The Economy Crushing Collapse Of Startup Jobs

Economist and Research Fellow, Hoover Institution

Everyone in Washington loves entrepreneurs. Or so they say. Supporting entrepreneurs is about as controversial as fighting poverty and honoring the troops. But in this election, especially with jobs as the top concern, voters will be looking at results, not rhetoric.

President Obama caused his campaign some heartburn in July during an unscripted moment, saying, "If you've got a business, you didn't build that." The gaffe obscured the fact that the Obama administration has trumpeted the importance of entrepreneurs more than any administration in history. His economic team devoted a full chapter to the topic in the 2011 Economic Report of the President. That was the first Report to analyze the importance of startups, and I was surprised and honored to learn that a 2010 study of mine was the first citation.

That study took advantage of new government data to distinguish newborn companies from all others. Historically, the cohort of startups represent about 10 percent of all U.S. firms – 500,000 out of 5 million total. I discovered that those startups create an average of 3 million net jobs every year, whereas the all the other existing companies combined lose a net 1 million jobs. Startup job creation held steady right around 3 million during business cycles until 2009, which was the most recent data back then.

The fact of startup primacy in job creation is as profound as it is new to the political consciousness. For example, it undermines the traditional mission of local economic development offices to lure existing companies to relocate, a zero-sum game. And it raises questions about "saving" jobs when the natural process of productivity is for companies to constantly trim their workforces.

Economists have long suspected that the industrial planning mentality is a dead end. That hasn't stopped Vice President Joe Biden from campaigning about keeping General Motors alive. In fact, the GM bailout was a triumph of special-interest economics that did nothing to help Michigan's entrepreneurs. Did the White House's focus on saving old companies come at the expense of startups?

Just last month, the Commerce Department released new data that allowed me to update my research on startup jobs through 2011. What I found is a U.S. startup scene even more troubled in 2011 than it was when the great recession ended in 2009. There were 170,000 fewer startup firms in 2010 than in 2009. As for the steady 3 million annual startup jobs created in previous years, that number fell to 2.5 million in 2009, then 2.3 million in 2010, and even lower in 2011 based on quarterly data.

Annually, there were 11 new entrepreneurial employees for each 1000 Americans from 1988 to 2008. This startup jobs rate for the three previous presidents was 11.3, 11.2, and 10.8, respectively, which. The rate has fallen by a third to 7.8 during the Obama presidency. Some might blame this drop on the recession, but the rate declined further in 2010 and lower still in 2011, supposedly years of recovery.

This is a puzzle, because it should be easier than ever to start a company in America. Fixed capital costs are much lower for a service-based business than a manufacturing shop. And today's low interest rates means initial financing is a safer risk. So what is holding startups back?

Government regulation could be the reason. In the fall of 2009, the Internal Revenue Service began cracking down on companies that hired American part-time workers without full-time employment benefits. Perhaps the IRS didn't want independent contractors swimming outside the health insurance pool. The theory is that companies are exploiting non-permanent workers, so government should mandate fringe benefits. But can struggling startups afford the extra costs? If not, they will turn to overseas service providers.

Protecting American workers is an admirable goal, but the results so far remind me of the damage that "helicopter parents" can do to their own children. When Washington overprotects the domestic labor force and ties startups in red tape, everyone loses. You didn't build that? Another four years of this policy environment and American entrepreneurs may not be building anything at all.