The Slow-Motion Collapse of American Entrepreneurship

The experts tell us new business start-ups will save the American economy. So how come there are fewer and fewer of them?
July 10, 2012 |
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"For all its current economic woes,” the Economist magazine recently asserted, “America remains a beacon of entrepreneurialism.” That idea is at the heart of America’s self-image. Both parties celebrate entrepreneurial small business as the fount of innovation and growth. Even if America no longer manufactures its own smartphones or computers, we cling to the idea that American entrepreneurs invent most of the new products and services that matter to the world.

Americans also view entrepreneurialism as a vital route to upward mobility—a way for average people to build wealth, in the form of a business venture that can be passed on to one’s children or sold upon retirement. Whether it’s the family farm or the local diner, small businesses have traditionally provided citizens not only with income but also with a place to teach kids the value of responsibility and hard work.

Then there’s the role entrepreneurs play in creating jobs. One recent study by the Small Business Administration (SBA) showed that businesses with fewer than twenty employees were responsible for more than 97 percent of all new jobs between 1988 and 2004.

More broadly, Americans have traditionally seen entrepreneurship as a crucial measure of the nation’s political vibrancy and liberty. We hold that the more independent citizens we have, the more widely power, responsibility, and voice will be distributed, and hence the stronger our democracy will be. The basic thinking here was best expressed by James Madison more than 200 years ago, when he wrote that the “greater the proportion” of citizens who are their own masters, “the more free, the more independent, and the more happy must be society itself.”

Yet how much does this faith in the vigor of American entrepreneurialism stand up to scrutiny? To a casual news consumer, it might seem that it has never been easier to launch and grow a new venture. One highly publicized study claimed that the United States leads all major industrial economies in the percentage of the adult population engaged in entrepreneurial activity. “We are in the midst of the largest entrepreneurial surge this country has ever seen,” a CNNMoney article tells us. Or, as the Council on Competitiveness has observed, “One of the critical drivers of America’s economic dynamism and flexibility has been the strength of its entrepreneurial economy.”

Last summer, however, a report by the Ewing Marion Kauffman Foundation exposed a big crack at the base of this widely held belief. “Even before the overall economy started its most recent downturn,” the authors noted, the number of business births had already “peaked.” Worse, with the onset of the Great Recession these numbers began to “plummet,” with the number of new independent employers dropping 27 percent in only three years.

This spring Kauffman followed with a second report that was in many ways even more dire. Compared to a generation ago, the report said, it is now much harder to start a business in America and keep it running. In 1980 “young firms”—those less than five years old—accounted for almost half of all going concerns. By 2010, their share of the total had collapsed to less than 35 percent. And as the Kauffman authors made clear, this doesn’t only mean less opportunity for America’s entrepreneurs. It also means millions fewer jobs every year, and much less economic growth.

Inspired by Kauffman’s report last summer, we set out to examine for ourselves the health of America’s entrepreneurial economy. What we discovered is that the decline in entrepreneurship is even bigger and more systemic in nature than was clear from Kaufmann’s work. America really is undergoing a radical change in the structure of our political economy. And yet this revolutionary shift of power, control, and wealth has remained all but unrecognized and unstudied by the mainstream media, Capitol Hill, the White House, state legislatures, and both party machines.

A good way to begin getting a sense of the magnitude of the drop-off in entrepreneurship—and its potential significance—is to examine the number of new “employer businesses” created every year, as compiled by the Census Bureau. The Census defines employer businesses as proprietorships, partnerships, and corporations that have at least one paid employee. In other words, we’re not talking about the midlevel executive turned “consultant,” not the nanny who pays taxes, not the part-time potter puttering around Etsy.

According to the Census Bureau’s raw data, the total number of employer businesses has grown continuously over the last three decades. When we focus only on this one number, we get an image of slow and steady expansion in the ranks of entrepreneurs. Which is why this figure is used so often to buttress claims of the nation’s entrepreneurial health.

The problem with this picture, however, is that it does not account for the fact that between 1977 (the first year the Census captured this “employer business” data) and 2009 the working-age population in the United States increased by seventy-five million people. If we adjust for this expansion, a much darker picture emerges. New business formation in America is revealed to have actually fallen dramatically over the last generation.

