Has US business dynamism declined?

In the popular imagination, the U.S. is often envisioned as an entrepreneurship-based economy with a startup-friendly culture that celebrates the forces of creative destruction. Such an archetypal vision of the U.S. economy may no longer reflect reality. The U.S., while still a global leader in innovation and knowledge creation, has in recent years experienced a decline in business dynamism that has generated widespread concern. If business dynamism is reflected by the pace and scale of the perpetual churn in business activity (entry of new businesses and exit of others and high level of job and labor market turnover), then the U.S. economy has clearly lost some of its sparkle.

Well before the COVID-19 shock, economists had highlighted the steady decline in business dynamism and expressed concern over the resultant consequences for the U.S. economy. Economic research had shown that, even as the pace of business closures had remained relatively steady, the rate of new business formation had plummeted over the past four decades. A troubling slowdown in geographical mobility and a disturbing decline in labor market fluidity further contributed to waning business dynamism. The decline in business dynamism adversely affects long-term U.S. economic prospects as it limits efficient allocation of labor and capital and reduces the pace of innovation and productivity growth.

Rising market concentration and reduced competition, lobbying and growing regulatory burden, excessive occupational licensing, zoning and land use restrictions, the rise of information and communication technology, financialization of the economy, persistently low interest rates and the emergence of zombie firms have all contributed to the decline in U.S. business dynamism. Intriguingly, economists have also noted that the growing burden of knowledge results in large, well-established firms becoming more attractive vis-à-vis startups or small firms to highly qualified researchers. This has resulted in fewer new firm entries in the high-tech arena. Increasingly limited prospects for success and the high failure rate associated with the rise of an “Entrepreneurship Industry” have also been flagged as factors impeding business dynamism.

While there are no simple or quick fixes when it comes to reinvigorating America’s startup culture and galvanizing entrepreneurs or boosting labor market fluidity and geographic mobility, there are several steps that can be taken on the policy front to enhance business dynamism. Creating a more level playing field by reducing entry barriers for new startups and, more broadly, increasing the level of competition is crucial. This requires a fundamental rethink of existing antitrust and intellectual protection policies and enforcement mechanisms as these favor large and powerful incumbents. Furthermore, reform of underlying institutional and regulatory framework is necessary to create a shift towards a simple, smart and effective regulatory regime. Research suggests that not all regulations are bad. However, inefficient, complex and costly regulations are particularly harmful to small businesses and startups. 

In addition to key structural reforms, in the near- to medium-term, the heightened level of uncertainty generated by the COVID-19 pandemic adds an extra layer of difficulty for policymakers. Viewing the crisis as an opportunity to reform and improve the unemployment insurance system can provide a long-term boost to business dynamism. 

Tackling NIMBYism by reforming zoning and building laws to increase the supply of affordable housing in major urban clusters can enhance labor mobility and boost job turnover over the long run. Additionally, the pandemic offers a unique opportunity for firms, workers and public officials to reconsider fundamental assumptions regarding agglomeration and clustering effects and the future role of cities in an increasingly knowledge-based economy. There is a possibility that previously successful urban clusters may struggle to fully recover their luster in the post-pandemic era. This could significantly affect the extent of geographic concentration of economic activity going forward.

Monetary policymakers at the Federal Reserve need to be cognizant of the long-term implications of their policy actions. Commitment to sustaining near-zero interest rates for long periods of time has the potential to adversely affect U.S. business dynamism by propping up so-called zombie firms. The pandemic offers an opportunity to consider reversing the trend towards ever greater financialization of the U.S. economy that has been observed over the past four decades. Excessive focus on short-term profits and reliance on cheap credit and debt accumulation to sustain unbalanced and consumption-driven growth posed a threat to the U.S. economy even prior to the pandemic, and, will likely create future challenges in the absence of key reforms. 

As the U.S. economy continues to deal with the consequences of the pandemic, there is considerable uncertainty regarding the extent to which business dynamism will be affected. The closure of many small businesses and the expected conversion of some temporary layoffs into permanent job cuts may force those affected to engage in new entrepreneurial ventures. There is also a distinct possibility that big firms might become even more entrenched after the pandemic as they come out the crisis largely unscathed and retain or grow their dominant market positions. Resilient and flexible firms that are capable of offering work-from-home options to their employees may prove to be very attractive to highly skilled workers. The pandemic shock may have a lasting impact on business dynamism if it deters many talented and highly skilled workers from engaging with risky new entrepreneurial ventures, and, instead, encourages them to seek out careers at dominant and well-established firms that are able to offer job security as well workplace flexibility.

Vivekanand Jayakumar is an associate professor of economics at the University of Tampa.