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The golden age of American entrepreneurship

TechCrunch TechCrunch 30/06/2016 Aaron Chatterji and David Robinson

In an otherwise contentious 2016 U.S. presidential election, there will be one issue on which both candidates can agree: Entrepreneurship is good. Entrepreneurs have been embraced by both political parties, along with a wide swath of the American people, who tell pollsters they trust small business more than almost any other institution.

That is why some of the statistics about the state of American entrepreneurship are troubling. New business starts are declining. More businesses closed than opened last year. Quantitative measures of business formation paint a grim portrait of a supposedly entrepreneurial nation.

These numbers are not just cherry-picked factoids by pundits with axes to grind. These facts are accepted by a broad consensus of mainstream economists working with U.S. government statistics on business startup activity.

On the other hand, if we look only at Silicon Valley, New York or Boston, and other highly educated, high-technology regions, we find an entirely different view of American entrepreneurship. Despite the aftermath of Brexit and some recent reminders that the laws of gravity also apply to startup valuations, entrepreneurship is still incredibly hot.

New companies are being started and funded every day, targeting billion-dollar markets and attracting the best and brightest minds of our generation. The innovations these companies produce will almost surely transform the way that daily life operates. Indeed, the term unicorn, which applies to companies valued at over $1 billion, was initially coined because it signified something elusive, rare — but the term has lost that meaning. With more than 170 private companies with valuations of over $1 billion, we might just be living in the golden age of American entrepreneurship.

So what is going on? How can both sets of facts be true at the same time? How can more businesses be closing than opening (true) during the same period in which smart money will tell you there has never been a better time to start a new venture (probably also true)? The answer lies in which data you are looking at and, more importantly, how you measure entrepreneurship.

Many U.S. government statistical series that count employment in newly started firms suggest that entrepreneurship is declining in the U.S., and has been for a long time. Data from the U.S. Census clearly show that the rate of new firm creation has been steadily declining since the 1970s. While the rate of new firm creation ticked up briefly between 2002 and 2007, it has plummeted in the aftermath of the financial crisis. In the mid-to-late 1970s, there were about 1.5 new firms created for every firm that exited the economy, but after more than 30 years of secular decline in the rate of firm creation, firm deaths now outnumber firm births — and have since the Great Recession.

Entrepreneurship is getting more selective.

However, when we move from simple counts of employees at newly created firms — including the vast majority of small businesses that have low growth potential and little intention to grow — to measures of entrepreneurship that place more weight on innovation, other teams of researchers have found no evidence at all that entrepreneurship is on the decline in the U.S. In fact, the quality of entrepreneurial ventures being started today could be at an all-time high.

The economists Jorge Guzman and Scott Stern at MIT have used state business registration data to zero in on businesses that are formed by founders that intend to grow. Their key insight is that many characteristics observable at firm founding are predictive of the intention to grow.

For example, formal business registration is a mandatory first step for any business with any intention of growing — incorporating in business-friendly Delaware also raises the odds. So does an application to protect intellectual property.

Using these cues, and others, Stern and Guzman build a statistical model that predicts entrepreneurial quality. With their quality-weighted entrepreneurial index, which does a good job of tracking broader economic fluctuations, they find no evidence of a decline in American entrepreneurship.

In short, both of the competing narratives about American entrepreneurship are true because we are witnessing a divergence based on the skill set of would-be founders. Fewer new businesses are being started in aggregate, but the expected quality of the new businesses that are starting is high — possibly higher than ever before. Entrepreneurship is getting more selective.

A sports analogy might help here. It might be intuitive to think that the best way to make more three-pointers in a basketball game is for every player to take more shots from three-point range.  The more shots on basket, the greater the number of points. This logic might seem sensible, but, in fact, the opposite could well be true.

We are maximizing the number of entrepreneurs with great three-point skills who are getting a good look at the basket.

If you’re a Golden State Warrior, you don’t just toss the ball toward the basket from anywhere outside the arc, you pass it to Steph Curry or Klay Thompson. Why? Because even if you’re a Golden State Warrior, Curry and Thompson are much, much more skilled than you at scoring from three-point range (the recent NBA Finals notwithstanding). Fewer total shots from outside the arc, but better shots from a skilled shooter, could actually add up to more points.

So, back to entrepreneurship: Is this good news or bad news?  The answer depends critically on why we think this is occurring, and from whose perspective we judge the outcome.

This divergence in entrepreneurship could reflect a more efficient labor market where would-be lifestyle entrepreneurs, or necessity entrepreneurs, are finding the right job at an existing firm rather than taking a wild shot that’s unlikely to even hit the rim. One way to read the data is that we are maximizing the number of entrepreneurs with great three-point skills who are getting a good look at the basket. These are the entrepreneurs who are most likely to succeed and create jobs for the rest of us.

That sounds good as an economic theory, but most of us have a feeling that all entrepreneurship should not be confined to California, New York, Massachusetts and similar hubs where these growth entrepreneurs are clustering. Moreover, the idea that starting a business is something only individuals living in certain areas or with certain characteristics can do seems antithetical to our nation’s values. The upcoming presidential election has demonstrated that there is a growing sense among the American people that the gulf between the haves and the have-nots is widening.

If all the wealth creation and jobs from entrepreneurship are confined to a few major metro areas, the disturbing trends in inequality, particular across geographies, will become more pronounced. If we now live in a world where ordinary Americans are increasingly unable to start businesses, while a handful of gifted, technological elites find it increasingly easy to start billion-dollar enterprises, we will add entrepreneurship to the growing list of American dreams that now seem out of reach.

So should we celebrate higher-quality entrepreneurship or lament lower quantities of it? As economists, we revert to our stock answer: “It depends.”

If you believe that entrepreneurship is incredibly risky and should only be tried by those who can endure the financial implications of failing, the recent data should not worry you. Alternatively, if you think entrepreneurship represents something bigger than just an occupational choice, and is an expression of liberty that ought to be accessible to every American, then we should focus on strategies to reverse recent trends.

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