In 1977, Americans created more than thirty-five new employer businesses for every 10,000 citizens age sixteen and over. By 2009, however, Americans were annually creating fewer than eighteen such businesses, a 50 percent drop. While the Great Recession clearly cut into new business creation, the decline was clear well before 2007. The averages across decades capture that decline: between 1977 and 1989 Americans created more than twenty-seven new businesses for every 10,000 working-age citizens. This compares to fewer than twenty-five in the 1990s and around twenty-two in the 2000s. In and of itself, this decline in the number of new employer firms does not prove that the average American citizen is less able or less willing to launch a new business. A greater percentage of our entrepreneurially minded citizens might, for instance, be content to work as one-person operations. Indeed, in recent years we saw the rise of a new form of entrepreneurial hero—the self-employed “freelancer.” In the well-known phrase coined by business guru Dan Pink in the late 1990s, America was to become a “free agent nation,” in which individual citizens voluntarily choose the flexible work arrangements that come with solo gigs and short-time contract arrangements.

Here, too, we decided to test the common perception—repeated endlessly in the business press—against actual Census Bureau figures, once again adjusting for the growth in the working-age population. And here, too, we found that the official statistics contradicted the theory—at least as it applies to the population as a whole.

Data kept by the Small Business Administration, for instance, shows that the share of the working-age population that is self-employed has been declining since 1994. The share fell steadily until 2002, stayed level between 2003 and 2006, then began to drop again. Overall, between 1994 and 2009, the share declined nearly 25 percent.

This drop in the number of self-employed citizens relative to the overall working population is also captured by the Bureau of Labor Statistics, which isolates nonfarm workers. The BLS survey asks workers if they are employed by a private company, a nonprofit organization, or the government, or are self-employed. Self-employed workers are further separated into those who have incorporated their businesses and those who have not.

According to the BLS, the number of Americans who are both self-employed and not incorporated has fallen significantly as a share of the working-age population, from 461 per 10,000 in 1990 to 359 in 2011. This decline—more than 22 percent—reversed a long trend in the opposite direction during the 1970s and ’80s. The BLS data shows a somewhat different picture when it comes to self-employed persons who incorporate their businesses. As a share of the working-age population, their ranks grew 35 percent between 1989 and 2008, before dropping off sharply in 2009. Yet this increase in incorporation may be evidence not so much of rising entrepreneurship as of existing unincorporated one-person firms deciding to change their legal status—to take better advantage of new limited liability laws in many states, for instance, in order to cut their tax bills.

Even if we accept this number without question, however, the total share of the self-employed dropped steadily over the last two decades. In 1994 there were roughly 663 self-employed (incorporated and unincorporated) for every 10,000 working-age Americans; by 2009 this number was down to 606, an 8.5 percent decline.

If anything, there’s good reason to believe that this decline in entrepreneurship is even steeper than government data shows, thanks to what appears to be systematic miscategorization by the government of what counts as a true independent company. Since the 1990s, large companies have increasingly relied on temporary help to do work that formerly was performed by permanent salaried employees. These arrangements enable firms to hire and fire workers with far greater flexibility and free them from having to provide traditional benefits like unemployment insurance, health insurance, retirement plans, and paid vacations. The workers themselves go by many different names: temps, contingent workers, contractors, freelancers. But while some fit the traditional sense of what it means to be an entrepreneur or independent business owner, many, if not most, do not—precisely because they remain entirely dependent on a single power for their employment.

Consider, for instance, how FedEx Ground has long treated the men and women who drive its trucks. The company obligated the drivers to lease FedEx trucks, to wear FedEx uniforms, and to deliver FedEx packages along routes assigned by the company. Then the company insisted on classifying the drivers as independent contractors, a status that enabled FedEx to protect itself against unionization and to avoid paying benefits.

Over the years, FedEx Ground’s treatment of its drivers was the subject of protracted—and highly public—legal battles. Yet the Census Bureau never made any attempt to adjust government statistics to distinguish these drivers (and the legions of other similarly “independent” workers who depend entirely on a single employer) from the upstart entrepreneur who designs a new sports shoe or opens a new restaurant or founds a biotech firm. Since 2010 FedEx Ground has moved away from the independent contractor model, and the company now requires its drivers to register as corporations. Even those drivers who might have been counted as wage and salary workers before are now counted as independent small businesses.

The conclusion is clear. We see a sharp decline in entrepreneurship across the board, among new employer firms and one-person shops. And at least when it comes to employer firms, this decline traces back more than thirty years, to the late 1970s. The drop-off in entrepreneurship in America, in other words, is big, and it is fundamental.

