use firm-level data for the entire U.S. economy to explore whether a fall in business dynamism has resulted in a decline in productivity growth.

The authors first review the significant fall in business dynamism over time. For example, as Figure 1 shows, there is a clear downward trend in the rate of startups (new firms), and a slower decline in the rate of firm exits. Similarly, over the last several decades, the share of employment at young firms has dropped from 20 percent to 10 percent. They also review recent evidence on declining high-growth firm activity (especially by young firms).

Figure 1: Annual firm startup and exit rates, U.S. private non-farm sector, 1981-2013

fig1

Declining business dynamism: Implications for productivity?

The authors explore the potential causes and consequences of this declining dynamism, and have two main findings. First, using revenue per employee as a measure of productivity, the authors show that the gap in productivity between the most and least productive firms has widened over time. This widening is most apparent in the information sector, a sector that has historically been an important source of productivity growth. Widening dispersion in productivity is potentially a sign that firms are facing increasing frictions in adjusting to their appropriate size, or that the least productive firms are not catching up to the most productive firms as quickly as they used to.

Second, they show that the link between a firm’s level of labor productivity and its rate of employment growth has been getting weaker over time. Whereas in the past more productive firms in the same industry expanded employment while less productive firms contracted, today this is less true. This decline in reallocation from less productive to more productive firms is likely holding down overall productivity growth.

Declining business dynamism: What does it mean for social mobility? byROBERT E. LITAN

Business dynamism has been declining over the past two to three decades in the United States, as a number of papers I have co-authored with Ian Hathaway demonstrate. This decline is manifested in two disturbing trends: more or less steady drops in the “startup rate” (the ratio of firms one year old or less to total firms) and in a measure of employee churn among firms.

Startups, associated with innovation, are unambiguously good for economic growth. Employee churn—movement of workers between jobs—is a sign of both new business creation and growth, but also of a healthy labor market in which workers are moving from areas where demand is weak to those where it is strong.

Business dynamism and economic opportunity

But is a more dynamic economy—with more startups, presumably more disruption, and more movement of people between firms—good, bad or neutral for social mobility and economic opportunity?

We don’t have that more dynamic economy yet, and the one we have already has aroused fears that income inequality will only continue to widen and what might be called “desirable mobility,” or the ability to climb up the economic ladder by gaining more skills and working hard, is becoming more difficult.

In particular, there is a widespread concern, even among many previously skeptical economists, that automation trends “this time”—continuing advances in information technology and robotics—is fundamentally different in character than all previous waves of automation, which lowered costs for consumers without widening income inequalities. This was because workers gained skills at roughly the same rate as technology advanced. So in the aggregate, displaced workers found new jobs—the total number of jobs did not fall as many feared—at roughly the same wages, maybe better.

Declining business dynamism: Implications for productivity?

Automation and downward mobility

The case that current and future waves of innovation, however rapidly they may come, will worsen inequality has been made by some noted economists – including George Mason’s Tyler Cowen, and MIT’s Erik Brynjolfsson and David Autor. In their view, those at the very top, facile in IT skills, do well, while many new low-paying jobs are created to service them. Jobs for workers paying “middle class wages” are disappearing. We are headed, if these trends continue, to an “hourglass” economy, or maybe worse (a 20/80 economy is Cowen’s prediction). In such a world, there may be plenty of mobility, but far more people will move downward than will move upward.

Business dynamism as defense against automation

Does this dystopian future have to come to pass? Federal Reserve Chair Janet Yellen suggested in a recent speech on income inequality that a pick-up in new firm formation—yes, more business dynamism—could spur more upward mobility, at least for founders and their employees. Whether mobility would be enhanced for others will depend on the nature of the new firms that are created and what products and services they sell.

In a global economy, business dynamism is really not a choice. If other economies exhibit more dynamic firm structures and thus faster innovation than us, our firms will either gradually lose out or move their facilities abroad. Either outcome would augur poorly for mobility at home.

Whether the needed turnaround in entrepreneurship rates and education can be accomplished in time to prevent the dystopian futures many fear is the great economic challenge of our time.

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