Will American entrepreneurial dynamism continue to rebound after the Covid-19 pandemic? Or, will it revert to the pre-pandemic downward trend?
Those are the basic questions posed by an excellent recent report by the Economic Innovation Group (EIG). There are two presuppositions embedded in those questions. One is that American entrepreneurial dynamism was in decline prior to the pandemic. Another is that, perhaps paradoxically, that decline reversed over the last two years.
What Is Entrepreneurial Dynamism?
The EIG report doesn’t actually use the phrase “entrepreneurial dynamism.” Their lens is a bit broader: economic dynamism writ large. That larger frame includes overall demographic trends (namely, population aging), the rate at which Americans move from one part of the country to another (interstate migration, falling for decades), and a general notion of “sclerosis.”
The most interesting—and controversial—part of economic dynamism is the entrepreneurial component. It’s difficult to dispute demographic trends; those can be seen in population statistics on births, longevity, and more. Interstate migration is also tough to argue with. The Census Bureau tracks data on state-to-state and county-to-county moves. It can be counted and tracked in a straightforward way.
Entrepreneurial dynamism is not so easily monitored. Why? There is some disagreement about what data does and does not mean. When a baby is born, it’s registered with the government, a Social Security number is assigned—hard to argue with. A business “birth” is not so clean (see below).
In general, however, entrepreneurial dynamism can be defined as the continuous in-and-out, up-and-down of firms. Businesses start, businesses close, businesses grow, businesses shrink, and so on. Job creation, wage growth, innovation, and prosperity depend, to an enormous extent, on entrepreneurial dynamism.
Was Entrepreneurship Declining Prior to Covid-19?
By some measures, unquestionably yes. By others, maybe not.
The EIG report relies, as many researchers do, on the Business Dynamics Statistics (BDS) data from the Census Bureau. This is excellent data. The “startup rate” derived from the BDS captures the number of “age 0” firms (in the statistical parlance) as a share of the total number of firms, of all ages. Use of the word “startup” here is slightly at odds with how it is used in popular discourse to refer, usually, to a venture-backed or technology-based young firm. One can often find 10-year-old “startups.”
It’s not entirely clear, too, just how new these “age 0” firms are. The Business Formation Statistics (BFS), also from Census, track something called “firm formation within four [and eight] quarters.” Out of the mass of employer identification number (EIN) applications, only a certain share eventually have employees. That’s what gets captured in the BDS data. Prior research, also based on Census data, has found that around one-third of employer firms that appear in the data each year are transitioning from the population of nonemployer firms.
Data on firm starts and exits are laboriously tabulated by Census statisticians from tax records and it is no small feat that the BDS and BDS exist. Necessarily, because they’re attempts at clean, usable datasets, they obscure a lot of the ferment, false starts, and failure that can precede the official creation of an employer business.
The startup rate calculated from BDS data, as shown in the EIG report, was declining for years prior to Covid-19. (The current BDS data go through 2019). As the EIG report points out, there was also considerable decline among high-growth firms. From this vantage point, entrepreneurial dynamism was diminishing prior to the pandemic.
Other researchers, using incorporation data, found the opposite. Looking at the quality as well as the quantity of new businesses, these researchers found that “entrepreneurial quality” is much more cyclical than the BDS data indicate. And, levels of that quality have not fallen steadily over time.
Does Covid-19 Mark a Turning Point?
So far, yes. As explored previously, business formation has ballooned since the middle of 2020. There are various reasons for this, not all of them positive. Many people may have closed their businesses and then opened new ones. Many may have turned to starting a business when jobs were scarce in the worst of the pandemic. Others no doubt identified opportunities presented by the pandemic (such as e-commerce) and jumped in with no hesitation.
Meanwhile, at the high end of the entrepreneurship market, venture capital (VC) investing smashed records in 2020 and 2021. Not all of this reflected bets on new entrants; larger, later-stage rounds have been on the rise for some time. Yet angel and seed investing has still been at elevated levels.
It is far from certain whether these welcome developments will continue. The EIG report points to “powerful headwinds” swirling against the recent trends in business formation and VC investing. An October paper from the Census Bureau documented not only similar trends in firm creation as EIG but also growing concentration of employment in larger and older firms. The paper also detailed stagnation in terms of entrepreneurial activity in high-tech industries, typically the most dynamic parts of the U.S. economy and responsible for disproportionate economic impact, both direct and indirect.
The balance of evidence, at this moment, favors the EIG report—high rates of business formation are unlikely to continue and reverse years of decline. Different dynamics are at play in the world of venture investing, but it’s worth watching VC trends as the Federal Reserve raises interest rates to fight inflation. Venture capital has benefited from a world of zero interest rates and ceaseless search for yield.
This is not reason for pessimism among entrepreneurs, startup supporters, advocates, and policymakers. In fact, the likely possibility that deep-seated trends point toward a return of diminished dynamism adds urgency to efforts to fight even harder against them. Figuring out how to do that effectively is a topic for another day.