So what explains the steep decline in American entrepreneurship? Some might point to high taxes. Yet tax rates have generally gotten lower during exactly the period when entrepreneurship rates have been in decline. Others would finger oppressive regulation. And certainly there’s little doubt that poorly conceived government regulation can make it hard for entrepreneurs to get ahead or just to stay in business. In one recent example, a county health inspector in California threatened to shut a twenty-year-old farmers market because the nearest restroom was 220 feet away, rather than the 200 feet stipulated by law.

Yet it’s hard to hold “regulation” per se responsible for the dramatic decline in entrepreneurship we’ve witnessed over the last generation. Indeed, from a regulatory point of view, in many respects it is now easier than it has been in decades to start a new business. Not only has the Internet simplified the tasks of tracking regulations and interacting with regulators, but many states now offer one-stop incorporation services.

Another common explanation for the decline in entrepreneurship is technology. Over the last generation, digitization has displaced many independent businesses—think travel agencies, bookstores, and record stores. Moreover, technology creates an opportunity to combine many smaller businesses into a few giant concerns—as, for instance, when a single online retailer like Amazon takes advantage of the fact that the Internet destroys all traditional geographic constraints to create a nation-spanning book sales monopoly. Yet here again, on balance, it’s hard to blame technology for a decline of this magnitude. For one thing, many of the most celebrated start-ups in recent decades have been in high-tech fields. More important, many of these new digital technologies—like automated bookkeeping programs and wireless credit card readers—have made it far easier for other small operators to get into business and to keep going.

Two other possible explanations for the decline are harder to dismiss.

Perhaps the most common complaint among small business entrepreneurs is a shortage of financing. While the rise of the venture capital business might give the impression that financial support for entrepreneurs has never been easier to obtain, the truth is that only a tiny fraction of start-ups have access to venture funds. To get their businesses up and running, the vast majority of entrepreneurs today tend to rely at first, as they always have, on a combination of personal savings and contributions from family and friends. But with family balance sheets ravaged by stagnant wages and skyrocketing costs for health care and higher education, fewer and fewer average families have the savings needed to invest in a small business.

The effects of the radical consolidation in the banking industry that began in the 1980s are equally dramatic. Relatively few bank officers today have the leeway and local knowledge to lend to established local businesses, much less new ventures. This is especially true in bad times, when big institutions come under great pressure both from Wall Street and regulators. In Maryland, for example, Bank of America made 312 SBA-guaranteed loans to local businesses in 2007. In 2010, it made two. Consolidation also concentrates the power of a few financial institutions over small businesses, and radically raises the risk that entire funding systems can collapse all at once. The near breakdown of CIT Group in early 2009—averted only by a last-minute deal with bondholders—would have cut more than a million small businesses off from some of the most important forms of day-to-day business financing.

The single biggest factor driving down entrepreneurship is precisely the radical concentration of power we have seen not only in the banking industry but throughout the U.S. economy over the last thirty years. This revolutionary remaking of almost every economic activity in the nation was set in motion in 1981, when officials in the Reagan administration all but suspended traditional enforcement of America’s antimonopoly laws, a change in policy then adopted by every subsequent administration. Since then, regulators have done almost nothing to stop the great waves of mergers and acquisitions, with the result that control over most major economic activities is now more consolidated than at any time since the Gilded Age.

The effects have been nowhere more dramatic than in those sectors that have always been most congenial to individual proprietorships, like retail, services, farming, and small manufacturing. These were the activities most affected, for instance, by the type of “roll-up” strategies pioneered by financiers like Mitt Romney’s Bain Capital. In the case of the office-supply retailer Staples, Bain’s investment helped propel the company from a one-store operation to a 2,000-store international behemoth. Similar plays resulted in Home Depot capturing a vast proportion of the nation’s hardware business, in Best Buy capturing a vast proportion of America’s electronics business, and in Macy’s capturing a vast proportion of all department store sales. Just one company, Wal-Mart, now controls upward of 50 percent of some lines of grocery and general merchandise business—commerce that a generation ago was divided among tens of thousands of families.

Indeed, the decline of small business documented here appears to confirm that the great social experiment undertaken a generation ago—when we allowed our government to cease enforcement of our antimonopoly laws—has had a devastating effect not only on our democracy but also on the ability of ordinary Americans to build their assets and move up the socioeconomic ladder through enterprise. The loss of job creation that comes with the hollowing out of America’s entrepreneurial sector also goes a long way toward explaining why American businesses were creating fewer and fewer jobs even before the Great Recession hit. The founding generation was right: as America’s entrepreneurs go, so goes America’s prosperity and democracy. If we are ever to recapture the promise of this land, we must first break down the great powers that crush the individual citizen’s initiative and ability to create and build what is new and better.